It’s no secret that the UK animation industry is in a spot of trouble right now. According to Securing the Future of UK Animation, released this fall by Animation UK, as much as 40% of the animation companies located in the territory were either just breaking even or losing money in 2011. The 64-page report, based on quantitative and qualitative research culled from UK stakeholders (large animation producers and small studios alike) not only gives government policy makers a clear picture of the region’s animation landscape, but it also does a good job of articulating the frustrations that have been percolating there.

Animation UK, formed in 2010 to represent the territory’s animation industry and lobby the British government for fairer trading conditions, emerged on the heels of a tumultuous five-year period that’s seen some of the UK’s best and brightest animation companies falter. It’s left the industry wondering how its top-notch content can survive with fewer domestic broadcasting slots, while operating in an increasingly competitive global market.

The UK animation industry currently employs 4,700 people, generates US$469 million in annual revenues, and is also a key contributor to the territory’s US$1.5 billion videogame industry, US$219-million DVD market, US$740-million children’s book business and US$1.1-billion toy market. (Amounts are approximations based on 2011 British to US currency exchange rates.) Despite such robust appearances, Securing the Future estimates that 28% of UK animation companies have gone out of business or left animation in the last three years. In fact, hundreds of column inches have been dedicated to the numerous high-profile closures and restructures racked up during this period that have consequently changed the shape of the entire industry.

One of the first high-profile victims, Cosgrove Hall Films, founded in 1976 and responsible for producing iconic UK toons Postman Pat and Noddy, was shuttered in 2009. Parentco and British terrestrial broadcaster ITV readily cited the dwindling commissioning budgets available for animation and increasing competition from overseas imports as reasons for the closure. But more recently, the turmoil in the British and European financial capital markets that’s making creditors arguably more cautious and reactionary than ever before has forced the hands of several perceived UK success stories.

Notably, despite earning an aggregate profit between 2007 and 2010, thanks to hit preschool properties Fifi and the Flowertots and Roary the Racing Car, Chapman Entertainment had to extensively restructure its licensing, marketing, production and finance teams when a proposed buyout failed to materialize last July. Although it laid off a raft of employees, the prodco continued on with production on upcoming CBeebies series Little Charley Bear and Raa Raa the Noisy Lion.  Despite the changes, the company has announced that it remains optimistic, especially for the the rollout of Roary the Racing Car products in Toys ‘R’ Us across the US this year.

London-based prodco and rights management firm Chorion, meanwhile, collapsed last fall under the weight of its own debt—which reportedly sat at US$113 million against US$7.67 million in annual earnings—even with a new homegrown CBeebies hit series on its hands with The Octonauts. It went into administration in September 2011 and its remaining assets were broken apart and sold off by December. (Former chair Lord Waheed Alli, however, did manage buy the representation rights to The Octonauts and upcoming preschool series The Tales of Peter Rabbit through his new company Silvergate Media, so that story is not quite over.)

And the most hotly reported sale of the season turned out to be Mattel’s US$680-million buyout of HIT Entertainment from private equity firm Apax Partners, which was looking to cash out after its 2005 purchase of the entertainment company for £489.4 million (roughly US$1 billion at 2005 exchange rates). Top performer Thomas & Friends, as well as Barney, Bob the Builder, Fireman Sam and Angelina Ballerina, are now being placed under the Mattel umbrella. Rumors surrounding a HIT sale emerged nearly 12 months prior, at which point the company was valued at more than US$1 billion. At press time, the deal was in the last throes of being finalized, but there was no word about the fate of HIT’s New York and London offices or its senior executive team.

HIT COO Sangeeta Desai says late 2010 was good time to start looking at a sale, based on the back of very robust Thomas & Friends consumer products revenues generated that year. She explains that the management team had been preparing for its inevitable exit since the 2005 acquisition, as venture capital firm Apax would eventually look to recoup its investment. “It’s a testament to the strength of our brands that our ultimate buyer was a consumer products company—it underscores the strength of our consumer products sales,” says Desai. (The 66-year-old Thomas brand currently ranks as one of the top licensed preschool properties in the world and reaches roughly one billion households worldwide through programming and DVDs. And with more than US$180 million in annual revenues, HIT represents one of the largest indie owners of preschool IP.)

