(FORTUNE Magazine) – FEW OF AMERICA'S movie theaters look like the dazzler at the left. The price of admission at all too many of them buys an experience that sensible people would pay to avoid. The lobby carpet, blackened and musty, could be a relic of the silent-film era. The $1.25 bucket of popcorn -- that's the small size -- holds 10 cents worth of corn covered by a strange liquid, perhaps derived from petroleum. Beneath the broken seats sticky coats of spilled soda pop varnish the floor. The screen is tiny, the sound tinny, the audience rude. Oh, and one more thing -- the picture stinks. Run by a ragtag collection of aging entrepreneurs and a few powerful public companies, the $5-billion-a-year American movie theater industry is fighting for survival. Many theater owners bought into the business at fire-sale prices soon after 1948, when the major Hollywood studios, which had previously owned the leading theater chains, settled antitrust suits by agreeing to give up their movie houses. The new owners got a great deal. They controlled the only show in town, and the studios worked hard to hype movies. As the easy profits eventually rolled in, many exhibitors lost touch with the customers, milking the business and letting the quality of their theaters deteriorate. The success of videocassettes and pay TV in converting moviegoers to stay-at- homes is forcing exhibitors to recognize their folly at last. No longer the only show in town, the theaters suffered a 12% drop in attendance during the year just ended. As Sumner Redstone, 60, owner of the extraordinarily profitable 360-screen National Amusements chain puts it: ''Anyone who doesn't believe videocassettes are devastating competition to theaters is a fool.'' Now the theater owners are in a bind. To regain the loyalty of their customers, they will have to pour money into refurbishing, rebuilding, restoring the glamour of moviegoing -- just when they are being impoverished by the new technologies that compete with them. As videocassette-recorder ownership keeps growing, this vicious cycle is likely to get more distressing. The theater owners' natural ally in this predicament would logically be the Hollywood studios, whose feature films also depend primarily on box office revenues. But since the theaters and studios were split apart, they have fought bitterly over the division of those revenues. Videocassettes and pay TV became a weapon. The studios used these new film markets to reduce dependence on the theaters. Seeing a chance for extra revenues, they increased production and ultimately created a glut. The exhibitors then seized on the oversupply to negotiate a larger share of the box office take. So, far from cooperating to make the most of the business they share, the exhibitors and studios have been at each other's throats.

To survive in this peculiar environment, the exhibition industry has exploited a couple of ingenious ideas. The first was to nurture a source of revenues that the studios couldn't touch: the lobby concession stand. To lure customers, theaters keep ticket prices low -- the average is around $3.50 and has lagged behind inflation. Once inside, though, moviegoers become a captive market for popcorn, soda, and candy sold at stupendous markups ranging to 500% or more. A well-run concession stand generates at least $1 of sales and as much as 75 cents of profit per ticket buyer. To their immense relief, exhibitors have found they can cut their financial dependence on studios by simply charging ever more outrageous prices for popcorn. The industry's more recent, and most brilliant, innovation was the multiscreen theater. In the Seventies exhibitors chopped up their often splendid old theaters into lots of smaller ones, all too many of them the nasty little rooms moviegoers loathe. For the theater owners, however, even shoddy examples of this so-called multiplexing proved boffo on the bottom line. A theater with four screens, roughly the national average, is four times more likely than a one-screen house to book a hit picture. Exhibitors can vary the number of seats they allocate to different screens. While hits do well in big rooms, duds can often pay their way in small ones. The extra screens can thus boost total attendance without adding much to costs, increasing profits 20% or more. The success of the divvied-up theater as a popcorn-vending device encouraged exhibitors to build multiplexes from scratch that are bigger and more efficient. With ten screens arranged around a central projectionist, for instance, one man can show ten movies. The best new theaters easily stole customers from tattier competitors, and strong chains saw building them as the way to grow. Today the three largest chains, all publicly traded and with over 1,000 screens each, are General Cinema of Chestnut Hill, Massachusetts, San Francisco's United Artists Communications, and Cineplex Odeon, which is headquartered in Toronto but has half its theaters in the U.S. Small chains competing with these powerhouses figured they had to build to survive. Construction became a craze. Since 1980 screens have surged 22% to an estimated 21,500 in the U.S. and Canada, which the industry treats as a single market. Sensible as it initially seemed, the building boom has magnified exhibitors' woes. All too frequently it led to excess: as many as 27 screens crowd together in some Houston neighborhoods. And unlike the conversion of existing theaters to