It's... Profitmón!
From Pokémon to Full Metal Panic, the anime industry is doing everything the rest of show biz isn't: embracing technology, coddling fans--and making a killing.

(FORTUNE Magazine) – It was 2 A.M. when John Ledford heard the banging at his door. Stumbling from bed on that night in the fall of 1999, he threw on a robe over his boxers and opened the door of his Houston apartment to a twentysomething guy with glasses and a face full of freckles. Ledford was about to tell him he had the wrong apartment when the stranger launched into a speech. At that moment, Ledford knew: This visit was no accident. This stranger was an otaku.

Translated literally, the word is Japanese for "your household." But for obscure reasons, otaku morphed in modern Japan to connote a scarily hard-core fan, a nerd obsessed with a hobby to the point of unhealthiness. In the U.S. the otaku's infatuation is focused on anime--the Japanese style of animation that typically features saucer-eyed women and giant mechanical men. American otaku wear the label with pride.

The specimen at Ledford's door was going on about an anime TV show called Neon Genesis Evangelion, a series about humans fighting an alien invasion. He had a problem with the ending. "I don't like the direction you went in and I want you to go back and fix it," he demanded. Ledford explained that he didn't make the show and closed the door. He was rattled by the nocturnal visit--later that morning, leaving for Japan, he called his assistant and told her to find him a new place to live. But he should have known: That's what happens when your customers are wild with desire.

Ledford is CEO of AD Vision, the largest importer and distributor of anime in the country. ADV may not have made Evangelion, but it did get the show into the hands of American otaku. "The hard-core fan base is very rabid," says Ledford. "They will get behind you as a company. You don't have to spend a dollar in marketing; you just have to be friends with them." (With the understanding that any true friendship needs limits--and visiting hours.)

There must be a few studio heads out there who would accept 2 A.M. chats with customers in exchange for a rosier state of business. The numbers in mainstream entertainment are bad: Hollywood box-office receipts are down 7% over last year's middling performance. Home video, which in the past couple of years accounted for about a quarter of the profits on average at the major studios, is losing its shine too. Goldman Sachs forecasts virtually no growth in DVD sales for the major studios in 2006 and an outright decline in sales the year after that. In TV land, prime viewers are fleeing prime time: The networks have seen a 7.4% drop in viewings by 18- to 49-year-olds so far this fall compared with last year. There are plenty of reasons for these declines--fickle tastes, videogames, piracy. But there's also the fact that, frankly, the entertainment industry tends not to show the fans much love. Any business that prices popcorn the way gas stations price gas, encodes software into its CDs that compromises computer security, or persists in building sitcoms around Jim Belushi needs work in staying close to customers.

Yet with anime and its print cousin--the paperback-sized cartoon books called manga--the otaku keep showing up, cash in hand. This tidy little corner of the show-biz universe--a market worth more than $625 million last year at retail in North America, of which AD Vision captured $150 million--makes for a rare example of an entertainment niche that does more than not alienate its customers: It has found ways to keep them buying and buying.

In the process, anime and manga firms have taken on forms very different from Hollywood studios or publishing houses. They more closely resemble the constantly updating startups of Silicon Valley. Their ethos is to get the product out to the right people--whether it's on a DVD or over a mobile phone or downloadable--and see what happens. If it succeeds, milk it; if not, try something different. And if the fans are into file sharing (which they are), keep the lawyers leashed and find a way to make piracy work for you. "Companies in this space live and die by their ability not only to produce quality product but to retain street cred with the audience," says Mike Kiley, editor-in-chief and co-founder of Tokyopop, which dominates manga in the U.S. "We're always adopting new technology, and we get in front of 250,000 to a half-million fans at trade shows every year all over the country. It's retail politics. It's working the crowd." In Baltimore last summer, some 22,000 anime fans--many dressed up as their favorite characters--paid up to $55 each to attend the Otakon anime convention. By the second day of the three-day event, Baltimore's convention center had sold out and the scalpers started offering up tickets. Another 33,000 showed up at the Anime Expo in Anaheim.

True, it's a rather, shall we say, "elite" subset of fans who'll dress up in public as the miniskirted title character from Sailor Moon, but anime really has gone mainstream. The Cartoon Network's Adult Swim--a late-night block of adult-oriented cartoons that lean heavily on anime shows--has managed for the majority of the year to be the top cable draw for 18- to 24-year-olds. What draws them in? These cartoons all have a soap opera appeal: Plots build over the course of an unusually long season (typically 52 episodes, vs. 13 or so for traditional U.S. shows), as characters die, fall in love, do dumb things. Even Pokémon, the gateway anime of today's otaku, built from episode to episode, drawing in fans. On the manga side, sales have more than doubled since 2002, to $125 million in 2004, according to pop-culture market analysts ICv2; whole aisles of Borders and Barnes & Noble are now devoted to the graphic novels. Even women are starting to get into the once male-dominated action. Female fans now make up about half the attendees at the conferences. Responding to the interest, CosmoGirl last summer began running its own manga strip on the back page of every issue. "We started hearing girls say their favorite books and favorite things to read were manga," says Ann Shoket, the magazine's executive editor. "The girls have drawn their own manga for us. Not just one weird girl--a lot of girls."

