Part 1: Let's Make An Anime!

Part 2: Shiny Discs

Anime has always appealed to the nerdy, the intellectually curious, and the technically savvy, and from the earliest days of American anime fandom we've used the internet to congregate, to exchange information, and as soon as the technology allowed, trade anime. It's only in the last few years that the industry has caught up, competing with fansubs and largely meeting the fans where they're at, and going to quite some expense to do so.

Part 3: Digital Pennies

TV shows, generally, are meant to be disposable entertainment. The entire medium was designed with impermanence in mind: before the VCR, a show aired once or twice and was gone forever. DVD changed all that in theory, but in practice, most people just want something to watch, something they've never seen before. And once it's over they forget about it.

That impermanence was always part of anime in Japan, where most of it airs on TV, but for American fans, who once had to buy everything permanently just to see it, it's a relatively new luxury. First with a handful of TV airings, and then with fansubs, and now with legal streaming, fans are finally getting to watch anime TV series as they were meant to be seen: once or twice, for free (or a small subscription fee), and maybe with ads.

Giving content away is always a tenuous business: there always has to be SOME way to make money from doing it. But the streaming business is a nascent one, and the ways a TV series can make a profit are still being borne out. Which is to say, right now most of it isn't making much money.

A Crowbar to the System

Just getting to this point was not easy. Despite the advance of computers in the production process, the anime business is a fairly old fashioned one. While the production tools have changed, the business of anime has gone largely unchanged. Any changes in day-to-day business were usually in the pursuit of finding new sources of financing.

When it came to the actual logistics of delivering the final product, things worked pretty much the same way in 2006 as it did in 1986: the lab assembled the final show onto a broadcast quality videotape. That went to the TV network, and then the lab cut out all the commercial breaks and sent it the duplication plant for home video. And then, when all that was done, the licensor made up some presentation materials and a crappy looking VHS screener copy for overseas publishers to peruse. If they wanted it, the licensor negotiated a deal with them, signed a contract, and then called up the lab again. The lab made a copy of the masters and FedEx-ed them to the publisher. The end.

This system was reliable, but extremely expensive and slow -- two things that online streaming, with its razor thin margins and gotta-have-it-now delivery schedule, make completely unacceptable. With episodes sometimes being finished only hours before they air, the only way to do a simulcast is to send the finished video to the streaming service digitally, as a file. But adjusting to a new, all-digital way of doing things has been a steep learning curve for licensors... and an expensive one.

Licensing offices never had to deal with the technical side of video before. Most of these guys are bureaucrats, not geeks. Their time was spent on contracts and approvals. With the advent of the streaming business, suddenly they had to worry about things like video encoding, interlacing, frame rates, and a whole host of other stuff that "just worked" before. They had to invest tens of thousands of dollars in equipment to deal with broadcast quality video, hire in-house video engineers, and completely re-invent their entire process.

It's been slow and painful. Licensors were reluctant to give up the safety of videotape, which was secure, long-lasting and reliable, and while it cost quite a bit of money, was uncomplicated and easy to work with. It wasn't until the 2011 Tohoku Earthquake and tsunami wiped out Sony's only broadcast tape manufacturing plant (and the worldwide tape shortage that followed) that many of the bigger licensors started taking a serious look at going "tapeless".

The last year has seen a lot of changes. While tape is still used for backup and archival, many licensors are now quite capable of sending a broadcast quality file over the internet. But they still occasionally need to use professional video gear or bring in outside people to help with technical things, and every time they do, it costs money.

How much money? Most anime these days is mastered on a tape format called HD-CAM. The price of a single recorder starts at US$45,000.

How To Get Ahead In Advertising... or not

Advertising is the bread and butter of most internet companies, and in the past decade the major ad agencies have come together and built a decent system for buying and selling ads. When video streaming came along, it seemed like a natural extension to the business of selling banner ads.

Every time you see an ad on the internet, that ad was custom loaded just for you, and carefully tallied behind the scenes, based on how many "impressions" the advertiser bought. Ads are sold by the thousands-of-impressions, and the rate paid for them is called CPM (Cost Per Mille - French for a thousand). Different ads sell for different amounts, based on how popular that location is, how prominent the ad, how big, and how annoying it is.

