Once dominated by huge vertically integrated corporations, Hollywood has become the shining model of our industrial future -- a network of flexible small businesses that get things done in here-today-gone-tomorrow alliances. Here's what it means for your company

A storm is heaving the ocean off a Northwest "coast," tossing a large tanker toward the rocks. In moments there will be a major oil spill from its caved-in hull, all before the watchful eyes of whales swimming in their icy home waters.

At least that's what millions will see when Free Willy II hits the theaters this summer. In reality, though, this sequence in the film is being shot not in the northwestern Pacific but in an outdoor pool beside the venerable Los Angeles Coliseum, where the only real threat is posed by the ultraviolet rays of the warm Southern California sun.

"I'm not going to sink a 400-foot ship on real rocks," explains Doug Merrifield, the film's associate producer. "So this is where we do all the underwater sequences."

Yet the miniature seascapes, robotic whales, and other products of movie magic are not the only illusions at work here. The public will know Free Willy II -- the sequel to 1993's highly successful Free Willy -- as a Warner Bros. release. But the real creators of the film, responsible for everything from its special effects to payroll and security, are a host of small companies and freelance contributors who collaborate for only as long as the project requires -- and who are drawn from the loose network of specialists that today holds the real power in Hollywood.

"Over the course of any picture you depend on 20 to 30 outside vendors to get the job done," notes Merrifield, a 20-year industry veteran. "It's a question of getting the best companies that have the expertise you need."

In the case of the underwater-scenes shoot, much of that expertise is being provided by Cinnabar, a Hollywood props maker, and its cofounder, Jonathan Katz. Katz, like Merrifield, is no newcomer -- he got his start two decades ago building floats for the Rose Bowl parade. His company operates project by project. One day it might be working on a film, the next day on a commercial, the following day on a television special -- each project a different product for a different client, requiring not only very different skills but different workers. To Katz, that means running a different kind of company.

Management no longer involves creating an integrated, rigid operation that can consistently repeat its function, he says. Instead, the challenge at Cinnabar -- as at every company in a network economy -- is "to get a highly temporary alliance of creative individuals to work together in harmony." The need to maintain relationships with creative people, financial types, and business managers is the only constant. The competitive edge belongs to those who can bring together those contributors in the most timely and efficient manner -- as Katz has been able to do. In 1994 Cinnabar recorded a very profitable $8 million in revenues, up from $7.1 million the year before.

Katz's success with Cinnabar may not be the stuff that makes the gossip sheets or gets major showbiz media coverage. But in many ways the growth of his company and of thousands like it in the entertainment industry -- not to mention the very careers of freelancers such as Merrifield -- represents a trend that is transforming not only entertainment but all business. Hollywood's network economy isn't unique, it's just more evolved than most -- and as a result offers a picture of how, and where, companies in all kinds of industries will do their work in the years to come. Eventually, every knowledge-intensive industry will end up in the same flattened, atomized state. Hollywood just has gotten there first.

Coming Soon to an Industry Near You
The collaborative, fragmented, demanding network-economy world
The business forces that changed Hollywood have become almost commonplace -- regardless of industry type. How many company builders these days can say they're not confronting --

· demand for more and faster product development, mostly because of shortened product life cycles and increased distribution channels (such as cable TV and videocassettes, in the Hollywood example);

· intensified global competition; and,

· rising customer expectations, especially about improved quality and greater customization -- born in part from the explosion in choices.

Hollywood's collective response has been to mutate from an industry of classic huge, vertically integrated corporations into the world's best example of a network economy. Its mostly small, uniquely skilled companies collaborate to create specialized products that can't be easily copied. Drawing on a dense concentration of talent, network economies like Hollywood lead what Japanese writer Taichi Sakaiya calls the "knowledge value" revolution, and possess a critical -- perhaps even decisive -- edge against competing industrial regions that produce lower-cost but less differentiated goods. Industries in higher-cost developed countries that build Hollywood-like concentrations of skill may not only survive but thrive against the increasingly sophisticated onslaught from developing nations such as Mexico and China.