multiplexes, almost completed by 1980, new construction adds to the industry's seating capacity. Instead of conveniently going out of business, many old theaters linger to compete as cut-price houses. It's as if the airlines bought 747s without retiring their old DC-3s. More seats are the last thing this industry needs. North American exhibitors sell roughly one billion tickets annually -- and that hasn't varied much for 25 years. With a growing population, this translates into a 24% per capita decline in moviegoing. And as the population ages, the number of under-30- year-olds, who buy two-thirds of the movie tickets, is starting to shrink. Says Art Murphy, a writer for trade publication Variety and a leading analyst of the movie business, ''Filmgoing used to be part of the social fabric. Now it's an impulse purchase.'' THE IMPULSE is waning partly because many films inspired by videocassette demand turned out to be junk. A horde of movie companies independent of the big studios is aiming at the stay-at-home viewer as its primary audience. Companies such as Cannon Group (Death Wish III) earn modest but consistent profits from lurid ''exploitation'' films with very low budgets. Like most movie companies they push their films through the theaters first -- but if the movies do poorly there, the producers don't much care. With income from videocassettes and other markets, films with rock-bottom budgets of $3 million or so -- compared with the major studios' average of $15.8 million -- are virtually assured a profit. If one of them becomes a surprise theatrical hit, such as Missing in Action, that's gravy. According to Variety, the big studios and the independents released 445 movies in 1985, the most in a decade. Few big studios are now making money on feature films. All but a handful of pictures released in 1985 have been bad news at the box office. Following the pattern, only one certified smash has emerged from the early Christmas releases. Rocky IV, the latest rehash of Sylvester Stallone's 1976 blockbuster, displays the Italian Stallion beating up a Russian; it knocked down $65 million in three weeks. Says Frank Price, chief of Universal Studios, ''More production almost always means more bad pictures, not more good ones.'' And bad movies in large quantities seem to numb moviegoers. Consumers apparently prefer to watch lousy movies at home, where the popcorn is cheaper. SO FAR, having their pick of so many pictures has helped exhibitors hold out for a larger share of box office receipts: over 60% in 1985, about ten percentage points more than in 1980. But the glut won't last. In recent months the studios have slashed production drastically. With fewer potentially successful films available, studios should regain the advantage in negotiations with theaters and wrest a bigger chunk of box office revenue from them. For weaker theater owners, the reduced income could set off the looming financial crisis, leaving them too poor to invest in needed improvements. If too many theaters get into this pickle, disaster could strike the major studios. They still depend on theaters for fully two-thirds of their feature film revenues. Theaters can tap vast mass audiences beyond the reach of videocassettes or pay TV, and they return far more revenue per viewer to the studios: about $1.20, vs. perhaps 25 cents from videocassettes. Studios also depend on box office results to establish the relative values of their films in markets ranging from pay TV to toy licensing. A theatrical blockbuster will sell a lot more videocassettes, for instance, than a bomb. In seven weeks Columbia Pictures' Ghostbusters, the top box office smash of 1984, has sold over 400,000 cassettes for about $20 million. At their best, theaters help Hollywood maintain the conceit that movies are inherently glamorous. Publicists once spoke of ''the magic of motion ^ pictures,'' and indeed there can be something special about the experience of seeing a terrific film in a great theater with an appreciative audience. Donald Fox, 30, the hip, bearded son of the president of the National Association of Theatre Owners and president of the family's 77-screen chain, puts it this way: ''People want to go into the dark and share that experience with strangers. It's erotic.'' And with such technologies as wide-screen 70- millimeter projection and wraparound Dolby sound, theaters can create a sense of spectacle that no TV set can match. To survive, the exhibition industry must relearn how to wow moviegoers. That is harder now than in the old days. Divorced from the studios that control the quality of their main attraction, exhibitors hardly control their own destinies. But they can make their theaters clean, comfortable, even palatial. Some companies have profited by following that principle for years. General Cinema, for example, insists on quality standards that make its houses reliably pleasant. Sumner Redstone of National Amusements goes further. His carefully designed theaters coddle customers with extra-comfy customized seats that cost $130 each, twice the industry average. The most innovative chain of all is probably Cineplex Odeon. In November it took control of the Los Angeles-based Plitt chain to become the third-largest circuit in North America. Says Chief Executive Garth Drabinsky, 37, ''We have to upgrade the quality of the moviegoing experience.'' He is as good as his word. Cineplex Odeon is among the five fastest-growing companies in