To keep afloat in an ever-shrinking international work pool, animation service companies are increasingly being forced to find alternative sources of revenue. And invariably, that has meant functioning more like full-blown studios–by developing content, either on their own or through co-productions.

Five years ago, around 80% of Philippines-based PASI’s revenues came from fee-for-service work; today it accounts for just 20% to 25%. Recognizing in ’99 that the service work well was starting to dry up, PASI’s executive producer and creative director Frank Saperstein (then part of a recently installed management team) decided to change the company’s identity from service provider to content provider. ‘Today, we’re not relying on someone else to give us work,’ says Saperstein. ‘We’re trying to be more proactive by adopting a U.S. business model.’

So, what happened to all the service work? One might think that the global market penetration of offshore studios is at the crux of the shift, but industry consensus is that Asian partners are still limited to paint-and-ink and compositing duties on animation projects, while North American studios handle most of the pre- and post-production. What has changed is the nature of the deals that big conglomerates are striking with both North American and Asian studios.

‘The majority of what used to be called service work is now co-production work,’ says Saperstein. Whereas PASI didn’t do any co-pros five years ago, they now make up 50% to 60% of the company’s workload. That’s not to say that traditional service contracts no longer exist. Though the figure is less than what it was five years ago, 50% of Woodland Hills, California-based Mike Young Productions’ slate is comprised of straight service work for companies including Scholastic (Clifford) and Cartoon Network (He-Man). But MYP partner Bill Schultz says he’s noticed that co-pro deals are the business model many studios are choosing in order to stay in the production game.

There are many factors that have created this environment. Falling TV license fees in the U.S.–exacerbated by one of the worst advertising years in recent memory–have driven down the amount of money that networks are willing to spend on new shows. As a consequence, service work fees have remained flat or decreased in the last five years.

In the early ’90s, ‘a studio could get 90% of its budget for a show from a U.S. network, and the remaining 10% from overseas investors,’ says MYP’s Schultz. ‘Today, you’re lucky to get 20% of your funding from the States, and 80% overseas.’ While U.S. nets are paying less and pulling back on investing in new animated productions, studios in Europe, Canada, Asia and other territories are increasing their level of activity, says Mike Young, president and namesake of MYP. Spurred by production subsidies from their governments and international production treatises with other countries, companies in these territories are able to raise a good chunk of the financing for new shows.

‘To a large extent, financing dictates where the work is done,’ admits Beth Stevenson, a partner with Toronto, Canada-based studio Decode Entertainment. Though seemingly nonsensical, in countries like Canada (where there are plenty of production tax credits to be had), Stevenson says labor-intensive work traditionally handled by Asian outfits is increasingly being shopped out at home, even though it’s more expensive.

But the treaties and subsidies are only one piece of the funding puzzle. And that’s where the smaller servicecos come in. ‘Nelvana is now doing more co-productions with service companies because we’d rather have the additional investment in our shows, as opposed to just sending the service money out,’ says Patricia Burns, the toonco’s VP of international production. ‘This tactic helps us finance our shows and keeps us working with the same studios that have been doing such a great job for us on the service side.’ Nelvana’s production slate is almost entirely comprised of co-productions, most of which are with studios located in Asia or Europe, such as PASI, with which it’s currently working on Seven Little Monsters and Moville Mysteries.

While the way co-production deals are structured varies widely, there’s one guiding principle that smaller studios should always consider. ‘You have to believe that you’ll be able to recoup your capital investment,’ says MYP’s Schultz. What that translates into when it comes to deciding what rights to retain differs from deal to deal. For Peer Counseling, a new teen-skewing show MYP is co-producing with MTV, the company retained all international TV distribution and merchandising rights (except for soundtracks); whereas for Butt-Ugly Martians, on which it partnered with London-based Just Group and DCDC, MYP initially only held onto theatrical and some ancillary rights. (These rights were later awarded to Universal as part of a larger deal MYP inked with the studio.)

‘Co-production is a terrific option for small to mid-size companies because it allows them to keep their studios running and gives them the chance to produce their own shows–a luxury previously reserved for the larger studios,’ says Rob Davies, VP of business development and director of Vancouver, Canada-based Atomic Cartoons. On the downside, if a co-pro tanks, companies risk losing labor and capital investments–unlike with fee-for-service work.

Beyond co-pros, the other new initiative studios are pursuing is the development of their own content. Compared to five years ago, Toronto-based stop-frame house Cuppa Coffee Animation is churning out eight times more original output and currently has six children’s shows in production. But president Adam Shaheen says the company isn’t focusing on original content to make up for a shortfall in service work; it just wants to be involved in the entire creative process of developing shows to ‘have a much bigger say in terms of merchandising and home video revenues.’

PASI is using co-pro work to platform into original production. Last month, the company launched a one-hour PASI Cartoon Show block of series that the studio has either produced or co-produced on Philippine nets ABC-TV and Channel 5. ‘We’re using the block to create material for a whole market, with the hope of eventually exporting the shows to the rest of the world,’ says Saperstein.

Though Saperstein says the ultimate goal is to strike a healthy balance between co-pros, original content and service work, that business model is often hard for smaller studios to maintain. ‘The problem is that when the well-paying service work comes in, the original stuff takes a backseat because you don’t always have the luxury of dedicating resources to both,’ says Saperstein.

Still other companies, especially in North America, are relying on the relatively low cost of Flash animation to elbow their way into original production. Atomic’s Davies, however, is dubious of the long-term State-side prospects for Flash: ‘I think a lot of North American studios that are setting up Flash departments are kidding themselves. Animation, whether Flash or otherwise, is still labor-intensive, so there’s always going to be stiff competition from Asia. I think many companies are going to find that out the hard way.’

One positive development working in favor of indie outlets is a trend among large U.S. studios to farm out more of their work. Five years ago, studios like Disney and Warner Bros. set up massive in-house animation divisions with the goal of retaining all profits. However, they soon realized that it was much cheaper to outsource the work to U.S. indies, says Mike Young.

Additionally, in Schultz’s opinion, North American studios still offer U.S. nets and entertainment companies creative expertise that offshore outfits can’t match. There’s a blind spot, he says, that the Asian servicecos and even many of the European companies have when it comes to producing shows that meet the ‘Hollywood standard.’ Says Schultz: ‘They may be able to do a show at a very low cost, but they don’t know how to interpret the source material so that it will be palatable to a North American audience.’

That said, Schultz can foresee the day–say 10 years down the road–when more offshore outfits will be producing shows from stem to stern as they become more familiar with the North American production process. ‘Ten years ago, the Asian studios were producing entirely as subcontractors. Someone would send them the pre-production materials, and they’d do them,’ he says. ‘In the last five years, though, because their TV markets have matured, they’ve been producing some of their own shows, and they’re getting a feel for pre-production and development. The product is still a little unfriendly for the worldwide marketplace, but they’re getting there.’

Advances in digital technology are also helping to bridge the cultural disconnect that stifles Asian offshores. Mike Young Productions is currently using Indian studio Crest to do 3-D CGI work on its new series The Curley Tales of Piggley Winks. Every day, the two companies shuttle work back and forth using a high-speed Internet connection. ‘They might as well be working in the next room with us,’ says Mike Young. ‘If they build a model, we can see it. We see more now than we ever did working with traditional 2-D.’

With files from Amanda Burgess