There are "knowledge value" industry concentrations other than Hollywood -- the New York financial markets, Silicon Valley's high-technology sector, and Japan's automotive industry among them -- but none as successful or as illustrative of the shift from one kind of industry structure to another. In just the past 16 years the number of entertainment-related companies in Southern California more than tripled, and nearly 95,000 of the industry's workers are freelancers or are employed by companies with fewer than 10 people. Those small entities offer a huge range of products and services, from unique theatrical lighting and set design to animation and software for digital images, not to mention numerous customized business services.

In contrast, there are only 19 entertainment companies in all of California that employ as many as 1,000 people, and they're mostly the remnants of the old studios and large production companies. In today's Hollywood those studios provide back-office support for the region's elite production teams, helping to coordinate advertising, financing, and, most important, distribution.

"Hollywood is not the big studios anymore," observes Michael Storper, a UCLA professor and expert on the industry's structure. "It's a collection of small and medium-sized firms -- independent producers who come together and actually make films project by project. Very little filming is actually done by the big studios themselves."

For Hollywood producers like Merrifield, and for the industry as a whole, learning to bring together the best possible film and television specialists on a project-by-project basis yields several concrete business benefits.

It means that each job can be staffed with the talent most suited to its demands, rather than with the talent that, at a conventional company, is already on staff and must be adapted to a variety of jobs even if the fit is poor. It means bureaucracy and overhead are minimal, since there is no lasting organization to maintain. And it means that long-term risks and their costs (layoffs, for instance, or other personnel-related problems) are reduced, since there is no long term -- just a team assembled for a finite period and then disbanded.

Taken together, such consequences of the network system are likely to yield higher quality and lower costs. In Hollywood that approach is made possible by the huge concentration of specialists, ensuring that virtually every need can be met by some individual or independent company in the region.

Of course, there are some daunting consequences of this here-today-gone-tomorrow production strategy. For example, like many of the vendors he hires, Merrifield himself is an individual entrepreneur. He works not for Warner Bros. or even directly for the cofinanciers of his current project, New Regency Productions, but for a temporary entity called Free Willy Two Inc., which actually is responsible for making the film. When Free Willy II is finished, Merrifield, like virtually everyone else involved, will be out looking for a new film, television show, or commercial production to work on.

"This is a totally temporary corporation," Merrifield explains as workers touch up the artificial ocean bottom behind him. "After this, everyone goes back to finding another job."

The Way We Were
How the marketplace made Hollywood do it
In the past year's hype about the so-called information superhighway, most media coverage has concentrated on the marquee names, studio chiefs, and heads of large cable operators and technology and phone companies as if they were the dominant forces shaping the entertainment industry.

And 40 or more years ago, they would have been. Back then seven major studios dominated movie production and controlled distribution in many markets. Films were produced largely in-house by permanent staffs of artists, writers, editors, lighting technicians, and props makers, all ruled by domineering and often-flamboyant studio chieftains.

Up to the 1950s, in fact, there were few better examples of vertically integrated, mass-production industries in the world than filmed entertainment. Far from attracting customers on the basis of product uniqueness, the studios -- like their counterparts in autos or steel -- sold their products by the foot, churning out formulaic cinematic entertainment through the movie houses they exclusively controlled.

All that changed as Hollywood experienced a series of dramatic market changes. The first blow was a major antitrust case in 1948, which forced the studios to loosen their iron grip on the nation's movie houses. Exhibitors were free to demand better and more interesting films from their suppliers -- and they did.

By the 1950s, new competitors emerged to meet that demand. Europeans, in particular, began to offer quality films for worldwide audiences. Some, like François Truffaut and Federico Fellini, would become known as great masters of the medium, but many others simply made standard Hollywood-like films -- such as the "spaghetti westerns" of the 1960s -- using low-budget European locations and crews. Suddenly, the once-semimonopolistic, sedentary film market erupted into a hotbed of competition, driving down the margins for cookie-cutter filmed products.