Canada, and Drabinsky, whose 8% stake was recently worth $20 million, is one of the industry's few respected visionaries. Undeterred by a severe limp -- he had polio as a child -- he persists in regularly visiting all of his theaters, where he often finds opportunities for improvement. Most exhibitors, for example, serve popcorn in stiff tubs; the clever Drabinsky says he saves $1 million a year by using coated paper sacks instead. The sacks are cheaper, but the big saving comes because they fill fewer plastic garbage bags at cleanup time. Drabinsky's newest theaters boast gleaming granite-floored lobbies with original murals on pastel walls and clean, spacious auditoriums with comfortable seats and first-rate sound and projection. The high cost of building such lavish theaters -- $450,000 or so per screen -- doesn't bother Drabinsky because they attract plenty of patrons despite high admission prices, and their concession stands generate a splendid $1.35 per ticket buyer. But such theaters are still rare. The chief of film distribution at a top studio makes the startling admission that he would prefer not to book his pictures at 80% of the screens in North America. There just aren't enough Drabinskys around. Wealthy men of retirement age still dominate the exhibition business; few can match Drabinsky's drive. Moreover, says Lawrence Lapidus, president of the privately held 134-screen RKO Century Warner chain, ''It's hard to attract young people.'' Even successful owners like Sumner Redstone are finding their privileged offspring unwilling to enter a business characterized by seven-day workweeks and brutal negotiations with people who chew on cigars. ''It's not an elegant business,'' says a young second-generation exhibitor. Some big players are leaving the business. Laurence A. Tisch, chairman of Loews Inc. and known as one of the savviest investors around, sold the company's venerable 215-screen chain for $160 million in July. Industry gossips say the No. 2-ranked United Artists chain is up for grabs, although the company denies it. The reluctance or inability of many remaining owners to upgrade their movie houses could force the studios into action. Studios determined to keep theaters healthy have but two options: they can bully theater owners or buy them out. The bullying, which is cheaper, has already begun. Says Tom Sherak, chief of film distribution for the Twentieth Century-Fox studio, ''If the lousy theaters are squeezed out, we'd all be better off.'' In October he announced that henceforth the company will offer none of its films to competitive bidding by theaters. Instead the studio will pick the most desirable theater in each area and try to negotiate a deal. While competitive bidding usually raises the studios' revenues, Sherak seems willing to give up this extra money in the near term for more control over the theaters. Richard A. Fox, Donald's father and head of the theater owners' association, fears that most studios will follow suit, leaving exhibitors feeling vulnerable. Lest they miss out on getting the best movies, even leading exhibitors in a competitive market might grow reluctant to displease major suppliers by refusing to show their unpromising films. In that event the theater owners could become the studios' vassals. Says Sumner Redstone, ''Studios can control theaters without building them.'' When it comes to buying them, the legal barrier is considerably less formidable than it was. In 1984 the Justice Department offered to support the studios if they sued to get back into the business. Divided among themselves and fearful of costly litigation, the studios didn't pursue the offer -- for the moment. But the old idea of vertical integration appeals to Martin S. Davis, chief executive of cash-rich Gulf & Western, owner of the Paramount Pictures studio. And Coca-Cola, parent of Columbia Pictures, is becoming the first company in decades to own both a major studio and a theater chain. It is acquiring control of the 12-screen Walter Reade chain of theaters in New York, and so far the Justice Department hasn't said boo. As the drama unfolds, the great beneficiary will be the long-suffering moviegoer. When he enters the theater of the future he may not encounter a marvel of technology, but at least he won't stick to the floor. BOX: INVESTOR'S SNAPSHOT GENERAL CINEMA SALES (LATEST FOUR QUARTERS) $951.8 MILLION CHANGE FROM YEAR EARLIER UP 5% NET PROFIT $85.3 MILLION CHANGE UP 24% RETURN ON COMMON STOCKHOLDERS' EQUITY 21% . FIVE-YEAR AVERAGE 26% RECENT SHARE PRICE $41.25 PRICE/EARNINGS MULTIPLE 18 TOTAL RETURN TO INVESTORS (12 MONTHS TO 12/20) 59% PRINCIPAL MARKET NYSE

BOX: INVESTOR'S SNAPSHOTS UNITED ARTISTS COMMUNICATIONS SALES (LATEST FOUR QUARTERS) $476.1 MILLION CHANGE FROM YEAR EARLIER UP 17% NET PROFIT $14.9 MILLION CHANGE DOWN 5% RETURN ON COMMON STOCKHOLDERS' EQUITY 14% FIVE-YEAR AVERAGE 15% RECENT SHARE PRICE $27 PRICE/EARNINGS MULTIPLE 37 TOTAL RETURN TO INVESTORS (12 MONTHS TO 12/20) 101% PRINCIPAL MARKET OTC Explanatory notes: page 120

BOX: INVESTOR'S SNAPSHOT CINEPLEX ODEON SALES (LATEST FOUR QUARTERS) $118.5 MILLION* CHANGE FROM YEAR EARLIER UP 134% NET PROFIT $12.7 MILLION* CHANGE UP 255% RETURN ON COMMON STOCKHOLDERS' EQUITY 37% FIVE-YEAR AVERAGE N.A.** RECENT SHARE PRICE $7.75* PRICE/EARNINGS MULTIPLE 11 TOTAL RETURN TO INVESTORS (12 MONTHS TO 12/20) 152% PRINCIPAL MARKET TORONTO *Converted from Canadian to U.S. dollars **Initial public offering 4/19/82