Wall Street Meets Pornography

[Gary Ruskin]

Commercial Alert			October 24, 2000

Following is an article on the big business of pornography, from
yesterday's New York Times.

http://www.nytimes.com/2000/10/23/technology/23PORN.html

Wall Street Meets Pornography
By Timothy Egan

Provo, Utah — The video-store chain that Larry W. Peterman owned in this
valley of wide streets and ubiquitous churches carried the kind of
rentals found anywhere in the country — from Disney classics to films
about the sexual adventures of nurses. Mr. Peterman built a thriving
business until he was charged last year with selling obscene material
and faced the prospect of bankruptcy and jail.

Just before the trial, Mr. Peterman's lawyer, Randy Spencer, came up
with an idea while looking out the window of the courtroom at the Provo
Marriott. He sent an investigator to the hotel to record all the sex
films that a guest could obtain through the hotel's pay-per-view
channels. He then obtained records on how much erotic fare people here
were buying from their cable and satellite television providers.

As it turned out, people in Utah County, a place that often boasts of
being the most conservative area in the nation, were disproportionately
large consumers of the very videos that prosecutors had labeled obscene
and illegal. And far more Utah County residents were getting their adult
movies from the sky or cable than they were from the stores owned by
Larry Peterman.

Why file criminal charges against a lone video retailer, Mr. Spencer
argued, when some of the biggest corporations in America, including a
hotel chain whose board of directors includes W. Mitt Romney, president
of the Salt Lake City Olympics organizing committee, and a satellite
broadcaster heavily backed by Rupert Murdoch, chairman of the News
Corporation, were selling the same product?

"I despise this stuff — some of it is really raunchy," said Mr. Spencer,
a public defender who described himself as a devout Mormon. "But the
fact is that an awful lot of people here in Utah County are paying to
look at porn. What that says to me is that we're normal."

It took only a few minutes for the jury to find Mr. Peterman not guilty
on all charges. His case illustrates what has happened to an industry
that used to be confined to the margins of commerce, in the seedy parts
of most towns, run by people who never dreamed of taking their companies
to Wall Street.

Spurred by changes in technology that make pornography easier to order
into the home than pizza, and court decisions that offer broad legal
protection, the business of selling sexual desire through images has
become a $10 billion annual industry in the United States, according to
Forrester Research of Cambridge, Mass., and the industry's own
Securities and Exchange Commission filings. 

Whatever the phenomenon may say about the nature of American society,
the financial rewards are so great that some of the biggest distributors
of explicit sex on film and online include the country's most
recognizable corporate names.

The General Motors Corporation, the world's largest company, now sells
more graphic sex films every year than does Larry Flynt, owner of the
Hustler empire. The 8.7 million Americans who subscribe to DirecTV, a
General Motors subsidiary, buy nearly $200 million a year in
pay-per-view sex films from satellite, according to estimates provided
by distributors of the films, estimates the company did not dispute.

EchoStar Communications Corporation, the No. 2 satellite provider, whose
chief financial backers include Mr. Murdoch, makes more money selling
graphic adult films through its satellite subsidiary than Playboy, the
oldest and best-known company in the sex business, does with its
magazine, cable and Internet businesses combined, according to public
and private revenue accounts by the companies.

AT&T Corporation, the nation's biggest communications company, offers a
hard- core sex channel called the Hot Network to subscribers to its
broadband cable service. It also owns a company that sells sex videos to
nearly a million hotel rooms. Nearly one in five of AT&T's broadband
cable customers pays an average of $10 a film to see what the
distributor calls "real, live all-American sex — not simulated by
actors."

For all the money being made on sex — legally — by mainstream
corporations, the topic remains taboo outside the boardroom. The major
satellite and cable companies do very little marketing of their X-rated
products, and they are not mentioned in annual reports except in the
vaguest of euphemisms.

None of the corporate leaders of AT&T, Time Warner, General Motors,
EchoStar, Liberty Media, Marriott International, Hilton, On Command,
LodgeNet Entertainment or the News Corporation — all companies that have
a big financial stake in adult films and that are held by millions of
shareholders — were willing to speak publicly about the sex side of
their businesses.