AD Vision is based in a rundown retail center in Houston. There is no sign, only a tinted-window door that opens up into a chaotic rat's maze of a workplace: Executive offices lead to cubicles for producers; twisting hallways shoot off into recording studios; shrink-wrapped DVDs seem to fill every corner. Salesman Chris Oarr points out where a hallway used to lead into the offices of Newtype magazine--ADV's anime and manga monthly that, at $13 an issue, outsells every other film and entertainment magazine at Waldenbooks--until one day a wall just showed up. (He's not sure who built it.)

In fact, ADV's whole business model has a bolted-together, interchangeable vibe, a result of the company's willingness to take on what works and jettison what doesn't. The philosophy has been in place from its earliest days. Ledford, a college dropout, started Gametronix, the predecessor to ADV, in 1991, importing Japanese videogames and hawking them out of a small storefront in Houston. The following year he bought the rights to the movie version of the videogame hit Devil Hunter Yohko. The Japanese company that owned the show, Toho, which also manages the career of a veteran star named Godzilla, expressed surprise that any American would be interested in a show about a 16-year-old Japanese girl who fights an army of demons trying to kill her family and take her virginity (which would somehow stop her demon-slaying skills). Ledford spent around $55,000 licensing the work and producing it for the U.S., hiring a local anime fan named Matt Greenfield--who would become ADV's co-founder--to subtitle it. Ledford made his money back in 90 days and never looked back at videogames: "I said, 'Hey, that's pretty good, let's try it again.' " Since then, ADV has been a voracious buyer, releasing more than 700 anime series on DVD. Those hungering for giant robots can watch Robotech; fans of teen female assassins (and come on, who isn't?) can turn to Madlax. According to the DVD Release Report newsletter, ADV's output is more than the combined DVD distribution of the top two American TV show distributors, Warner Bros. and Paramount.

Anyone can build up a huge library. It's what ADV does with it that's interesting. Ledford aims his shows at small groups, knowing that if he can keep costs down--licensing properties on the cheap, basing his operation in low-cost Houston, using non-union actors to do voice-overs in his own studio--he does not need boffo box office to make money. (His average per-title margin: 25%.) As long as the otaku are nice and frenzied, the formula works. So Ledford makes sure voice actors and execs in his companies make a big presence at the fan shows. He's also adept at creating useful controversies: When ADV thought a Scooby Doo-esque series called Ghost Stories would be a dud, it issued a version with an intentionally inaccurate translation of the script--redubbing the characters to be more American (the leader now has attitude, and the boring sidekick was made into a born-again Christian)--knowing that would stir powerful passions. Authenticity being the Way of the Otaku, fans obliged by erupting in a furor. Then they ran out to buy the DVDs to assess the damage. Some found they actually liked the show and turned Ghost Stories into a mini hit for ADV. That's just what Ledford's looking for. "Our company is built around base hits," he says.

We're sitting in a conference room and Ledford, just back from Tokyo, where he spends half the year, is chugging lime Diet Cokes. His Japanese business partners have nicknamed him "Hamtaro," after the hamster star of a kids' anime series, presumably because he's pudgy and frenetic. He's 37, stands 6-foot-3, and on this occasion is letting his beefy hands pound the table to make points about his company's performance. ADV now gets about 90% of its $50 million in wholesale revenues from DVD sales, yet Ledford is determined to deliver content via whatever medium the fans want. "That's video-on-demand, that's mobile, that's going to our website and being able to buy an episode from us for four bucks. Instead of a DVD costing you 30 bucks, we'll sell you an episode. You can access our entire 500-terabyte library." The company's video- on-demand service, the Anime Network, is available in 28 million homes and ranks as one of Comcast's most popular on-demand channels, after music and premium stations like HBO On Demand. Internet and mobile services are the next step, though both are still in the planning stages. The day that Apple unveiled the video iPod, Oarr was on the phone with the company, trying to figure out how to get ADV's library onto the iTunes Music Store.

Other entertainment companies, of course, are embracing the new platforms: Disney had a few ABC shows ready for sale on the video iPod at its launch. And in early November both CBS and NBC announced that they'll be offering a limited set of shows on-demand over cable and satellite.

But as the majors take their first tentative steps, Ledford and his peers keep racing along. The most dramatic example of this attitude is their tolerance for folks who have the potential to put them out of business: pirates trading anime online. And not just trading, but competing to see who can create the best subtitled version of a particular show.

