2.3 The foundations of vertical integration strategies
Anyone seeking to identify objective reasons for the various different vertical integration situations experienced within the film and cinema sector, will find the task proves to be very difficult. In certain cases, these situations have not even in fact been the object of specific strategic decisions on behalf of the relevant group. Their origin, sometimes very old, can be linked to mergers or acquisition resulting in the enterprises owning, amongst their other activities, a circuit, even if this was not originally the motivation or determinant of its operations.
Improving the profitability of investments
Moreover, the motives on which financial integration strategies are based may surely also relate to purely financial logic, even before commercial and industrial considerations. For a firm, integration is no more than one of many strategic options, which include diversifying or entering a new sector of activity. In this case, the enterprise simply judges that the practical investment in the downstream activity (in the case of downstream integration) or in the upstream activity (in the case of upstream integration) is likely to offer a higher return than the capital venture cost.
One would be wrong to believe that the fall in the number of admissions had a negative effect on the results of the principal exhibitors. The very fact that a sector is "in decline" makes the appearance of new opportunities for the more dynamic and powerful players more likely.
Exhibition activity, in a certain number of cases, can in fact prove very attractive: the profit margins obtained by the most dynamic players are high: the Kinepolis group, for example, announced that the pay-back of its investments relative to the multiplex located in the outskirts of Brussels is less than 7 years. But it must be stressed that the property and construction costs relating to that enterprise were very favourable, and that a return on investment could only be expected in the long term, in Antwerp, say, or in Germany generally, where investment per seat is three times that required the figure possible in Brussels. This financial motivation can also be reinforced if the players present reckon that staying within the same sector gives them a distinctive advantage given the operational knowledge that they have already gained in that domain, or given their image or public profile.
It is thus incontestable having a record company with a high public profile amongst young people considerably facilitated the opening by Virgin of its Megastores in the UK and France. Everybody already knows at least the name of Metro Goldwyn Mayer and Warners. At a lower level, French and Italian spectators have grown accustomed to the names Gaumont or Fininvest. The significance of these "brands" is nevertheless still a minor factor in the film market. And, to the extent that it exists, it undoubtedly is less relevant - with the exception of Disney - than the name of the director or his principal artistic collaborators (the actors). It is far from certain that a cinema belonging to the same group as a distribution structure really counts when spectators are choosing which cinema to go to. Conversely, it is difficult to see how links with a cinema circuit helps to raise the public profile or image of a distribution structure.
This brings us to the conclusion that the "transfer of brand" effect, which is in practice the source of numerous integration movements in various different sectors of activity, only plays a very marginal role in the film business.
By contrast, financial motivation is accentuated in this sector by the complementary character of investment in distribution and exhibition. Investments in distribution - and, a fortiori, in production - are generally considered as high risk operations - a recent study by BIPE showed that in France, the costs of release (prints and promotion) are not covered by returns from theatrical except for a very small minority of films - but have to be viewed in a short or medium term perspective. On the other hand, investment in exhibition, if only because of the property component, is less risky and more long term.

Trends towards integration can therefore be considered, in the first analysis, as simple diversification operations, dictated purely by financial considerations. In the United Kingdom, for example, the mere fact that a distributor like Rank could think of selling its circuit of cinemas shows that the shift to vertical integration is very far from being the "natural" pattern for the cinema industry.
However, it is not just financial considerations which should be taken into account. The basis of vertical integration situations can also appear to be linked to the characteristics which are specific to the sector considered - here the film business - and its configuration. These reasons are, however, very rarely unique. On the contrary, they are usually multiple; besides, they interact, between themselves and with financial motives. For the purposes of this analysis, it is, however, possible to distinguish them as follows:
Lower costs
In a general way, integration strategies can be explained by the economies they engender: savings, linked to one of the following phenomena:

These explanations are only, however, relevant in an industrial sector or situation where one encounters "complete" integration, that is when an integrated structure exists that unites both upstream and downstream activities sufficiently for there to be no recourse to the market. If we have seen this situation in the film industry, it has been exceptional, and only applied to specialist enterprises concerned with auteur films.
In the case of "incomplete" or "modulated" integration, cost economies can be revealed when the upstream unit - the distribution structure - fixes different prices between its clients, according to whether they belong to the group or not. It is obviously difficult to discover the costs of internal transactions within an integrated group.
Three comments need to be made on this subject: For these reasons, practically all the integrated cinema groups - particularly UCI, MGM and Warner - insist that they are organised around independent profit centres. Officially in all cases, the exchanges between these profit centres will always be carried out at the market price.
But this wish to reduce costs is also relevant within the longer term perspective. An integrated group may well be based on the fact that a player perceives a disequilibrium in market forces currently affecting the sector, to the detriment of the part of the value chain in which he is currently active. This is supposedly why US distributors might be tempted to open a multiplex in Antwerpen in Belgium, in order to counter-balance the market power of the Kinepolis group. In the same vein, the opening by MGM and UCI, of complexes in Dublin, undoubtedly had its origin in the desire to weaken the local leader, Ward Anderson. Conversely, faced with a distribution sector which is becoming increasingly concentrated, exhibitors may wish get involved in upstream activities in order to get supply at the best price.
Stimulating the downstream market, or adapting it to one's product
Distributors may also wish to intervene downstream, in the exhibition sector, if they decide that the performance of cinemas or circuits is inadequate. Exhibitors who enjoy a monopolistic or semi-monopolistic position in the various local markets where their cinemas are settled, often tend to be satisfied with earning the same return as in the past. In a context characterised by a tendential reduction in the number of admissions, this type of behaviour obviously creates a conflict with the interests of the distributors. The latter will see a potential for growth in the country, where, as a result of under-investment, the state of cinema sites is dilapidated.

