Fees paid to A-list actors in Bollywood have doubled in the last three years, with stars commanding up to $5.5 million per film.

According to boxofficeindia.com - a website that tracks movie ticket sales and is closely followed by the film fraternity - out of the 175-odd movies released in 2010 by the Mumbai-based Hindi film industry or Bollywood, only 10 films made money with the rest declared ‘disasters’ or ‘flops'.

Another industry estimate puts Bollywood’s strike rate or percentage of profitability at 5 percent.

The FICCI-KPMG Media and Entertainment Industry Report of 2011, says the Indian film industry’s revenue shrunk from $2.3 billion in 2008 to $1.85 billion in 2010. The worst hit was the home video segment that fell nearly 50 percent on the back of high costs of DVD rights, piracy and lowered retail prices.

Even revenue from the overseas market, with its huge Indian Diaspora, has fallen 9 per cent over the last three years to $150 million, according to the FICCI-KPMG report.

If it were not for alternate sources of revenue like one-time buying of cable & satellite rights by TV channels and music sales, the contraction in the industry would have been even more dramatic, say Bollywood sources.

One of the main reasons why the 100-year old Indian film industry is in this financial mess is because of soaring production costs driven in a huge part by exorbitant fees paid to its stars. Fees paid to A-list actors in Bollywood have doubled in the last three years, with stars like Shah Rukh Khan, Salman Khan, Saif Ali Khan and Aishwarya Rai commanding $3.5-5.5 million per film. Talent fee, which includes the money paid to actors, directors and screen writers, makes up roughly 40-50 percent of a film’s cost, according to production house executives.

A case in point is the much-hyped movie of 2010 starring Bollywood star Hrithik Roshan and Mexican actress Barbara Mori. It was made for $13 million, but its worldwide earnings were just $2.9 million, according to industry estimates.

Another factor pushing up costs is the entry of corporate houses. While these professionally managed production companies have brought some discipline to an industry, which is still largely run by a network of independent producers, financiers and distributors, they have also contributed to increasing costs.

“In their eagerness to establish themselves as serious players, executives announced big budgets and big fees for stars hiking up the production costs of films,” says Sabrina Dhawan, a screenwriter who works in India and the United States. As a result, the breakeven threshold for Indian films has moved up dramatically.

While companies like UTV Motion Pictures, Reliance Big Entertainment, Mukta Arts, YRF Studios, and Dreamz Unlimited are trying to bring in a commercial imperative to the creative process of filmmaking, their contribution has acted as a double-edged sword. These companies have brought in sophisticated production technologies, hi-tech special effects and increased marketing and promotional activities, but all at a huge cost, which is eating into a film’s bottom line.

Marketing and promotional activities now make 30-35 percent of a film’s cost, but getting the audience to notice you is becoming more and more difficult. “The space once occupied almost singularly by films is now being infringed by TV soaps, cricket and retail brands causing film producers to spend much more to get the mindshare of the audience,” says Rahul Puri, Executive Director, Mukta Arts, a publicly-listed film production house.

Besides increased production costs, the hit rate is also being affected by poor creativity as quantity replaces quality.

"A case in point is the much-hyped movie of 2010 starring Bollywood star Hrithik Roshan and Mexican actress Barbara Mori. It was made for $13 million, but its worldwide earnings were just $2.9 million, according to industry estimates.”

“In India hardly any time or resources are spent on pre-production research of consumer tastes or on scientific study of what will work vis-à-vis Hollywood where 20-25 percent of the film budget is allocated to pre-production activity,” say Siddharth Roy Kapoor, CEO of UTV Motion Pictures, another listed production studio.

Rajesh Jain, Executive Director, Media and Entertainment at KPMG says, “Bollywood needs fresh ideas, storylines and original content for the films to make money.”

According to Arnold Peter, a Los-Angles based film industry lawyer, "Indian films tend to be formulaic and that is why no pure Indian film has crossed over to a global audience."

Besides improving creative input, Bollywood also needs to expand its business model to include more alternative sources of revenue. It needs to, for example, allow 3G and You Tube downloads, says Kapoor.

“The Indian film business is robust but because it has captured virtually the entire theatrical market, it is a relatively flat business… It needs to look at additional revenue streams such as secondary markets and film merchandising,” says Peter.

Another perennial problem is piracy, which swallows as much as 30 percent of film revenues.

Industry players are of the opinion that one way of fighting the combined onslaught of piracy, star fees and marketing costs is to consolidate. KPMG's Jain points out that even though there are 1,200 films made every year you can count the number of large, corporate production houses on your fingers, leaving plenty of room for further mergers and acquistions. "It speaks volumes about [the industry's] structure,” says Jain.

© 2011 CNBC.com