"How can we?" said an official at AT&T. "It's the crazy aunt in the
attic. Everyone knows she's there, but you can't say anything about it."

For hotels, the sex that can be piped through television generates far
more money than the beer, wine and snacks sold from the rooms'
mini-bars. Just under 1.5 million hotel rooms, or about 40 percent of
all hotel rooms in the nation, are equipped with television boxes that
sell the kind of films that used to be seen mostly in adults-only
theaters, according to the two leading companies in the business. Based
on estimates provided by the hotel industry, at least half of all guests
buy these adult movies, which means that pay-per-view sex from
television hotel rooms may generate about $190 million a year in sales.

At home, Americans buy or rent more than $4 billion a year worth of
graphic sex videos from retail outlets and spend an additional $800
million on less explicit sexual films — all told, about 32 percent of
the business for general-interest video retailers that carry adult
topics, according to compilations done by two trade organizations that
track video rentals. Chains like Tower Records now stock nearly 500
titles in their so-called erotic category, far more than films about
history or dinosaurs.

On the Internet, sex is one of the few things that prompts large numbers
of people to disclose their credit card numbers. According to two Web
ratings services, about one in four regular Internet users, or 21
million Americans, visits one of the more than 60,000 sex sites on the
Web at least once a month — more people than go to sports or government
sites. 

Though estimates have been greatly inflated by some e-commerce sex
merchants, analysts from Forrester Research say that sex sites on the
Web generate at least $1 billion a year in revenue, providing a windfall
for credit card companies, Internet search engines and people who build
Web sites, among others in the commercial food chain.

Some of the most popular Web properties — which feature quick links to
sites labeled "Virgin Sluts" and "See Teens Have Sex" — are owned by a
publicly held company in Boulder, Colo. That company, New Frontier
Media, has stock traded like any other, and it expects its video network
to be in 25 million homes within a few years. It does business with
several major companies, including EchoStar and In Demand, the nation's
leading pay-per-view distributor, which is owned in part by AT&T, Time
Warner, Advance-Newhouse, Cox Communications and Comcast.

Another company, LodgeNet, whose chairman is Scott C. Petersen, does
$180 million in annual business selling sex videos and other forms of
room entertainment to hotels. LodgeNet is a major employer in Sioux
Falls, S.D., its home base. It is a client of the accounting giant
Arthur Andersen, and nearly a fifth of the company's public shares are
held by a Park Avenue investment firm, Red Coat Capital Management of
New York.

"We feel good about what we do," said Ann Parker, a spokeswoman for
LodgeNet, which trades on the Nasdaq market. "We're good corporate
citizens. We contribute to local charities."

The biggest provider of hard-core sex videos and adult Web content,
Vivid Entertainment Group of Van Nuys, Calif., whose founders and
principal owners are Steven Hirsch and David James, has been making the
rounds of investment bankers of late, preparing for an initial public
stock offering next year that could ultimately lead to the first porn
billionaire.

"The adult entertainment business is just exploding," said Bill Asher,
the president of Vivid, whose offices are in a new granite and glass
building that houses investment and venture capital firms. "Right now
there are a lot of people making a lot of money. Somebody's got to take
control of it, and we figure it might as well be us. We see ourselves as
the designated driver of this business."

To the astonishment of Mr. Flynt, who began in the pornography business
by selling poor-quality pictures of naked girls as a way to build
interest in his strip clubs, his competitors in the $10 billion annual
adult market are mainstream corporations whose board members are among
the American business elite.

"We're in the small leagues compared to some of those companies like
General Motors or AT&T," Mr. Flynt said. "But it doesn't surprise me
that they got into it. I've always said that other than the desire for
survival, the strongest desire we have is sex."

The Technology Factor
Look, Ma, No Staples!

Thirty years ago, a federal study put the total retail value of
hard-core pornography in the United States between $5 million and $10
million — or about the same amount that a single successful sex-related
Web site brings in today. It seemed likely that the industry would
remain where it had always been — largely out of sight, but profitable,
and faced with consistent legal problems. 