It was television, however, that struck the final blow. By the late 1950s Americans could view for free an entertainment medium that could rival the basic product coming from the studios. Movie receipts in the country began to plummet. Suddenly, what had been sold by the foot faced a marketplace filled with more and more discriminating customers demanding new and ever-better motion pictures.

Those factors forced Hollywood to "restructure" and "reengineer" itself long before doing so became the rage in other industries. Its main strategy was to specialize: if television and cheap imports had captured the market's low end, the movie industry would create a high-end product that would draw people back to the theaters. Rather than flooding the market with formula movies, Hollywood would offer far fewer movies, but they'd be blockbusters for which exhibitors and moviegoers would pay a premium.

Those shifts required massive changes within the studio system itself. Filmmaking became a craft instead of a commodity, with all contributors -- actors, writers, musicians, public-relations specialists, cinematographers, editors, and financiers -- adding only the highest caliber of skill in order to generate a final product that no one could easily copy. Yet as people became more specialized and capable, they also demanded higher pay. Soon the studios were unable to keep much of their key staff in-house.

As a result, starting in the mid-1960s, Hollywood witnessed an explosion of independent filmmakers, service providers, and other entertainment-related companies. Between 1966 and 1981 the number of independent production companies almost tripled. In 1960, 72% of U.S. films were made by the major studios; by 1990 the studios' share had dropped to a mere 36%.

Today it is independents such as Steven Spielberg, not the studio bosses, who are the true stars in the Hollywood production world. Indeed, even the films "made" under the studio trademark often rely on independent vendors for critical artistic and technical contributions.

By late last year there were clear signs that the old studio system was not just changed but possibly doomed altogether. The announcement of a new alliance by three of the industry's creative giants -- record promoter and former agent David Geffen, director Steven Spielberg, and former Disney executive Jeffrey Katzenberg -- shook the multibillion-dollar corporate owners of the major studios to their foundations. In the starkest terms, the move by the three showed to what extent the studios could become empty vessels, whose direction and value were determined by the people who understood the new Hollywood network economy.

Being There
Why where your company locates matters after all
It's not an accident that the new studio of the "dream team" -- as the three powers are collectively known -- will be located in Los Angeles. At a time when conventional wisdom suggests that companies would do better to locate far from urban areas (or anywhere they wish, for that matter), the predominance of the Hollywood entertainment complex highlights the importance of location for companies in any highly networked, high "knowledge value" industry.

Hollywood's entertainment-business concentration has produced remarkable economic results even during the 1990s recession. In defense-cut-devastated Los Angeles County, home to 92% of the nearly 370,000 people directly or indirectly employed in the California entertainment industry, the number of production companies grew at a 10% to 12% clip from 1991 to 1993. The industry improved sales by 7% in 1993, despite the continued economic weakness in such key overseas markets as Europe and Japan. Entertainment also is one of the few American industries in which U.S. competitiveness is virtually unchallenged, with total net exports of more than $3.5 billion.

The extraordinary density of the crafts companies within Hollywood, note UCLA professor Storper and other experts, goes far toward explaining why U.S. entertainment products enjoy such extraordinary global success. Over the past two decades, in fact, Hollywood has all but crushed its chief European and Japanese rivals -- to a degree unimaginable in other key industries -- dominating major markets from Britain and Japan to Hungary, Brazil, and Turkey. When it comes to exports, show business is second only to aerospace: foreign sales now account for more than one-third of all revenues for U.S.-based entertainment companies and could make up fully half the industry's sales by the year 2000.

Given Hollywood's huge success in world markets, it's not surprising that many regions and countries have sought to blunt or break up what is widely perceived as its entertainment hegemony. The most quixotic efforts have been made by French bureaucrats who seem to compare Hollywood's dominance -- American films accounted for 8 of the top 10 films and 40% of French box-office receipts in 1993 -- to the German occupation of the country during the Second World War. So bitter are the French that one top producer, Daniel Toscan du Plantier, joked that the January 1994 L.A. earthquake was a sign that God was taking France's side in the dispute.

