What Hollywood can teach us about the end of the entrepreneurial era

Pick up any newspaper these days and you can read about galloping giantism in the entertainment industry. Time and Warner Communications agree to merge. Sony -- which already owns CBS Records -- announces a deal to buy Columbia Pictures Entertainment. Columbia itself has gone on an expansion binge in the past few years, snapping up Embassy Communications and Merv Griffin Enterprises and combining with Tri-Star Pictures, a joint venture of CBS/Columbia Pictures Industries and Home Box Office.

These developments make me nervous about the future of small companies. The reason: economically speaking (if in no other way), Hollywood has been America's trendsetter.

Here's my thinking. The entrepreneurial upsurge of the past decade had its roots in mammoth marketplace convulsions: fierce foreign competition, radical new technologies, sudden changes in the regulatory environment. The turbulence caught America's big industrial companies by surprise, forcing them to retrench and restructure. (The Fortune 500 employ 3.5 million fewer people now than they did in 1979.) Newer and smaller companies leaped into this roiling marketplace, and they prospered where their larger brethren could not. Compare upstarts such as Cypress Semiconductor Corp. with fading giants such as National Semiconductor Corp.

Well, the movie biz underwent just such a restructuring some time ago, spawning the same kind of entrepreneurial revolution the rest of us have witnessed more recently. So if Hollywood is now to be a stomping ground for a few King Kong-size corporations, small companies in other businesses better start looking over their shoulders.

So far, the Saga of the Big Screen divides neatly into three acts, two of which have been played out in the rest of the economy as well.

Act I. Like a lot of American industries, motion pictures came to be dominated by a few big companies in the decades following World War I. Universal Film Manufacturing Co., as it was known in the 1920s, pioneered the development of the full-service production studio. Paramount Pictures founder Adolph Zukor signed contracts with thousands of exhibitors, simultaneously assuring a market for his company's products and raising barriers to the competition. By the late 1940s Hollywood's "studio system" was in full flower. Seven major companies produced most of the films, owned most of the important first-run theaters, and had most actors under contract, often putting them in 20 to 40 movies a year. Production groups were expected to complete a film in five to seven working days.

In that "golden age," write Michael Storper and Susan Christopherson, two scholars who have traced the industry's evolution, "motion picture production resembled that of large-scale manufacturing industries with routinized production processes." Like Detroit, Hollywood only had to crank out the product and pay the workers, then sit back and count the receipts.

Act II. Other industries drifted along in this dreamland until the late 1970s, when factors ranging from deregulation to the Japanese renaissance woke them up with a jolt. Hollywood's day of reckoning dawned considerably earlier. A 1948 antitrust decision forced the studios to sell off the theaters they owned, meaning they no longer had guaranteed outlets for their wares. Suddenly moviemaking was considerably more risky than it had ever been. Soon after, a new technology called television began reshaping the marketplace, just as micro-electronics would do a few decades later. In 1948 only 172,000 American households owned TV sets. By 1956 the figure was 35 million.

The effects were dramatic. In 10 years movie audiences dropped by half. Studio profits plummeted. Like some late-1970s smokestack city, Los Angeles saw employment in its flagship industry fall by nearly 40%. For several years the studios tried to fight back -- with Cecil B. De Mille spectaculars, 3-D, Cinerama. When none of the gimmicks resurrected the glory days, the industry began restructuring. Landholdings and other valuable assets were sold off. Twentieth Century-Fox's back lot became Los Angeles's well-known Century City development. Newly lean and mean, the studios cut their permanent staffs and began contracting out film production.

The result: booming business for small entrepreneurial companies. Between 1966 and 1982, according to Storper and Christopherson's studies, the number of companies doing film editing increased by a factor of 28, the number of lighting companies by a factor of 11. Production companies -- the largest single category in the industry -- increased 162%. Most were very small; the companies averaged fewer than a dozen permanent employees.

So complete was the transformation, in fact, that the two scholars wrote about Hollywood as an example of "vertical disintegration" and "flexible specialization," a regional economy in which networks of small businesses had replaced the once-dominant large ones. This is the same scene that a lot of American industries are still playing. In automobile manufacturing it's called outsourcing. In high tech it's called strategic alliances. In all such industries, large companies are functioning more and more as financiers and marketers, while relying on small companies for production and technical innovation.

Meanwhile, though, Hollywood has gone on to . . .

Act III. "Our original data ended in 1985," explained Susan Christopherson when I called to ask how vertical disintegration could be reconciled with the conglomeratization I was seeing in the news. "I've been doing some more research since then, and there have been significant changes in the structure of the industry." Among them: movies can now be seen not just in theaters and on network TV but on videotape and on any number of cable outlets. With technology diversifying the distribution system, the government stopped enforcing its ban on ownership of outlets by the big studios. Most now own theaters, television stations, or -- like The Walt Disney Co. -- a cable channel.

When you own a pipeline, of course, you have to fill it, which gives you an incentive to control your own production. Thus MCA/ Universal has bought up a portion of Imagine Film Entertainment, the company that produced Parenthood; Disney set up two wholly owned subsidiaries, Hollywood Pictures and Touchstone Pictures, even while it continues to produce children's films under the Walt Disney Pictures name; Warner Communications bought Lorimar Telepictures outright and cut a five-year exclusive deal with Guber-Peters Entertainment, producers of Batman. (Sony acquired Guber-Peters at the same time it bought Columbia, queering Warner's deal. The Japanese giant wanted all this production capacity, so it was said, to feed the video pipeline -- notably in Sony's proprietary eight-millimeter format.)

Does all this presage an end to the flowering of small companies, and a return to the studio-dominated days of yesteryear? Not exactly, says Christopherson, who has recently moved from UCLA to Cornell University. No one expects the studios to put everyone back on their payrolls, or even to swallow up their new subsidiaries. The environment still isn't as predictable as it was in the old days, and none of the big studios wants to be saddled with high overheads. But there is, she adds, a noticeable shift in the balance of power between large and small companies. "Small firms' relations with large firms will be more dependent. They'll be more in the direction of the captive supplier."

To be sure, Hollywood's Act III may soon be followed by Acts IV and V: the technology of entertainment continues to change quickly, as do popular tastes. But the lesson of Hollywood is applicable to any industry in which big companies and small ones coexist, which is to say most of the American economy. In movies as in other industries, the old regime couldn't last forever. But the flexible, entrepreneurial systems that have replaced it may not be permanent either.