Case

The Madhouse Animation Crisis

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Problem Definition

Your client is Madhouse Studios, one of the largest anime producers in Japan. The anime-industry is flourishing. Originally revenue was generated mainly in Japan but the trend is that revenues outside of Japan are growing at a steady rate of 15% a year as more and more non-Japanese people enjoy anime. Despite this rapidly growing new segment, Madhouse lost $6m in profits at the end of 2017 even though profits were growing steadily the years before.

Madhouse has given you the objective to find the root cause of the loss in profitability and to advise them on how to proceed from here.


Comments

A lot of information has been included in this case to help both the interviewer and the interviewee to get a better conceptual understanding of the industry in case no prior knowledge exists. Not all the information available is necessary to arrive at the solution. The interviewer should read all available information to help guide the interviewee towards the solution.

The goal of this case is to practice handling a large amount of information and not getting overwhelmed by it but proactively identifying which information is necessary to solve the case in a timely manner and which information does not help the interviewee getting closer to the solution.

The interviewee should be able to structure the case into two distinct phases:

Phase 1 (problem isolation) should be about identifying the root cause of the profit decline and a revenue and a cost analysis would be the fastest way to do that in this case. Once the root cause has been identified the interviewee should move on to Phase 2.

Phase 2 (problem solution) is about coming up with hypotheses to address the root cause and fix it. To do that the interviewee should attempt to get a qualitative understanding of the root cause and suggest solutions to fix that cause or identify it to be a problem that cannot be solved. Once a list of solution hypotheses has been derived each one should be tested to determine the most effective way to handle the problem.


Short Solution

  • Madhouse is losing profits because Netflix entered the animation industry and bid up the labor cost involved in the animation process by importing talented artists from Japan to the US.
  • Madhouse should exit the animation industry and focus on selling animation-rights of popular manga (Japanese comic books) to Netflix. The reason for this is that Netflix lacks both the ability to negotiate with the authors of manga as well as the ability to pick the best performing manga before other studios acquire the rights to those.

Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.
Paragraphs highlighted in blue can be verbally communicated to the interviewee.
Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.

I. Understanding the Case & Structure

Once the interviewee has clarified terms and the objective of the case and explained their structure you can share with them Diagram 1 assuming their structure is not the same as outlined in Diagram 1 to help the interviewee start off correctly.
Share Diagram 1 with the interviewee if their structure is very different from the structure outlined on Diagram 1.

As this might be an industry unfamiliar to the interviewee the following information can be shared with the interviewee verbally as the interviewee draws out the profitability framework (you should read this information carefully beforehand to familiarize yourself with the available information on this industry).

Information to be revealed to the interviewee upon request:

  • Madhouse currently has 3 sources of revenue:
  1. Within Japan Madhouse generates revenue by selling the airing rights to its shows to local TV stations.
  2. Outside of Japan Madhouse sells rights to dubbing their Japanese shows into other languages as well as the rights to then airing the dubbed shows globally.
  3. In addition to that Madhouse recently started selling copyrighted material to a competitor instead of animating that material themselves.
  • Madhouse operations consist of 2 key tasks:
  1. The acquisition of exclusive rights to animate the most popular manga on the Japanese market.
  2. The animation of said manga into high-quality anime shows.
  • A manga is the equivalent of a US comic book. It is a fictional story imagined by an author (called mangaka) and then drawn in comic book format with drawn-out illustrations and speech-bubbles to narrate the story.
  • An anime can be thought of as the Japanese equivalent to animated cartoons like Disney’s Micky Mouse.
  • The interviewee should ask for revenue and cost data on all 3 sources of income Madhouse has available. Data should be requested over a 3-5-year timeframe starting from 2017 (The exact number of years is irrelevant as long as the interviewee indicates that historical data is necessary to solve the problem).
  • There is no numerical profit goal set by the client, the task is to maximize profitability given the current situation of the industry.

After the interviewee has had an opportunity to request some of the data above you should give the following information to the interviewee before moving on to the revenue analysis, even if the interviewee did not ask for it. This information is relevant for the rest of the case so the interviewee should have access to it:

  • To acquire exclusive animation-rights to a new manga Madhouse has a team of specialists that are very experienced in selecting the few high potential manga from the hundreds of new manga that are published every month. Then they make the artist(mangaka) an offer for his storyline, wherein the mangaka continues to create the manga and Madhouse gains exclusive rights to turn every published chapter of the manga into an anime episode. The manga-industry within Japan is considered to be a highly prestigious employment opportunity for artists by the Japanese people and in fact, many aspiring artists go to great lengths to find and hold a job in this industry.