Video ads that are attached to streaming video work the same way. They're sold by the thousands, and these days, go for around US$7-12 CPM. (Hulu, with its huge presence in the ad market and mainstream video lineup, can get about $30.) For every thousand ads viewed, the website gets only 7 to 12 dollars. It's enough to buy everyone coffee at McDonalds!

Anyway, with dreams of turning fansub viewers into people that actually contributed revenue, licensors offered their shows to sites like Crunchyroll and Hulu. Rather than charge them an up-front license fee, licensors agreed to a share of the ad money, usually 50-60%.

That didn't work out so well. The unfortunate reality is, with the exception of Naruto and Bleach, most anime just doesn't generate that much traffic. A middle-of-the-road new show might get 15,000 views per episode, which works out to 60,000 impressions -- $720 if we're getting $12 CPMs. Take away a few hundred dollars to subtitle the show, and we're left with around US$400 per episode, or $5,200 per season. That is not a lot of money. And that gets split between the streaming service and the licensor.

$5200 in 3 months is not enough money to run a functioning business. But some shows didn't even do that well -- a less popular show might only get 2,000 views per episode -- or less! With numbers like that, literally every expense related to the show is a loss. A real failure of an anime might lose US$200-300 per episode just on production expenses.

Trial and Error

After a few months of getting royalty checks smaller than the price of a soda, licensors pretty quickly realized that this whole "streaming" thing was a whole lot of work and expense for nothing. With the North American DVD market drying up at the same time, a few of them were ready to write off the American market entirely. Their biggest customers -- Funimation, Section23 and Crunchyroll -- saw that fans were starting to engage, and insisted that simulcasting online was the only way forward.

And so, licensors have asked those companies to put their money where their mouth is. Now, each anime costs a licensing fee (or "Minimum Guarantee") of $1-2,000 per episode for simulcast internet streaming rights. Which is still not much, but at least it's enough to ensure that the whole endeavor will contribute SOMETHING to the show's profitability.

Some licensors are still not convinced simulcasting is worth it. Some don't want to split up ownership of rights -- they don't want to have to deal with Crunchyroll AND Section23 AND Hulu, they want a single company to act as custodian for every line of business for a show, and if that means they miss their chance to simulcast, well, it's clearly not that big of a loss. Other licensors just aren't prepared for the mountain of approvals and other work that suddenly has to be done WHILE the show airs.

Mo' Money

By paying a license fee the streaming companies managed to keep the new shows flowing, but at quite a significant cost. How in the world would they make back a license fee IN ADDITION to subtitling and overhead costs?

Internet ads were clearly not the panacea everyone was hoping they'd be. But they still brought in a little bit of money from the total freeloaders, so they couldn't be jettisoned completely. Instead, pretty much everybody switched to a "freemium" subscription approach -- watch for free, but pay a little bit more for no ads and a better presentation.

The $6 or $7 per month that sites like Crunchyroll charge each user every month is way, way more than any viewer can earn for the site by sitting through ads. TV Tokyo recently announced that Crunchyroll had nearly 70,000 paid subscribers. If that number is accurate, that means, at $6.95 per user, that comes to $486,500 in revenue a month -- more than enough to keep the lights on and pay for the less popular shows. Clearly they're not getting rich on that kind of revenue, but if that's truly the sort of numbers they're doing (they wouldn't confirm for us), they're doing OK.

Crunchyroll isn't alone in going this route. Hulu is trying to push more of their user base towards their $7-per-month Hulu Plus service, which adds access to shows on game consoles, networked Blu-ray players and smartphones. In Europe, France's Kaze Anime has slowly been developing their subscription service.

While Funimation is also experimenting with Freemium subscriptions, they're also taking a "long haul" approach. Between their own website and partner sites like Hulu, they're trying a bit of everything that can make money on simulcasts. Once a show proves itself a hit, they'll go back to the licensor and pick up DVD rights and pump out discs. They'll dub it and put it up on pay-per-view platforms like iTunes and Xbox Live -- that works really well for some shows. They'll put the finished dubbed version up on Netflix and get licensing revenue that way. Section 23, between "partner companies" Sentai Filmworks and Anime Network, is also taking this approach.