What kept the market relatively small, in the view of people in the
industry, were the barriers between consumer and product. Typically, a
person would have to go to a run-down part of town, among people
considered less than savory, to find hard-core adult films or
bookstores. These retail outlets frequently were raided by law
enforcement authorities, further adding to the risk for a consumer — a
risk of shame, or arrest. 

In 1975, the Sony Corporation released the videocassette recorder to the
broad market, and within 10 years, about 75 percent of all American
households owned a VCR. Once the venue had moved from theater to the
privacy of the home, the adult entertainment industry was never the
same. For example, a single film, "Deep Throat," generated more than
$100 million in sales, thanks in large part to the popularity of VCR's,
Frederick S. Lane III writes in his book "Obscene Profits: The
Entrepreneurs of Pornography in the Cyber Age" (Routledge, 2000). 

But even with most Americans owning VCR's, people still had to take a
trip to the video store, risking some embarrassment. Pay-per-view
television and the Internet removed the final barriers.

Cable and satellite programmers allow people to buy a variety of
sex-based programming, from Playboy, on the lighter side, to the Hot
Network, owned by Vivid, and the Erotic Television Network, distributed
by New Frontier, on the more explicit end of the spectrum. Consumers
could watch movies of people having sex without ever leaving home.

What investors and bigger corporations soon discovered was the vast
audience for pornography — once the privacy barrier was eliminated.
Twenty percent of all American households with a VCR or cable access
will pay to watch an explicit adult video — and 10 percent will pay
frequently, according to the distributors New Frontier and Vivid. That
interest explains, in part, why the production of pornographic films has
grown tenfold in the last decade. There are now nearly 10,000 adult
movies made every year, according to an annual survey of the films
produced in the Los Angeles area.

Last year, there were 711 million rentals of hard-core sex films,
according to Adult Video News, an industry magazine that is to
pornographic films what the trade publication Billboard is to records.
It even has its own film awards —modeled after the Oscars. 

But video rentals have reached a plateau over the last two years. The
future is pay- per-view at home — driven by the easy access and good
technical quality of digital television — and pay-per-view from the
Internet, driven by the technological innovations of new cable and phone
lines that carry far more images, more quickly, to a computer screen.

"Videos changed the way people could view porn because they were able to
watch in the privacy of their homes," said Barry Parr, an electronic
commerce analyst with International Data Corporation. "Internet
pornography takes that a step further — they can do it with absolute
privacy."

The number of people visiting sex sites on the Web doubled over the last
year, outpacing the number of new Internet users. Some of the more
popular sex Web sites attract in excess of 50 million hits, or visits, a
month, according to the ratings services Nielsen/ Net and Media Metrix.
About one in a thousand people who visit a site will subscribe, for fees
averaging $20 a month, according to some of the leading Web pornography
providers and Flying Crocodile Inc., a company based in Seattle that
tracks and services the sexual-content market. 

At the same time that technology was making it easier for people to view
pornography, legal obstacles were falling. The 1973 Supreme Court case
Miller v. California established a threshold for defining illegal
pornography; a major test was that it had to be considered obscene to
the "average person, applying contemporary community standards."

Initially, the case helped prosecutors clamp down on publications and
movies. But that proved to be short-lived. If "Deep Throat" could sell
$100 million worth of copies, then what was the community standard?

"The court may have handed off the determination of obscenity to the
local community, but the standards of local communities had
fundamentally changed," writes Mr. Lane in "Obscene Profits." 

When Mr. Peterman was prosecuted for distributing obscene material in
Utah last year, he became one of the few video retailers in the nation
charged with such a crime in recent years. In a state long regarded as a
bastion of family-values morality, more than 4,000 people signed
petitions supporting his prosecution.

But Mr. Peterman showed that he had 4,000 regular customers for sex
videos. His lawyer argued that Mr. Peterman was not violating community
standards, because people in Utah County bought 20,000 adult sex videos
from one satellite programmer alone in the period that Mr. Peterman was
said to have broken the law; it was double the volume in most cities the
size of Provo. And in the Provo Marriott, guests were paying for nearly
3,000 explicit adult videos every year, according to court testimony.
After the Peterman trial, that hotel dropped its adult movies.