This desire to stimulate the local markets could explain the increasing intervention since 1985 of the US distributors in the UK market: it has to be said amongst other things that the modernisation of the sector which came in the wake of their intervention effectively turned the admissions curve around.
But distributors are not just seeking to stimulate the market, but also to adapt the commercial structures - the cinemas - to suit the characteristics of their products. The multiplex, the place where the public turns to "go to the cinema" as well as to see a particular film, corresponds perfectly in practice to the characteristics of the feature films produced by the Majors. It represents the only concept of a cinema flexible enough to be duplicated in each national market, adapted to the strategy developed by the Hollywood studios which seek to globalise the markets. In that sense, the opening of the multiplexes by the Majors must be considered in relation to a firm desire to harmonise the dates and programming strategies throughout Europe.
Controlling supply, or its outlets
A downstream intervention also makes controlling obstacles easier, both for the distribution houses and for the circuits wanting access to films. To the extent, in effect, that the downstream component can absorb a significant part of the "production" by the upstream component, that is to say, to the extent that the cinema circuit can build its programming around the films distributed by the other part of the group, the uncertainty in relation to supply and outlets can be considerably reduced.
When a significant part of the supply or the outlets is guaranteed, the upstream and downstream components are able to establish more efficient planning. They improve their market power in relation to other players in the market place and are thereby able to avoid a situation in which they would be forced to accept unfavourable terms of trade.
In a situation in which the market is dominated by an integrated structure, to opt for vertical integration might also be conceived as an essential element of a defensive strategy. In Denmark, for example, where the MGM/Nordisk screens mainly show films distributed by Store Nord (Nordisk), it is very useful for Warners, in order to assure outlets for its product, to put in place - or rather to link up with - another integrated structure like Dagmar/Scala.
Access to information about the market or suppliers
In a general way, downstream integration towards the stage in the value chain where final demand resides, is also capable of bringing new information about the market to a firm which is diversifying. This information will allow the firm to operate more efficiently. This explains why, for example, the major European publishers have each sought to acquire control of a chain of bookshops. And yet it is unlikely that this idea justifies integration strategies in the film industry:

It is improbable therefore that the need to have precise information about final demand would constitute a decisive reason for distributors to integrate downstream. In contrast, vertical integration is an open window on a sector and a business. In some circumstances, managing a group of cinemas, even on a modest scale like Warners in Germany, gives access to first-hand information about the real conditions for exhibitors. This can considerably reinforce the position of distribution companies when they come to negotiate with the circuits.
In most cases, integration strategies are not therefore based on simple financial calculations nor a preoccupation with costs. An analysis of integration activities must accordingly take into account the general organisational character of the sector and the competitive conditions in each country.
The multiplicity of explanatory factors explains moreover why integration activities do not follow any systematic pattern. Their pertinence is rather a function of the specific situation of a given market in a particular country. Whence is derived the wide variety of situations which are to be encountered throughout the European Union: half the member states have integrated structures, sometimes on a truly impressive scale as in the UK or Portugal, whereas in other national markets the functions of distribution and exhibition are quite separate.
Nor can it be said that integration activities take some kind of "natural" form. It is far from evident that any group would be interested in controlling outright a player upstream or downstream. It is sometimes possible to enjoy the advantages gained in an integrated situation without having to bear the inconveniences which are inevitably attached to such a strategy thanks to an approach termed "quasi-integrated". In this case, the distributor opts for a strategy of alliances without seeking to take complete control of a circuit. It is perhaps in this light that Warners' strategy in various national markets can best be interpreted: the alliance with Lusomundo in Portugal, with Metronome in Denmark. In the case of Denmark, even MGM has chosen the "quasi-integrated" approach by teaming up with Nordisk.
In conclusion, it should be kept in mind that some of the advantages associated with vertical integration can be achieved through long-term - and perhaps even short-term - agreements between separate companies. In Spain exclusivity arrangements obtain which contribute to limiting the risks of supply and outlets, while at the same time discouraging new entrants: this too could be considered to be an integration strategy.