Risk and subsidies

Risk and subsidies

This post is in response to a comment on the previous post Oh, the mess we’re in! . Blogger is unable to allow long comments so I've made a new post for the response.

Here's the comment:

" Mark said...

Thanks for replying to my comment. You're saying that the risk used to be that the studios would be held to ransom in some way, but now that's changed -- to a risk that the studio will find itself in financial difficulties.

I think it's unlikely that's a new consideration. The risk that the VFX house will be unable to complete the contract for some reason will already feature. Work gets pulled from even high-profile VFX houses which I see as the studio managing this risk in a hands-on way, and I expect they will continue to do so.

I think the reason I'm commenting on your blog is that it (and many others) are reducing the discussion to a simple one of "subsidies have introduced risk to the VFX business." Not acknowledging any existing risk is (to me) an indication that risk management is not high enough on the agenda within a sizable part of the VFX industry."

'I think it's unlikely that's a new consideration.'

Actually  it is. Obviously studios wouldn't award projects in the past to companies that were just starting up or which there were indications they would fail from the get go.

Now there may have been a company or two that closed during a production in the pre-digital days but I can't think of any. But as you can see with R&H, DD, Meteor Studios, etc. that's a real risk now where it wasn't before. And this is as risky of the big companies as the small companies. The risk that a company may not be able to handle shots as desired or they may not be able to handle hundreds of new shots was always there but a company going out of business while working on a project? - That's a new one. Do the studios going to Weta or ILM think that tomorrow they may get a call saying they closed their doors while working on a project? No. And that was the case with almost all vfx companies pre-digital as well. Yet many projects are not done 100% at Weta or ILM. The work is split up among a few companies, not to reduce their risk of going out of business but in an attempt not to have all of their eggs in one basket. And by that I mean the studios don't want to hear about delays or problems or change orders. And they think it's cheaper.

A studio can check the quality of the work the company has done for other films, they can check their budgets, meet with the crew, they can talk to other studios, producers and directors - all of this to assess the risk and quality factor before they sign a contract. But the thing they can't do is check the books of the company and do a true assessment of their financial stability. In the past, they never had to.

Now a studio may pull work from a company and that's aways happened if the company wasn't delivering what was requested in the required time. There have been certainly 911 calls (emergency) when work needed to be shifted or shots were added. But that's a risk that is evaluated before the contract is signed and is monitored by the studio. This is not something they're blindsided with. A company calling them up and saying we're filing for bankruptcy tomorrow (or next week) is a much different thing and a much higher level of risk.

The studios have many risks when they make a film. They take on that risk with their crews and locations.  But vfx is a 3rd party since the studios don't want to take on running their own vfx company (too risky).  The real risk is laid at the doorstep of the vfx company. But the risk for the company is constantly changing by external forces which they have no control over. And in many cases their clients are the ones putting the companies at more risk either directly or indirectly.

'I think the reason I'm commenting on your blog is that it (and many others) are reducing the discussion to a simple one of "subsidies have introduced risk to the VFX business." Not acknowledging any existing risk is (to me) an indication that risk management is not high enough on the agenda within a sizable part of the VFX industry.'

No offense but this sounds like a certain management software company or a studio talking and not someone working in visual effects or visual effects management. Would there be some risk without subsidies?  Yes but they'd likely to be much less.

As pointed out the studios and regions (countries, states) have created a situation where quality and efficiency are lower priority. If it were a true free market then those companies who were doing good work efficiently would be rewarded by more work. They'd be able to make a profit and be on much firmer ground financially.  The companies that did poor work or that were inefficient would see their profits go down and possibly have to close. Studios would be clearly able to see the different levels and know ahead of time what their general risks were. This is natural evolution. Just like in nature the weak ones would be dying off and the strong would survive.

But now you've added in subsidies into the mix. It's no longer evolution based on quality and efficiency. It's evolution based in large part on politics. And those politics change frequently. Companies that would be strong and survive in a free trade market now find that there is no way they can cut costs 50% or more. They find they have to invest $1 million dollar into a satellite branch they don't want and didn't plan for. And companies that wouldn't even exist without subsidies now exist only due to the subsidies. Companies that were small found themselves very big in a short time not because the companies were the best at what they did but because of subsidies.

 Imagine you've got 5 runners in the Olympics and you give some of them motorcycles. Is that fair? Is that a way to truly assess which runner is the best? Are people surprised when the actual runners don't win? Which one would you bet on?

Imagine a restaurant in a town and it's doing well. In fact it's very good and people are coming from other towns. And in another town right next to the first town the city government decides to pay for 50% of all orders at a similar restaurant.  Don't you think that would have an impact on the first restaurant? Almost all of the people from both towns would flock to the one that they could get food for 1/2 price.

 Is there a way for the first restaurant to compete with that? No. There are certain food, labor and building costs that they can't trim. They're not making over 100% markup so it's impossible to cut their prices 50% and still make any money.  What are their choices?
1. Close their doors
2. Try to offer food at the same price. And this will bring back some of the customers but since they're now losing money every month it's simply a matter of when they will close their doors.
3. They can open another restaurant in the town with the discounts. Now they have the extra burden of a duplicate restaurant. They have doubled their building and overhead costs. They've had to hire a manger, hostess and the entire group of chefs and wait staff just for this new place. Do they have enough money to do that? Will that added unexpected cost now make them more at risk of going out of business? Yes is the answer.

Now imagine that another town right next to these two starts offering a 70% discount. Now where does that put the owners of the restaurant? Do they now build a 3rd restaurant in this new town? Do they try to lower their price to match?  And with the more lucrative restaurant business in this new town, there will be more restaurants built by those who haven't done this before. The townspeople have paid their taxes and the town council has decided that offering food coupons is much more important than putting the money into their schools or their decaying bridges. There's no winners here except for the customer.

Are subsidies the only reason for troubles of the visual effects industry? No but it is a major reason. Natural evolution would tend to solve problems of poor management and other flaws by having them go out of business. Is there a risk? As in all of filmmaking, yes. Is the risk of a company running out of money on a project much greater now? Yes. See the restaurant example of options for a company.  None are good. And it's not a question on how good management is at that point, you can't do the work for 1/2 price. And that's whats created the largest risk - closing doors even while working on projects.

And lets not forget when studios do stop or pull projects that creates a huge loss for the companies that was unexpected. As I say, the companies take on a fair bit of risk outside their control. Now they're on even shakier ground. The studio that pulls 1/2 their work can't plead ignorance that they increased the financial burden of the company and increased the risk the company could go out of business. Between these types of actions and the subsidies it's no wonder some companies go out of business.

Related post:
Visual Effects Tax Incentives (aka subsidies)


Here's some more information on subsidies of other industries and the impact they have:

Choosing winners and losers: How government subsidies destroy the free market
Subsidy Insanity
WWF: subsidies destroying industry [PlanetArk]
Coalition of Gulf Shrimp Industries Files Petitions for Relief From Subsidized Shrimp Imports
New Study Reinforces USW Position that Improper Chinese Subsidies Destroy Jobs in American Paper Industry
USA Shrimp Industry Seeks Relief from Subsidized Imports
China subsidizing auto parts exporters: US industry
Solar energy firms 'bankrupted' after subsidies cut
Over Half of All U.S. Tax Subsidies Go to Four Industries. Guess Which Ones?
Germany Subsidizes China To Destroy The German Solar Industry
China Solar Subsidies Pose Dilemma For U.S. Trade
California Backfire: Energy Subsidies Destroy Economy
Put An End To Massive Logging Industry Subsidies in California