“The industry in the UK has gone through some structural changes,” Desai admits. “TV commissions have decreased, the home entertainment industry is changing. What that has meant is that consumer products revenue streams have become all the more important.”

The squeeze from the recession experienced by the local animation industry, says CEO of Zodiak Kids’ UK operations Nigel Pickard, is being compounded by the influx of producers and IP holders into the preschool arena—all of whom are competing for fewer broadcast opportunities.

“So we’ve got an interesting and difficult dynamic going on, which has too many of us pitching for far too little,” says Pickard. “British producers, in the meantime, are beating paths to Canada, Singapore, Australia and anywhere else they can get a tax break, which means work is leaving the UK,” he contends. In fact Securing the Future found that 64% of its respondents blamed work lost to international competition as the main threat facing UK animation producers, second only to the reduction in broadcast commissions at 68%. The report also points out that numerous governments around the world now provide substantial financial support for their animation industries. Tax credits, investment funds and quotas available in countries like Canada, France and Ireland not only underpin and help grow the animation sectors in those countries, but often fund 20% or more of a production budget.

As many industry members lament, support and incentives in the UK are virtually non-existent. The report also suggests that reliance on alternative revenue models, like co-productions takes its toll on the industry. With co-pros, UK producers often outsource most of the animation work to offshore service providers, surrender IP and revenue rights, and incur co-ordination costs that can leach away a UK firm’s expertise and highly skilled animators, so the report states.

“The big argument is that it’s not a level playing field,” explains Jeanette Steemers, co-director of the communications and media research institute at the University of Westminster and author of Creating Preschool Television: A Story of Commerce, Creativity and Curriculum, released in 2010. “Creating co-pro partnerships with places that have good tax breaks not only means sharing revenues, it also shifts and dilutes the cultural content.”

Of course, a big part of the problem is the fact that there are not enough commissioning opportunities for UK-grown animated series. In fact, ITV-owned CiTV only recently threw its hat back into the commissioning ring after ceasing to invest in original programming between 2006 and 2010. (ITV1 nixed its kids tea-time block six years ago and moved kids content to diginet CiTV.) While CiTV program manager Jamila Metran explains that ITV now airs a CiTV block on weekend mornings, and there are currently more hours of preschool programming available on the digital channel than ever before, the fact remains that CiTV can commit to just three commissions per year, including preschool and older-kids series. A funding plan also has to be in place before Metran can give the greenlight, and often those deals are synced with rights exploitation arm ITV Global, which looks to pick up licensing and merchandising rights to CiTV original series. Finally, Metran isn’t in a position to fully finance a show. “Depending on budget, I try and go up to 20%, but the producers have to go out and find partners from places like Canada, Australia and Ireland, where they can take advantage of tax breaks,” she notes.

Given that UK cabsat nets like Nickelodeon, Nick Jr., Disney Channel and Cartoon Network are in a similar position to CiTV when it comes to commissioning (and their market share is a fraction of terrestrial outlets), BBC Children’s is often perceived as carrying the weight of the industry. It’s true that when it comes to preschool animation, for example, BBC’s CBeebies dominates the market. But the channel can only provide between 10% and 24% of the production budget for shows it commissions, despite having its commissioning pot bumped up from roughly US$28.1 million in 2006 to US$45.4 million in 2010.

“It is a big role,” says CBeebies controller Kay Benbow. “I simply can’t take all the good ideas I’m pitched, not because they’re not good ideas, but because I don’t have the money or the slots to do everything,” she adds. CBeebies caps the spend on acquisitions at 20% of its annual budget and also fulfills a remit to broadcast live-action programming that reflects the lives of British children.