"My client was just a little guy," Mr. Spencer said, "a mom-and-pop
dealer in a very big business."

The Corporate Factor
It's the Demand, Companies Say

At a time when political campaigns from the presidential level down to
that of the local school board have made an issue of sexual excess in
broadcasting, the corporate entanglements in the pornography business
have blurred the lines of the debate.

In Missouri this year, Senator John Ashcroft, a Republican, ran ads
denouncing "Hollywood's decaying influence" on society, singling out his
Democratic opponent, Gov. Mel Carnahan, for accepting donations from
Christie Hefner, the Playboy executive.

Mr. Carnahan, who died last week in a plane crash, had countered by
pointing to donations to Mr. Ashcroft from Charles W. Ergen, chief
executive of EchoStar, which sells adult pay-per-view through its
fast-growing DishNetwork satellite division. 

"If he's going to start that, he's in greater trouble than I am," Mr.
Carnahan had said. 

Mr. Ashcroft's supporters had replied that there was still a distinction
between the two companies: EchoStar did not produce pornography — it
merely sold it, while Playboy created its own videos and pictures, they
said.

"We added adult at the request of our customers," said Judiann Atencio,
a spokeswoman for EchoStar. "We have something for everybody, from Irish
hurling to cricket. Adult is there if you want it."

When AT&T announced that it would start offering the hard-core Hot
Network to its 2.2 million digital cable subscribers beginning in
August, they were castigated by critics and pressured by religious and
civic groups that hold stock in the company.

A group of mutual-fund investors, which included the Sisters of Charity
of New York, the Evangelical Lutheran Church of America and the
Mennonite Church, told AT&T its members did not want their three million
shares invested in a company that sold pornography.

"At the heart of our concern is the concept of mainstream companies
getting into hard-core pornography," said Mark Regier, who manages a
mutual fund for 800,000 members of the Mennonite faith. "For a company
with AT&T's tradition and its charitable work to be involved with
pornography at this level is unbelievable. And I don't think many people
understand what it means to take away the barriers to this kind of
material, such as AT&T is doing."

For AT&T, there are sound business reasons to start carrying the highly
profitable Hot Network. Unlike distributors of mainstream Hollywood
pictures, sex-film distributors typically offer the programmers a split
of 80 percent of the revenue, compared with 50 percent or less for
routine features.

Impulse buys, in which customers tap a code into a remote and a movie
follows, have also spurred in-home sales of pornographic films.

"Impulse technology — that's been just incredible," said Mr. Asher of
Vivid Entertainment, which makes hundreds of adult films and claims that
it sells a million copies a month to cable, satellite, home video and
hotel retailers. "You have about 35 million homes with this kind of
technology now," Mr. Asher said, "and it's growing enormously. It's easy
and it's private — that's the key."

Although the companies that program explicit sex films will not give out
their revenue figures for this category, a report by the Showtime Event
Television company found that adult pay-per-view took in $367 million
last year — a more than sixfold increase from the $54 million of 1993,
easily outpacing the growth of pay-per-view "events" like boxing and
wrestling.

Time Warner, EchoStar, General Motors and AT&T all say they are simply
responding to a growing American market that wants pornography in the
home. At the same time, the companies say new technology makes it
possible for parents to keep such programming away from children.

"We call it choice and control," said Tracy Hollingsworth, a spokeswoman
for AT&T Broadband, the company's cable division. "Basically, you use
your remote to block out any programming you don't want. But if you want
it, we offer a wide range of programming that is available in the market
we're in."

Hotel chains have made similar decisions when, this year, several groups
urged them to get rid of the adult pay-per-view programs that are in
nearly 60 percent of all middle- to high-end hotels. Only one chain, the
relatively small Omni Hotels, chose to remove the sex films.

"What we noticed was that early on, the content was R-rated, but then it
migrated rather quickly to really raunchy stuff — just hard-core porn,"
said Jim Caldwell, the president of Omni. "I thought: What are we doing?
We don't have topless waitresses in the restaurant."

Mr. Caldwell said more than 50 percent of all guests were buying the sex
films. "The anonymity is the big thing," he said. 