II. Revenue Analysis by Region & Product Line

You should now share Diagram 2 with the interviewee. Ask them to synthesize any insights they can derive from the diagram and what those insights mean for the client’s objective.
Tell the interviewee that there is more information available that you can give verbally. If the interviewee does not ask for all the information provided below share the rest:
Information to give to the interviewee after Diagram 2 upon request:

  • Animation-rights per show are sold for $100,000 each.
  • Our client has sold all animation-rights in this time period to a single buyer, the strongest international competitor Netflix. Madhouse is the only Japanese studio willing to sell animation-rights to Netflix at $100,000 apiece.
  • No information on how much a single animated show generates in revenue but that is not important for this case.
  • No information on how many shows our client animates every year which is again not important for this case.
  • The animation market in Japan is not growing as the population is not growing.
  • The animation market outside of Japan is growing at 15% every year.

The interviewee should derive the following insights from Diagram 2:

  • There is no growth in the Japanese animation market. This implies constant market share as the overall market is not growing.
  • There is no sig. growth in the animation market outside of Japan which implies that our client is losing market share in the international market because that market is growing at 15% every year.
  • Selling animation-rights seems to be a fast-growing business where all our client’s revenue growth is coming from. This could be a business the client should focus on.
  • The root cause of the steep profit decline seems to be on the cost side not on the revenue side.

III. Cost Analysis by Product Line

You should now share Diagram 3 with the interviewee. Ask them to synthesize any insights they can derive from the diagram and what those insights mean for the client’s objective.
Tell the interviewee that there is more information available that you can give verbally. If the interviewee does not ask for all the information provided below share the rest:
Information to give to the interviewee after Diagram 3 upon request:

  • Acquiring rights to a single manga costs $60,000. 10 animation-rights are acquired every year.
  • The number of animation-rights acquired has stayed fixed at 10 per year. Costs for acquiring have also remained fixed.
  • Animation cost can be assumed to be almost 100% labor cost paid to the animators drawing the individual scenes within the anime show as salaries.
  • Our client received an avalanche of resignation letters from their animator staff at the beginning of 2017. The most common reason for leaving was that our animators had found more attractive work in the US.
  • Netflix is reaching out to animators in Japan offering them relocation, English courses, cultural integration support and a permanent secure job in the US at about 20 times their current salary.
  • Animators in Japan work for about $2-$3 an hour often more than 12 hours a day. The reason they subject themselves to these terrible conditions is the prestige associated with working on one of the popular anime for one of the big Japanese studios.
  • Netflix does not just offer 20 times the wage but also normal working hours of 8h a day with only 5 workdays per week.
  • Our client has attempted to raise salaries to 17.5 times the original rates to keep their workforce but employees are still resigning. Due to the low number of employees now our client is not able to offer employees less working hours per day but in fact has to increase overtime hours even more on the remaining workforce.
  • Netflix tries to get Japanese animators because the customer base that Netflix serves consists to 80% of very knowledgeable fans that prefer the Japanese drawing style which is only professionally taught in Japan. Customers recognize if the anime was animated by Japanese or non-Japanese artists and prefer the original work of Japanese artists.
  • All competitors of Madhouse have seen a similar rise in their labor cost due to the action of Netflix.

The interviewee should derive the following insights from Diagram 3:

  • Acquisition of rights is flat which might indicate a constant amount of rights acquired each year at a constant cost per right. This is, in fact, true but should be verified by the interviewee by requesting data on changes to either the number of rights acquired during that time period or the cost of acquiring the rights to a single manga.
  • The root cause of the profitability problem of the client is the fact that animation cost has grown by $7m. in a single year.
  • Given the revenue data, it appears that the animation product line is no longer worth pursuing for Madhouse especially considering that they would still need to increase salaries further from 17.5 times the original to 20 times just to match Netflix in terms of salary. In terms of working conditions due to the high understaffing and the intense overtime, the current workforce has to put in to pick up the slack Madhouse will remain a less attractive option to work for even if Madhouse was to match wages with the ones paid by Netflix.

A good interviewee will ask many qualitative “why” and “how” questions throughout the case to uncover the meaning behind the quantitative data available. Questions such as: “why did the animation cost grow by $7m. in a single year?”, are definitely the right questions to ask here to understand what can be done about this problem. This should be the point where the interviewee switches from Phase 1 (problem isolation) to Phase 2 (problem solution).

If the interviewee is outstanding you should reply to that example question above by asking: “How could you determine why the labor cost has risen this much?”.

Then you can indicate that the workforce of Madhouse has been shrinking rapidly lately as many animators have been resigning. A great candidate should then proactively suggest that the client ought to investigate why the employees are resigning and ask for the results if this has been done already. At this point, you can reveal that we know the reason why they resign is that Netflix offers them better pay and better working conditions.

