By Steven Pearlstein
Friday, March 27, 2009

LOS ANGELES

You can't think about Southern California without thinking about the entertainment industry. It's not just the $30 billion it pumps into the region, or the nearly quarter-million jobs it creates. It's also that it's an apt metaphor for the economy here.

Like many industries here, it started with the weather, which for the movie studios meant all those reliably warm and sunny days to film movies and then television outdoors.

And like many of the region's other major industries, it retains a good deal of its entrepreneurial culture, years after the studios created by Jack Warner and Louis Mayer were bought up by giant corporations headquartered on the East Coast or abroad.

But what entertainment also shares with other sectors is a history of almost unbroken success. Things have been so good for so long, and the companies have been so successful in fending off competitive threats, that it has grown incredibly fat and happy. From superstar actors, their agents and business managers to gaffers and on-set caterers, the money people make is vastly out of proportion to what similarly skilled people make in most other industries. And, even allowing for the process of trial and error inherent in any creative process, its ways of doing business remain stubbornly inefficient.

Now, however, there is a sense that it may all be coming to an end, that the threat this time is real and that the old business models can't survive. With the rise of legal and illegal downloading, the Internet has already decimated the music business, and it is just beginning to overturn the economic foundations of the movies, television and electronic gaming as well. Financing is drying up, once-sacred expenses are being cut, whole layers of management eliminated and work shifted elsewhere.

Electronic Arts, the largest producer of electronic games, employs 400 software engineers, animators, producers and other technicians at its way cool campus south of the city in Playa del Rey, where hits like "Medal of Honor," "Lord of the Rings" and "Command and Conquer" were developed. In response to several years of stagnant sales and the shift from selling packaged software toward online distribution, EA has been cutting costs and changing the way it works. It recently announced it would eliminate 11 percent of its workforce, develop fewer new games and outsource parts of the development process overseas.

According to Nick Earl, a senior vice president, the retrenchment in the gaming industry comes after years in which growth in costs and employment outpaced growth in revenue. With growing collaboration between gaming and the movie and animation studios, Earl is confident Southern California will continue to be an important center for the industry.

Things are looking considerably more precarious for the television business, where there's been a dizzying drop in network and station advertising revenue, driven as much by the DVR as the souring economy. Syndication revenue has shriveled, and networks have been forced to move away from prime-time drama and comedy series in favor of reality series and talk shows that employ many fewer actors, directors, screenwriters and technicians. The industry's hopes are now focused on networks like HBO, AMC and Showtime, whose subscribers are still willing to pay for quality programming. But many of those networks' biggest hits have been produced elsewhere.

Conventional wisdom has it that the movie business does just fine when the economy tanks, as Americans take emotional refuge at the neighborhood theater. "My memory of the Depression is that the pool man came only once a week," recalls Frank Mankiewicz, the Washington politico and public relations executive and son of Herman Mankiewicz, who co-wrote the screenplay for "Citizen Kane." Indeed, movie attendance this year is up after two years of decline.

The mood in Hollywood, however, is decidedly anxious.

DVD sales, which for years have driven industry profits, have recently fallen by almost half as consumers turn to cable or the Internet to get movies they want, when they want them, for less than what it costs to buy the movie in a store. And piracy is cutting deeply into sales in fast-growing markets overseas.

At the same time, the Wall Street investment houses and hedge funds that have lavished cheap financing on the industry for the past decade are now in retreat. Some have closed their L.A. offices and are reportedly peddling their ownership interests in upcoming movies at discounts of 30 to 70 percent. Viacom gave up in its effort to raise $450 million from outside investors for its slate of movies, and credit ratings have been reduced on debt used to finance past pictures. Even famed director Steven Spielberg is reportedly having trouble raising the $700 million that his DreamWorks Studios needs for its next round of movies.

No surprise, then, that the number of movies produced is expected to decline again this year, or that many of those will be made outside of Southern California as producers respond to incentives from dozens of states and localities offering tax rebates equal to as much as 40 percent of production costs. To lure back what it considers "runaway" production, a strapped state legislature was forced this year to enact a modest tax break of its own.

Meanwhile, studios are under intense pressure to cut costs from corporate parents that over the years have been foiled in their efforts to rein in the industry's extravagant ways and earn a decent rate of return on their oversized investments. Movie openings have been canceled, weekend jets grounded and marketing budgets slashed, and even top stars are being told they won't be paid in full until the studios recoup production costs. Nearly every studio has announced layoffs, and a number are closing down subsidiaries and selling off facilities.

"There's no question the system needs to be shaken up," said Peter Bart, the editor of Variety, once himself a studio executive, who said the industry is going through "a reality check."

The day of my visit at Warner Brothers was a bittersweet one for the famed Burbank facility, the last day of shooting for the decade-running TV series "ER." Although more television programming is produced at Warner Brothers than any other studio, it is still way off what it once was, and it's been nearly two years since the last full-length motion picture was shot there. Given those volumes, says Gary Credle, who recently stepped down as the chief operating officer of the facility, it's getting increasingly difficult to justify the cost of maintaining a full-service studio on 110 prime acres in the heart of Southern California.

"Certainly if this didn't exist, we couldn't afford to build it today," said Credle as we walked through the studio's back lots and manicured gardens. "The models for this business are being challenged every day in every imaginable way, and nobody knows where it ends up. . . . What you see here is going away, and it's not obvious what is going to replace it."

The world will always need entertainment, and Southern California is the odds-on favorite to produce it. It has the history, the people, the infrastructure and the creative energy. But as Detroit automakers and New York's financiers have learned, these natural advantages can disappear when an arrogant and insular industry comes to view its dominance as inevitable and its outsized compensation as an entitlement.

Steven Pearlstein can be reached at pearlsteins@washpost.com.