Yet it's unlikely that even another 6.8 temblor would save other markets from Hollywood's reach. France's real problem is not so much American "cultural imperialism" as its inability to compete with Hollywood's combination of technical and artistic specialization and well-oiled collaboration.

Hollywood's success has significance far beyond entertainment. The same traits that enable entertainment companies to survive in one of the world's most demanding urban environments -- flexibility, specialization, continuous learning, and intercompany cooperation -- also characterize the growth sectors in other urban economies.

Computer companies in Silicon Valley during the 1980s faced a challenge similar to the one that Hollywood fought off during the 1960s. In their case, it was Japanese corporations, ones with deeper financial resources, that took over the manufacture of garden-variety microchips. Recognizing that facing off directly against the Japanese, and later Korean, manufacturers would prove suicidal, the valley's diverse companies learned to work together to produce highly specialized systems and components. And their efforts have led to a remarkable American resurgence in an industry in which many experts considered the Japanese juggernaut all but unstoppable.

Similar patterns can be found in a host of other industries. During the past decade, for example, U.S. automakers found that their focus on building in-house mass-production capabilities had eroded both their quality and their responsiveness to customers. Today they now buy up to 80% of the value of their cars from specialized, independent vendors -- an almost complete reversal from their historic procurement practices. Steel, textiles, and even agriculture and business services also increasingly exhibit the specialization and project-by-project collaboration essential for modern, successful high-wage industries.

The advantages of specialized-skill concentrations explain how Southern California has withstood the constant attempts by regions such as Arizona, Texas, Toronto, Florida, and North Carolina to lure away key parts of the industry. Those regions' packages of tax breaks, subsidies, and nonunion labor made some inroads on the percentage (though not the total amount) of on-location filming in California in the early 1980s but failed to halt the increased concentration of major preproduction and postproduction work in the state. Separated from the center of information and creative exchanges, companies outside Hollywood generally have more trouble remaining on the cutting edge of business practices and technical virtuosity that's critical to success.

Although any real estate mogul or government bureaucrat with money can build a soundstage and pay people to act on it, it still requires thousands of craftspeople and the coming together of unique companies and individuals to make an industry. In fact, Hollywood's network concentration has become so powerful that since 1985 the proportion of films shot partially or entirely in California has actually risen, from roughly half to around two-thirds. Nearly 75% of the state's film shoots take place in Los Angeles. California now accounts for roughly 60% of all the country's film-related jobs and has more than four times as many industry workers as its biggest rival, New York, and nearly 30 times as many as its much-ballyhooed competitor Florida.

Even newcomers to the entertainment battlefield -- such as the Japanese -- still most often choose to locate in Southern California for their expansion into the industry. Giant companies from the very European countries whose politicians and artists seek protection from Hollywood also invest hundreds of millions in the California industry.

That's true not only for conglomerates such as Matsushita and Sony but also for entrepreneurial ventures. Steve Michaels, chief executive of 525 Post-Production, based in California, a fast-growing entertainment unit of the London-based Virgin Group, says there's no real alternative for anyone who wants to make movies, videos, or commercials in the big time. Indeed, 525, which recently opened an office in Mexico City and has a sister unit in London, views its foreign relatives in Hollywood not as competitors but as sources of business development that educate other markets about Hollywood's resources and then serve as a conduit for work to go back into the region.

"A lot of markets have tried to pull work away from Los Angeles and have creative people and tremendous assets to offer in terms of location," notes Michaels, whose company has grown in seven years from 6 employees to more than 100. "But there's such a tremendous base of entertainment in Los Angeles that people have whatever resource they need at their fingertips. You can have a flying pony for a half day if that's what you need."

