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Losing Our Share of the Pi

Kevin Klowden
Managing Economist at the Milken Institute and Director of its California Center

The recent Chapter 11 bankruptcy announcement by Rhythm and Hues Studios occurred on the eve of an Oscars they not only won an Academy Award in Best Visual Effects for their visually stunning work in the film “Life of Pi,” but also helped to facilitate wins for Best Cinematography and Best Director.  At the same time the visual effects firm is seeing its work honored by the Academy, its principals are being forced to approach clients such as Legendary Pictures and Universal Studios for short term loans to meet a drastic cash crunch.

Despite “Pi’s” large $120 million budget, much of which went for visual effects, significant pressure for cost cutting, combined with the loss of anticipated projects from other studios, has resulted in the need for Rhythm and Hues bankruptcy declaration.   The situation of Rhythm and Hues – not the only shop in dire financial straits — reveals exactly why California is in real risk of losing the heart not only of its visual effects industry, but also other digital production including commercials, video games and other key products.   The major threats for the digital providers are the same as those facing other aspects of entertainment in California: cost-cutting pressure from the studios, increasing levels of overseas outsourcing, and, crucially, a lack of adequate, industry-saving state incentives.

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While movie studios would often pay top dollar for visual effects, and allot time into their production schedules for significant post-production effects work, the increasingly ubiquitous nature of digital effects has resulted in two key factors that are driving down margins for effects companies.   First, as low- to mid-level effects have become less expensive and more widely available, studios have been less willing to commit to projects with a large number of high-cost, high-margin effects.   As effects have become integrated into the overall production process, effects companies can no longer manage their time and budgets in a lengthy post-production process.  Instead they are increasingly at the whims of the studio production schedule.   Further, overcapacity in effects creators means that studios can play firms off each other, further reducing the ability of in-state companies to compete against digital shops in other states, Canada and overseas.

Knowing that costs are much lower due to significant incentives in British Columbia, studios push for a lower rate based on outsourcing to Canada.   In order to compete, Rhythm and Hues has announced it will increasingly shift effects production to new facilities in India and Taiwan, just as other companies move to Quebec, the UK, Florida, and even China.   The recent bankruptcy of Rhythm and Hues’ competitor Digital Domain was driven in large part by its attempt to diversify its products and locations with a new animation studio in Florida that never quite happened.   Computer and video game companies such as Microsoft and EA have also moved more production to incentive-rich Canada, or even farther away.

Meanwhile, California’s film incentives offer absolutely no mention of digital media, a fact we noted in “Fighting Production Flight.”  The end result is that if Los Angeles-based effects companies want to survive, they either must hope that more firms actually disappear, reducing competition, or they must send more and more jobs out of the state.   Neither outcome bodes well for California, and for our ability remain a center of digital content.  Our share of the Pi is diminishing, and looks likely to do so for the foreseeable future.

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