By Ilan Haimoff (Partner, GHJ) and David Simon (Media Executive, Simon Bros)

One of the advantages for a media conglomerate is its ability to leverage synergy between different businesses in their portfolio, resulting in efficiencies, which yield value to the shareholders and consumers. In the case of television, there is a natural case for vertical integration. All major networks are part of, or affiliated with, a larger company that also owns a television production company. For example, CBS is affiliated with Viacom, which also owns Showtime Networks, The CW (50%), MTV Networks and Nickelodeon Networks. Viacom also owns Paramount and is affiliated with CBS Television Productions. The same business model holds true for Comcast, Disney, Fox and Time Warner, as they all own television and cable networks as well as television production companies.

Beginning in 1970, the “big three” networks, ABC, CBS and NBC, were legally prohibited by the FCC Financial Interest and Syndication Rules (“Fin-Syn”) from owning any programming they broadcast in primetime. They were compelled to license programming from third party television production companies. The FCC implemented Fin-Syn for two main reasons: 1) To generate more innovation and variety in television programming and 2) To limit network control of the programming marketplace. As a cause for the ruling, there was general concern of vertical integration and its potentially negative impact on independent television production companies. Furthermore, there was fear that independent (unaffiliated to a network) television stations could be “locked out” of their main source of programming, which was? comprised of off-network half-hour sitcoms and one-hour dramas. Basic and premium cable channels were not restricted by Fin-Syn because they were not licensed by the FCC and, though still in their infancy, were allowed to produce unlimited content for their channels.

Fin-Syn was abolished in 1993 with the goal of creating an opportunity for producers to share the risk of deficit financing with a production company and a network. In success (at least four seasons on the network), the producers would recoup their deficit starting with the fifth season and most likely the adjusted license fee would cover all production costs for the duration of the series. Conversely, using overall efficiency goals, the networks were able to take advantage of corporate/studio vertical integration to employ their own production companies to produce programming for their networks and be more competitive with basic and premium channels. Under these vertically integrated deals, it is common practice for incremental rewards to be built-in to the license fee, such as a per-episode bonus for achieving top ranking in the audience ratings. Therefore the risk-reward basis can equate to a financial payoff for producers of a successful television series.

Regardless of the vertical integration trend, it was assumed that in entering into licensing agreements, the related parties are to pursue the best possible license fee with the highest rated buyer. Industry custom and standard is for the seller to act in good faith and at arms-length when negotiating a deal with a related party. If a better deal can be made with a third- party buyer, standard practice is for that production company to act in the best interest of their “bottom line” when a more favorable deal can be concluded with a third party. On the other hand, considering possible related party pressures, the wholly owned production company may deliver a potentially successful series to its related party network for a lower license fee. Under such a scenario, the related party network might not pay the “going” rate for the license fee, or provide the opportunity to pay off the deficit, or earn a bonus payment for a top rated series. Under this “self-dealing” model, the consolidated related party companies benefit from the economies of scale, but profit participants and investors in the series might lose out.

While vertical integration is intended to create synergy between related parties, it should not be exploited to create unfair business practice in the television production business in which producers, investors and other profit participants share the risk with the production company and the network, but not all benefit from the reward.

About David Simon (Media Executive, Simon Bros)

David L. Simon is a uniquely qualified entertainment industry veteran whose professional career has encompassed the U.S. and the world as a senior executive with major media companies including Fox, Disney and DreamWorks. Simon launched and operated television channels in the United States and international territories, with an extensive background producing content. He was vice president of programming for the Fox Television Stations. Simon went on to establish and operate Disney’s first international television production company in London as Senior Vice President & Managing Director, producing 45 series in 40 countries. He also launched the first international Disney Channels and Super RTL in Germany, as its chairman of the board. Simon served as head of DreamWorks Television Animation Studio. He founded Simon Bros Media, attracting domestic and international clientele including Fox, MGM, Microsoft, Sony, Turner, and set up animation studios in Los Angeles and Berlin. He served on the board of governors of the Television Academy, board of directors of the British Academy of Film and Television Arts in Los Angeles, as president of the National Association of Television Program Executives and currently serves on the board of directors of the San Francisco State University Foundation.