One Day at a Time
How companies work in the network economy
Today Hollywood has constructed one of the most developed high-value-added production networks in the world. The large number of film, commercial, and television projects in Southern California provides enough work to support rafts of highly specialized individuals and companies -- something that wouldn't happen in other, less dynamic regions. As those practitioners enhance their expertise, the combined skills of the network enable them to generate unique products commanding enormous premiums in both domestic and global markets. That allows Hollywood to pay some of the highest production salaries in the world.

For entrepreneurs like Cinnabar's Jonathan Katz, association with Hollywood not only gives him a special cachet in world markets but also provides day-to-day contact with the most demanding clients in the world, virtually forcing him to remain at the forefront of his craft. And to meet the needs of those clients, he has to form new work teams almost constantly.

"Most people in the film business are organized only for a specific project -- a lot of them are just freelancers -- and you can't do that in Orlando or in Chicago," Katz says as he walks through the bustling lot near his Hollywood Center Studios office, where the movie The Player was shot. "We decide to do a film on Friday and have a team on Monday. You have to have the resources available."

It is the vast resources available in the region that give the industry -- and companies like Cinnabar -- the ability to put together a television or movie production more effectively and with more creative energy than anywhere else in the world. The complex nature of filmmaking, notes Katz, means each production faces a horrendous challenge in trying to pull together the necessary talent. The Hollywood network makes it possible to assemble and coordinate the best team with incredible speed.

Many people that now are key players in the Hollywood network began as craftspeople providing extremely specialized, in-house services for the large studios. But once they mastered a particular skill, they began to apply their knowledge outside the studios, founding their own companies and often becoming part of an increasingly complex network of producers who service entertainment and nonentertainment sectors alike.

"The industry puts all those contributions together as needed, packages the result, and distributes it through these gigantic distribution networks," UCLA professor Storper observes. "So in a sense Hollywood has the advantages every industry would want: flexibility and suppleness in what it produces and how it produces it, enabling Hollywood to be at the same time very innovative and still able to take advantage of scale when it sends products to market."

Katz, like many of Hollywood's entrepreneurs, knows the business from the ground up. In the 1970s, before founding Cinnabar, he parlayed his skill building floats for the Rose Bowl parade into a leadership position at Festival Artists, one of the country's top float-building companies. After five years working for Jerry Brown and the California Conservation Corps, he came back to L.A. and went to work at a Hollywood special-effects-scenery house.

Katz found the traditional effects-design business -- heavily unionized and encumbered by strict job categories -- was becoming too slow and uncreative to meet the entertainment industry's rising demands. "It was a technical company, but the managers couldn't talk on the same level as the producers who came to it with work," he recalls in his crowded office, which is packed with movie flotsam and arcane pieces of Americana. "I remember one producer saying to me, 'What is a nice Jewish boy like you doing making props? I'm used to rednecks in overalls."

Soon Katz decided to start his own company. Rejecting the old industrialized union model, Katz ran Cinnabar as a collection of skilled craftspeople. With an initial investment of $22,000, he has built it into a company with a permanent workforce of more than 100. Today the company works not only on movies like Free Willy II but for large numbers of commercial, television, and retail clients around the world.

"We bring in a combination of people who normally might not work together," Katz says. "We act as producers, creative directors. It's an entertainment model. You put together a different team for a Paramount theme park than you do for Pepsi. Subcontracting does not describe it -- we really are working with these people because on a project we are all part of the same process."

Inside all the best Hollywood businesses the challenge is much the same: how to marshal the skills of people who like solving novel problems on a daily basis. As customers' demands for creativity, quality, price, and speedy performance increase, entertainment companies have been forced to evolve corporate structures that adapt quickly to change.

On any given entertainment project, such as Free Willy II, Cinnabar becomes part of a network that can include as many as 50 companies and scores of independent contractors. Ruck Goldreyer, the Cinnabar project manager for Free Willy II, is a veteran of countless movie, television, and commercial shoots. On the set he supervises the creation of a whole miniaturized environment -- from an ersatz ocean floor to a one-tenth-scale model of a doomed oil tanker.

"You get the fax with the specs from the producer," explains Goldreyer, a professional sculptor and former university lecturer. "You put it all together based on experience and craftsmanship. You bring that knowledge to each project."

