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Why are all the visual special effects studios going bust?

If movies are using more VFX, why aren't they coining it. To infinity?

By Tim Worstall, 27 May 2015

Worstall on Wednesday An interesting read popped up on Motherboard recently: if all and every movie now uses ever more visual effects, then why the heck are all the visual effects (VFX) studios going bust?

The answer given was apparently that Avatar didn't win the right Oscars. This is both amusing and wrong. The actual answer is that this is how the economy works.

Money flows to whoever it is that has the rare thing. Doesn't matter what that rarity is, but if there's a production chain for anything and some components of that chain – whether it be a part, an expertise or a knowledge – are rarer than others, then the value of the whole chain will flow to those who have that rarity.

There's another way to look at it here, seen through the lens of the standard business school approach.

Entirely right, but not quite sufficient.

VFX is high in up-front or capital costs, very low in the marginal cost of extra production. You've got to have your lab, with your animators (all of whom need gagillions of experience, this is a capital cost) but once you have them, the extra cost of pumping out another few minutes of FX is pretty low. In that, the business is very like the chip fab business: I've seen utterings that the next generation of fabs will cost $8bn each.

At that sort of price, the actual cost of making one single chip is nothing. All costs – at least, the only costs you're ever going to think about – are the costs of building the factory that is able to build the chips.

And as we also know, fabs can be hugely profitable things to own. So it's not just that and that alone that determines whether everyone in the business repeatedly goes bust or whether they're minting hot and cold running Ferraris.

The same economic model applies to Facebook and Google: the marginal cost of adding another user to such a network or search engine is to all intents and purposes zero, and that marginal punter brings in some revenue. But it costs quite a bit to have built the network or engine that someone wants to join.

Looked at in the way an economist thinks about business, these are really all just versions of the same case: high capital costs and low marginal costs.

What determines whether you're going to make money out of it depends therefore upon capacity utilisation. If you run your chip fab at 50 per cent of capacity then you will lose money hand over fist. If you can run it at 120 per cent (yes, it happens: capacity is something that is rated, not the actual maximum capacity of a plant), then welcome to that stream of Italian sports cars at the temperature of your choice.

And VFX? Well, there's lots of people who would like to do it, lots of people who can do it, and lots of people willing to spend money on setting up to be able to do it. So, while lots of people get contracts here and there, no-one ever really manages to run at capacity or above for any period of time. Thus they all lose money and most go bust.

Why Google can't help making money

However, we can go further than this. Money sticks to whoever it is that controls the rare resource in any production chain. Thus Google again: there's plenty of people willing to see ads, plenty willing to sell them, only a few who can intermediate between the two. Guess who gets all the money?

Or football (soccer to those across the pond). There's thousands of football clubs with the right to play in the Premier League if they can only fight their way there. The talent necessary to be able to play well in the Premier League is the rare thing, as we can see from some of the clodhoppers that currently do.

Thus the money flows to the players – who are hugely rewarded – and not to the clubs, almost all of which lose money. The effect of the latest Sky/BT rights auction is going to be to raise Wayne Rooney's wages and little else.

American sports are a cartel for the same reason. Talent is just as scarce, but there's no promotion up and down, so a place in that top league (MLB, NFL, NBA) is also a scarce and limited good and thus the teams can indeed make money.

Which brings us back to the movie business, of which William Goldman once said “nobody knows anything” (this may well be one of those quotes which has been edited over the years to sparkle, but the essence is there). No-one really does know where the really scarce item in the movie production chain is.

There are only so many who can carry a movie with star power. There are only so many who can organise the production chain (the studios). There are only so many who can actually launch on 3,000 screens at the same time, or launch globally and so on.

But the fact that we repeatedly have hits coming out of left field and repeatedly have hotly awaited debuts that tank, shows that no-one really does know nuttin'. Enough to move the odds a little, perhaps, but not enough for there to be sure-fire things either way, either hits or misses.

What we do know is that the ability to do those VFX bits, like animation, just isn't that scarce thing to which the profits will flow. An interesting example of which is Pixar, for when they were providing tools and animations, they really weren't going anywhere at all.

It was only by integrating everything into the production of the full movie that they prospered. Somewhere in that combination of everything is that scarce resource that gains the profits, not in the being able to animate an anglepoise lamp (however well).

At a deeper level, this also explains why competitive markets work so well. If all the stages in the production chain are in good supply, with no-one having a lock on any rare part of it, then the only rarity left is in our consumer desire to have that thing, good or service. Which means that the gains accrue to us, in what economists call the consumer surplus. ®

Want to hear more from Tim in person, or just tell him why he's wrong, face-to-face? Come and hear Tim at The Reg's Summer Lecture season as he explains the absurd economics underlying the technology industry by taking us on a journey around the world's rare metals hot-spots. Full details here.

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