Omni's decision to remove pay-per-view sex videos from the company's
15,000 rooms will cost the company more than $1.8 million a year, Mr.
Caldwell said. But he said he had received phone calls and letters of
thanks from 50,000 people — more than for any other corporate decision.

Much larger hotel chains, like Marriott, which calls itself the world's
largest hotel management firm, with nearly 300,000 rooms in the United
States, and Hilton, with 290,000 rooms under its control, have not made
changes.

Some critics said Marriott, run by several prominent members of the
Mormon Church, though not affiliated in any way with the church itself,
should drop its adult movies, given the stand against explicit sexual
materials that Mormons have long taken. But company officials said they
were mostly franchisers, and could not make unilateral decisions for the
hotel owners who paid to be a part of the Marriott chain. 

The two companies that provide hotels with pornographic films are both
traded on Wall Street and have enjoyed big run-ups in their stock prices
over the last few years. The leader, On Command, based in Denver, is
worth more than $400 million, and its principal owner is Liberty Media,
controlled by John C. Malone, the cable and telecommunications magnate
who sits on the board of AT&T and recently agreed to buy up to 15
percent of the shares of Mr. Murdoch's News Corporation.

The chairman and chief executive of On Command is Jerome H. Kern, a
former New York corporate lawyer active in civic and volunteer causes,
serving on the board of New York University and as a director of
Volunteers of America in Colorado.

On Command would not discuss how much money it is making on adult films.
But in its annual report, the company said it was generating $23 a room
each month for the 835,000 hotel rooms it reaches. The company goal is
to get into an additional one million hotel rooms. Analysts say at least
half the revenue comes from adult films. The company recently began
offering all-day erotic television to hotel customers, for a single
price of $15.99.

"Talk about your captive audience," said Mr. Asher of Vivid. "I've heard
that in some hotels, 85 to 90 percent of all profits from in- room
spending  comes from adult channels."

The Money Factor
Big Profits Now, Bigger Ones on Way

While the big companies that deliver sex films to homes and hotels will
not talk about how popular explicit sexual materials are, the makers and
distributors say the volume is enormous. And court testimony and
documents that were made public in the Peterman case also offered some
insight into the profit potential.

"Despite the fact that this material isn't marketed, revenue-wise, it's
one of our biggest moneymakers," said Peggy Simons of TCI Cable, in
court testimony in Mr. Peterman's case. TCI, controlled by Mr. Malone,
has since been bought by AT&T.

"When we talk to the companies one-on- one, they tell us we're great,
that we're a huge moneymaker for them," said Mr. Asher, whose company
owns the Hot Network, which is available in 16 million homes. "And by
the way, I tell my biggest customers — don't say you ever met me."

In trying to take public his company, which now does about $80 million a
year in sales, Mr. Asher said, "The biggest problem I have is the image
of the adult business. People think it's run by the mob, or a bunch of
guys with gold chains. I grew up in Paris, Illinois. I have a master's
of business administration degree."

The Hot Network portrays people having sex in a variety of methods —
what the company calls "widely accepted sexual activity" — and prohibits
scenes of violence, nonconsensual sex, drug use, forced bondage and sex
with minors.

Analysts of electronic commerce and telecommunications say the
mainstream sex market might be leveling off, but new technology is
likely to bring in even more consumers.

"The novelty of it has not worn off yet, and I don't believe it will
wear off," said Sean Calder, a vice president for e-commerce at
Nielsen/Net Ratings, which gauges the popularity of Web sites. "The
numbers point to a huge personal need. We see lots of people logging on
at 3 in the morning."

The $30 billion project to rewire the cable industry with lines capable
of bringing more material, and allowing people to buy on impulse, will
play a big part in the emerging home pornography market. 

"These companies like AT&T, they're thinking ahead to a time, perhaps in
10 years, when 50 million Americans will have broadband capability and
all their television and Internet will be interactive through one big
box," said Bryn Pryor, technology editor for Adult Video News, the
trade magazine. 

"But it's not just technology that made the big boys get into it," Mr.
Pryor said. "This just happens to be a business where you can't lose
money."
<-------article ends here-------->

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