By spreading a show across as many platforms as possible and making it as visible as possible, these companies hope to collect enough money from the slow drip of each platform to eventually recoup their investment. Putting shows on Netflix and Hulu also helps less informed fans find the shows they like. Maybe some of them will want to buy a DVD. Those mainstream websites are important replacements for the video store, where people used to be able to pick up a box and go, "huh... what is this?"

How will Niconico try to crack this nut? It's hard to know for sure right now, since they've barely started. But if their partnership with Funimation works the way it's designed, it will take a lot of burden off of Funi, who can concentrate on their core business of... well, everything not involving simulcasting.

Brave New World

Everything I'm describing here is a recent development. Things are still changing fast, and as technology improves and smart internet-connected televisions become more common, we'll see all sorts of new and interesting developments. It's impossible to tell exactly where things are going, but the subscription model seems to be working.

There are a few big problems yet to be sorted out. The first is with discovery: how do you get the non-obsessive fans, the ones who aren't up on each new anime season, to watch these shows? With a dedicated anime-only site like Crunchyroll or Funimation.com, it's pretty hard. The only people going to those sites are the ones who already know what anime is, and are actively seeking it out. Hulu and Netflix are great storefronts to entice new fans, but they're still not ideal marketing tools.

Actually, it's almost impossible to do any sort of marketing for a simulcast at all. Since the agreements to simulcast a show aren't hammered out until the week the show starts -- or later -- how does a company start to generate hype for their new product? Unless an anime fan is REALLY engaged -- the sort of fan that reads ANN every day and stays on top of every new release -- a show can slip by completely undetected.

Last but not least, piracy is still a huge problem. These days the fansubs themselves aren't as big a deal as they used to be -- streaming has made them less relevant, and torrent traffic is down significantly. The far bigger problem is with illegal streaming sites, the ones that will take fansubs and DVD rips and stream them without permission. These sites are everywhere, and are often way more prominent than the legal options. Just google "streaming anime", and you'll get a huge list of websites offering instant access to the latest shows. Almost all of them are illegal. In recent months, Funimation has filed paperwork with Google to have them removed from search results, with some success.

With ad-supported streaming being a barely-profitable venture at best, it's hard to argue, based on money alone, that suing each of these websites out of existence is worth the time and money. The people using them are probably not going to pay for a subscription, and the lost revenue from ads is negligible. The real damage they do is more subtle: they allow unsuspecting and uneducated fans to consume anime outside the system, never engaging, never seeing an opportunity to give back. It's a loss of something even less tangible than a potential sale: it's the loss of mindshare.

The Relationship is Everything

If the internet and the impact of piracy has taught us anything over the last few years, it's that consumers have choices, and don't need DVDs or legal websites to watch the shows they want. Not everyone will want to contribute to the shows they love, but many people have that sense of goodwill. That goodwill is very fragile. It's based on a sense of trust that, if they do contribute, their money will be well used.

Which is to say, the future of the anime market, and the entertainment market in general, is in building a relationship with fans, an emotional connection that they get something out of. That relationship gives them every opportunity to be a part of the shows they love, through collecting DVDs or merchandise, or taking part in a community, or some other means.

Increasingly, anime companies are bending over backwards to engage fans on this level. For example, look at Funimation's attempts to get fans to connect with their stable of voice actors, as well as company faces Adam Sheehan and Justin Rojas. The company spends thousands every year sending people to conventions, to meet-and-greets, and hosting online events. Similarly, Crunchyroll takes great pains to have a specific voice to the site, through company mascot "Shinji," through its newsletter, and with other fans through their comments section and forums.

However well this works, and what formula will eventually shake out, remains to be seen. But one thing is certain: in the future, some fans will spend more than their share, others will mooch everything for free. And somehow, the artists will figure out how to pay their bills and make more stuff, though sometimes making ends meet will get a little scary.

And when you think about how entertainment has worked over the years, and even over the centuries, that's pretty much always been the case.