If the interviewee does not attempt to understand the qualitative reasons behind the rise in animation cost give them feedback on this later and just share all information you have available on Diagram 3 in the blue box verbally with them and ask them to interpret this information.

IV. Solution

The interviewee should have realized by now that the animation product line will no longer be profitable if things continue due to the entry of Netflix into the market.

Madhouse has 2 options now: To focus on its remaining profitable product line (the animation-rights selling to Netflix) or to stop selling rights to Netflix to hopefully drive Netflix out of the animation marked by starving them of material to animate.

Regardless of what the interviewee suggest as a hypothesis to test you should ask the interviewee to instead test the hypothesis: ”Madhouse can remain profitable in the long run by continuing to sell animation-rights to Netflix as their main focus”.

To test this hypothesis the candidate should indicate that 2 things must be true in order for the hypothesis to be true:

1) Netflix must not be able to acquire rights themselves.

2) Madhouse must be able to acquire rights which are of interest to Netflix and that must remain true in the long run.

The interviewee may assume that condition 2) is met based on the large expertise Madhouse has and the fact that Netflix keeps buying more rights.

The following information can be revealed to the interviewee to verify the hypothesis:

Netflix cannot get rights to manga on their own, which means that they have to rely on Japanese people to get those for them. There are 3 reasons why this is the case:

1) Japanese mangaka are usually just common citizens of Japan that only speak Japanese and prefer to do business with people that share a common language and culture. Netflix does not yet have any experienced native Japanese staff that could negotiate with mangaka.

2) the prestige associated with working for a big animation studio only applies for the big Japanese animation studios. People in Japan generally do not really care about amine created outside of Japan as much.

3) It takes a large amount of experience to be able to pick the manga that have a chance to become popular amongst the hundreds of unsuccessful ones that are published monthly. Netflix does not have the experience to pick successful manga out of the crowd even if they could negotiate with the mangaka.

V. Conclusion

Madhouse should stop animating as Netflix will continue to drain talented animators and thus drive up Madhouse’s labor cost if it wants to keep its workforce which is already understaffed. Instead, Madhouse should focus on scouting new manga with high potential to become popular and acquire the rights to animate those. It can then sell those to Netflix. The following 4 reasons support this conclusion:

1) Netflix is willing to pay $100,000 per right which means Madhouse can make a profit of $40,000 for every right they sell making this a product with a 40% profit margin.

2) Netflix is forcing up labor costs so much that Japanese studios can no longer compete as salaries for animators overseas are still way higher then Madhouse offered in 2017 to mitigate the problem. This means that labor costs will have to rise even further for Madhouse to hold on to its remaining staff making animation an unprofitable business.

3) Netflix capabilities are in producing anime but they lack the ability to acquire animation-rights. As Madhouse is the leading studio in Japan with much experience in acquiring animation-rights it is able to fulfill the need that Netflix has so further purchases from Netflix are likely to occur.

4) Even if Madhouse stops selling rights to Netflix chances are that Netflix will attempt to get one of the other studios in Japan to sell their rights driving Madhouse potentially completely out of business.

VI. Next steps

To increase certainty in this recommendation or advise on a more specific recommendation we could:

1) Do a competitor response analysis for a scenario in which Madhouse stops selling rights to Netflix. Will Netflix offer other studios a higher price than $100,000 for rights? Is there a price for which a competitor is willing to sell their rights to Netflix? Are the shows (that our client’s competitors own the rights to animate) of comparable popularity to the portfolio Madhouse has i.e. are competitors able to acquire the best rights before Madhouse can or is Madhouse holding on to the majority of valuable rights? This analysis will help determine how much leverage Madhouse has. If Madhouse acquires rights to most of the popular shows before anybody else does then withholding rights would lower the quality of the shows Netflix can produce which might be enough of a negative pressure to push Netflix out of the anime-industry.

2) Analyse the potential for a direct partnership with Netflix as well as a potential merger to ensure that Netflix only buys animation-rights from Madhouse. If this is possible then Madhouse should not just exit the animation-industry but also start a partnership/merger with Netflix to secure its ability to sell rights at a profit margin of 40%. This margin is likely to fall if other studios in Japan start selling their rights to Netflix so a partnership now may help secure the 40% margin.

Difficult Questions

  • How would Netflix react if Madhouse stopped selling them animation-rights? What factors would you need to look at to predict the response of Netflix to that?
  • If Madhouse would on average acquire the rights to 8 out of the top 10 manga of the year what would happen if Madhouse stopped selling their rights to Netflix? If Madhouse would only be able to acquire 2 out of the top 10 manga every year what would that mean for partnership negotiations with Netflix?
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