It is precisely such knowledge -- based on experience -- that is critical to the making of movies. "It's all problem solving, and it's creative," says Goldreyer, who supervises 30 Cinnabar employees on this shoot. "Every shoot, every production is something new. That's what builds your knowledge and expertise."

The Eternal Open Market
Constant learning -- the secret to network-economy success
In an era when graduate-level academic degrees are often seen as the keys to business success, Hollywood is one place where pure skill, artistry, imagination, and the all-important street smarts consistently matter more. All three members of the Geffen/Spielberg/Katzenberg "dream team" were college dropouts, something one would rarely find among the corporate studio bosses and executives, much less those who pull their strings.

Rather than formal training, the key to Hollywood success lies in learning a specialized craft and then fitting it into the network economy. That can include everyone from an actor or director to the thousands of less visible figures who make movies and television possible. Many Hollywood entrepreneurs see themselves not simply as businesspeople but first and foremost as artisans.

Many, such as Richard Hart, actually started out working as technicians, performing fairly routine tasks at the major studios. Hart got his first look at big-time Hollywood by sneaking over the fence onto the lot at MGM, just a few miles from his childhood home in Santa Monica. "We played out our fantasies of being part of MGM films," the gray-bearded, barrel-chested Hart recalls. "But it was just that, a fantasy."

For Hart, that fantasy eventually met reality. Through a friend, he got a job as a lighting technician at MGM. It wasn't like being a star or a big director, but it paid four times as much as pumping gas at his father's service station. Using the skills he developed over the next 20 years as a lighting technician, Hart eventually opened his own small company, Xenotech, which has become a global leader in the manufacture of customized xenon lights for the movies, television, and, increasingly, architectural markets. But Hart doesn't picture himself as an up-to-date information-age manager running a high-tech business. He sees himself as more of a medieval craftsman, working with other skilled artisans in the unique network of companies and people that make up Hollywood.

Hart's current success is hard-earned. He learned all the dirty and difficult secrets of lighting as he worked his way to the post of gaffer -- or chief lighting technician -- on scores of movies such as Vanishing Point, Lady Sings the Blues, Cutter's Way, and Best Friends.

"You develop a reputation; that's how I approached the business and learned my craft," Hart recalls in his unpretentious digs at Xenotech, his 18-person enterprise in North Hollywood. "I worked with the cameramen, the directors. Doing lighting was like being a framer on a home. It's the secret, it's the mood. It's what you see."

In 1980, however, Hart met a director and a lighting challenge that stretched even his talents and ultimately gave birth to Xenotech. Ridley Scott, director of the 1980 movie Blade Runner, wanted never-before-seen effects -- he called them "shafts of light" -- to portray his image of an environmentally devastated futuristic Los Angeles.

"This was a vision of Ridley's of what the future would look like," Hart says. "Basically, it was a very polluted kind of an atmosphere. The populace was constantly being inundated with advertising. And one of the effects he wanted to achieve was a feeling that would be unique to his film -- this airship of some sort that would look as though it had lights shining out of it and as though it had a message board similar to the Goodyear blimp's."

Making that dramatic effect required a unique kind of lighting. Conventional stage lighting did not suffice, so Hart rigged up 1,000-watt xenon lights previously used only for lighting up billboards. He retrofitted them himself for the rigors of shooting, making them more mobile and easier to handle.

When Blade Runner was released, film experts were astounded by the effect. "The shafts-of-light look changed everything," Hart maintains. "People wanted to see how it was done and knew I was the gaffer, so they came after me."

That unexpected demand suddenly cast Hart in the unfamiliar role of businessman. First he bought a few xenon lights and tinkered with them in a shed near his Northridge home. Soon he had a thriving little rental business. But demand continued to grow from advertising, television, and film clients. It was becoming clear he could no longer satisfy their needs for lighter, quieter, and easier-to-use lights capable of producing the shafts-of-light effect.

In 1987, with profit