Though it’s impossible for every UK producer to rely on the BBC, there may be a silver lining to its success and reputation with producers and parents alike. “If the BBC is really good, it encourages the other players to up their game,” says Westminster’s Steemers. She says other research has shown that Disney and Nickelodeon tend to invest more in original programming in countries with strong public service broadcaster competition, particularly in preschool. “Disney Junior and Nick Jr. see CBeebies as their rival, and they want to be trusted by parents as well,” she says.

The irony of the situation is that the increasing reliance on co-productions, which Animation UK currently decries, may be the thing that keeps the industry vital, relevant and healthy moving forward. Put simply, broadcast license fees paid for TV animation typically cover less than 25% of production costs and there are no new government incentives in sight, so UK producers have to look beyond their borders and hatch creative funding models to survive.

Take London-based indie prodco and brand management house Coolabi, whose most recent series Poppy Cat was commissioned by Nick Jr. UK and has since landed on PBS Kids Sprout in the US, Disney Latin America and Al Jazeera Children’s Channel. The company just finalized a US$7.7-million management buyout by shareholder Edge Performance that will take the company private. Director of content Michael Dee says Coolabi has found stability with the move that gives it immediate access to US$1.5 million. The cash infusion will allow the company to further invest in its portfolio of brands, develop new properties and grow the business through strategic acquisitions.

“They are buying into the team that is here now and have loads of confidence in what we’re doing,” says Dee. Moving forward, he adds, Coolabi has to hone its focus on international markets, even though it’s a UK-based company. “People have to be sharper and smarter about territories that are growing, like South America and Asia,” he contends.

Scotland-based Red Kite Animation, for its part, decided to go one step beyond locating international co-production partners, and found a strategic backer in August Media. The prodco became a subsidiary of the Singaporean company in September 2010.

“The need to look for investment finance that would be more risk-friendly inspired the decision,” says Ken Anderson, creative director at August Media Holdings and founder of Red Kite Animation. He turned to Asia for potential partners because the region was ripe with companies aggressively looking to fund projects and get involved in the sector. Red Kite now focuses on animation production, while August Media serves as the holding company that takes on business development and investment opportunities. The new entity has already forged an extensive deal with Classic Media to develop and produce up to 10 series based on the US rights holder’s properties such as George of the Jungle and Richie Rich, and the agreement represents up to US$60 million in production investment.

“What’s happening is that broadcasters are realizing that August Media can actually raise the financing to get things made,” says Anderson. “To be able to sit down and say that we’ll bring 40% of the budget to the table, and we’ve already got a broadcaster involved, is very useful.”

For Marie Chappelow, director of sales and acquisitions of children’s content at London-based Parthenon Entertainment, exercising caution and keeping a diverse portfolio is key with both kids and factual programming.

“It’s important not to over-stretch and over-commit,” says Chappelow. “We’re working with various people on any single project and using our international reach to help finance productions.” This past fall the 10-year-old producer and distributor embarked on its first co-production, Big Bear and Squeak, with Welsh animation house Dinamo Productions and a presale to Knowledge Network in Canada.

The company also took on homegrown Olly the Little White Van, a co-pro with UK-based Ideas at Work and Blink Animation Studios. “You have to be selective and make sure that when you take on a series, you can give it maximum focus,” says Chappelow.

Animation UK predicts that without funding initiatives similar to those in other countries, animation production will continue to move overseas through co-productions, while long financing lead times will reduce the number of projects that get off the ground. It contends pre- and post-production work will also diminish, and more studios and animators will simply withdraw from the market. The organization is lobbying for a tax credit modelled after the existing Film Tax Credit, which allows domestic production companies to claim a payable cash rebate worth up to 20% of UK expenditure. A full 83% of the report’s participants agreed that an animation tax credit would have the potential to make a real impact. “It’s not like we’re starting with a new industry,” observes Coolabi’s Dee. “We have a great industry—we just need to keep it going. It would be awful to throw that all away.”