If you’ve heard just one take on business strategy, it’s probably Michael Porter’s five forces. The five forces provide a framework for looking at how competition shapes long-term profitability in an industry.
Let’s take them in order of their importance to the VFX industry:
#1. Bargaining Power of Buyers
This is the big one for the VFX industry, and here’s why: buyers wield more power in a market with fewer customers and more sellers.
Despite a big peak in demand for new content in the aftermath of the COVID-19 pandemic, the number of film & TV clients with production budgets sufficient to employ a high-end VFX company remains as small as it has ever been. There are the surviving major Hollywood studios, the tech giant streamers, and several production companies like Legendary and Skydance that drive big budget productions.
Within these companies, divisions and individual projects have quite a bit of autonomy to select VFX vendors. But for a VFX studio with annual revenues over, say, USD $5 million, the number of truly independent businesses spending enough on film and TV VFX to keep that VFX studio afloat is probably somewhere between 30 and 50 in the whole world. Add gaming companies and major brands with marketing budgets sufficient to hire a VFX studio directly, and the number increases to maybe a few hundred. That’s still not a lot, and the bulk of global spending on VFX is concentrated among a much smaller number of clients.
In an industry with strong buyer power, customers can demand lower prices, higher quality or improved service… all of which can eat into a company’s profitability. Sound familiar?
The situation improves when demand outpaces supply. In 2022, clients had difficulty finding VFX vendors to work on even very prestigious shows. There was less pressure on pricing, and more opportunity for newcomers to win work. This all changed abruptly the following year. With the industry at a standstill during the Hollywood strikes, and many VFX studios furloughing or laying off a big proportion of their crew due to lack of work, bargaining power is firmly back in the hands of buyers.
#2. Competitive Rivalry
Companies can combat strong bargaining power among buyers with unique value propositions, and differentiators that justify higher prices. Does this work in VFX?
Given the relatively small size of the market, there’s quite a bit of competition. You’ll find several established and highly capable VFX studios competing at every tier of scale and quality, both with each other and with larger or smaller studios. True, customers in this space value quality, not just price. But being able to deliver a certain level of quality is the price of admission for being in VFX in the first place. Once you’re over that threshold of quality, competition on price becomes a major factor.
Personally, my experience has been that there are very few factors a VFX studio can use to drive up prices or maintain margins. There’s room at the very top of the market for a handful of companies to produce premium work, or deliver premium client experience, and charge more for it than competitors. A client may be willing to turn down lower bids to keep working with a VFX Supervisor or team that they particularly like. Beyond that, there’s not enough differentiation in technology, quality or scale to allow VFX studios to avoid competing over rates. Rather, it’s about falling in line with clients’ budgetary expectations, and trying to maintain margin by balancing efficiency and quality.
#3. Threat of New Entrants
Competition between industry players is compounded by the fact barriers to entry are relatively low these days. Sure, forming a global-scale VFX business requires plenty of funding, but today’s technology allows a small VFX team to produce varied, high-quality work with very little upfront investment in tools and technology. While large studios might keep costs down through economies of scale, small studios can achieve this with low overhead. And, aside from the rigorous content security standards demanded by clients, the regulatory hurdles aren’t too high either. You can bootstrap a working VFX studio with tens of thousands of dollars, if that.
The cost to a client of switching from one VFX vendor to another is usually low too. Some level of trust, familiarity and communication shorthand may need to be reestablished if a project switches VFX providers, but there’s no costly technology integration between clients and vendors, or punitive multi-year contracts that drive up the costs of switching. Switching in the middle of a project can be enormously disruptive, but even that isn’t off the table if a client is very dissatisfied.
It's a different story when it comes to barriers to exiting the industry. Few VFX studios develop capabilities that make them competitive outside their core VFX and animation business. They occasionally co-produce content, productize and sell technology, or diversify their revenue streams to industries other than entertainment. For the most part, though, they suffer from a high level of specialization – not to mention emotional attachment – to their niche. This keeps companies locked in even if industry conditions aren’t favorable, which in turn increases competition and pressure on margins.
#4. Bargaining Power of Suppliers
I’m putting this one lower down the list than pressure from clients and competitors, mainly because the largest expense a VFX studio faces today is still the cost of labor, not equipment, at least in VFX markets like the US, the UK and Canada. (The bargaining power of suppliers may be a bigger factor for VFX studios operating in countries with a relatively lower cost of labor, like India.)
Being a specialized niche, a limited number of software products cater to the VFX industry. Most have applications in other industries (Autodesk Maya, 3ds MAX, Adobe Photoshop); a few are used mainly in VFX (the Foundry’s compositing software Nuke being a prime example). These days, the computer hardware and cloud platforms used by the VFX industry are fundamentally the same as those used in many other industries.
The cost of software licenses and cloud services is certainly significant for VFX studios, and their ability to push back on supplier pricing is limited by the small number of alternatives they have. That said, I suspect suppliers know VFX studios often operate on tight margins (due, first and foremost, to buyer power) and there’s only so hard they can squeeze before a VFX studio will tie itself in knots to avoid paying. The bargaining power of suppliers is limited in that sense.
#5. The Threat of Substitutes
The last of the Five Forces is the threat of VFX being replaced by solutions from another industry. I’ve put this at the bottom of the list because, as things stand today, there are no alternatives to the VFX-as-a-creative-service industry for clients who want high quality VFX for longform narrative content like movies and TV shows.
Industry practitioners will tell you that, contrary to the hype and misunderstanding surrounding it, for the foreseeable future AI is simply a tool in the hands of artists working within the existing VFX industry structure. Yes, AI has tremendous potential to make workflows more efficient and increase the quality of the imagery, but we’re a long way from technology becoming a substitute for talent driven VFX service businesses.
Virtual Production is the other technology that’s generated a lot of buzz in recent years (including interest from clients, investors and analysts). As with AI, this is another tool -- an option -- for the VFX market, one that works well in certain situations and less well in others. It’s best viewed as complementary to traditional post-production VFX services and shares quite a few of the skillsets needed to succeed in that.
Porter’s five forces aren’t the be-all and end-all of strategy, of course. They don’t really address companies’ ability to reshape the market within which they operate, or the critical role that talent and labor costs play in the VFX industry. But they do provide a solid high-level overview of why the industry is shaped the way it is.