This is open-source TV programming. "Fansubbers," as they're called, can spend more than a dozen hours collectively just to get a half-hour show ready for English speakers. The process is as orderly as an ant farm, with each fansubber having a specialized task. TV watchers in Japan start the process by recording an anime show and uploading it to the Net, typically a few hours after it airs. Bilingual fans around the world download the show and start writing out translations in text documents, which they post online or e-mail around. The first drafts have all kinds of mistakes--words are translated too literally or just wrong--and other translators make refinements. At this stage, self-appointed editors ask questions and make changes, then fan typesetters plug in the subtitles as well as the translations for words that pop up on signs or characters' T-shirts. Finally someone somewhere encodes the completed version--and here there's competition to see who can encode it with the fewest glitches and the best filters--and runs it through BitTorrent, a piece of software that allows large files to be downloaded quickly. Typically the fansubbers organize themselves in teams to make the process move more smoothly. All this is done for free.

If this were being done in any other industry--imagine Chinese Pontiac fans getting together to strip and build their own versions of General Motors cars--the lawsuits would be piling up. Not here. Part of the reason is that the fansubbers police themselves with a zero-tolerance policy that would impress Eliot Spitzer. The first rule of fansub club: Don't trade fansubs once a U.S. company licenses a show. So when ADV announces a new acquisition, Gerard Krijgsman, the founder of largest database of BitTorrent anime shows--immediately yanks the show from his site based in the Netherlands.

The fansubbers themselves also scour the Net to make sure that despite all their hours spent translating, no copies of their work remain. "If you really like the show, you should go out to buy the DVD," says the fansubber who goes by the online handle Quarkboy. In real life, Quarkboy is Sam Pinansky, a 25-year-old physics Ph.D. student at University California at Santa Barbara who's researching string theory. Pinansky doesn't mind the ephemeral nature of what he does. All he cares about is making sure there's plenty of anime out there for him. "If you do buy the DVD, more shows like it will be licensed in the future. Our whole goal from the beginning was to get more people to like anime."

Fansubbers also act as free focus groups for the U.S. anime distributors. The more people rally to translate a show on the Internet, the more likely it is to do well as a commercial product. In September, when Cartoon Network launched the widely fansubbed Naruto, about a tween ninja, it instantly rocketed to the top of the network's ratings. Executives tip their hats to the otaku: "With anime, almost more than any other medium except maybe music, the hard-core fans drive everyone else's interest," says Jason DeMarco, a creative director for Cartoon Network. "If the fans are putting out a bunch of Naruto fansubs and talking about the show, even the casual fans are going to say, 'What's this Naruto that all these crazy guys are talking about?' Eventually it's going to filter to us because they really are a quality indicator."

The flip side is also true: The fans can help wreck a show if they don't like what they're seeing. With that in mind, Ledford makes a point of keeping his fans in the loop. Since 2003 he's been shopping the idea of making a live-action version of Neon Genesis Evangelion, the same show that spurred Ledford's stalker--it is to otaku what Star Trek is to Trekkies. Ledford signed on the Weta Companies, the New Zealand special-effects firm behind the Lord of the Rings trilogy and the new King Kong, to come up with plans for what the Evangelion world might look like. But instead of micromanaging the project, Ledford had Weta answer to two Evangelion fanatics at his company.

Richard Taylor, Weta's co-founder, says he's never experienced anything quite like it. Twice a week he'd have a conference call with the fans at ADV, sending them renderings of his designs for things like the 100-foot-tall robots and getting in return their encyclopedic take on the interpretations. "These are people who could be considered scholars on the world of Evangelion," says Taylor. "We had to appease them and find their approval." That wasn't the only odd thing: Once the Weta-ADV partnership hit the news, the company's in-box started overflowing. "We get a lot of e-mails, a lot of letters from people around the world about Lord of the Rings. But we get 25 e-mails about Evangelion to every one we get about Lord of the Rings," says Taylor. "And Evangelion has not even been made yet: It's just a whisper in the corridors of ADV, and it's a suggestion in the hallways of Weta."

Last July, Taylor flew to San Diego to attend Comic-Con, the once dorky gathering of comic and sci-fi fans. The convention now pulls in more than 100,000 attendees. Taylor took a proposed producer of the Evangelion film out to lunch to see if he couldn't jump-start production, now that the project has raised about half of the $100 million to $120 million Ledford estimates he needs to make this movie right. Before they could sit down, a fan recognized Taylor and asked him not about anything he's actually done, but about Evangelion. Taylor turned to the producer and said, "This is why we have to do this movie."

Some in Hollywood are starting to catch on--if not to the idea of embracing the latest technology (or piracy), then at least to paying attention to the fans. The wave of comic-book movies over the past few years is one indication; another is the increasing presence of producers at fan shows like Comic-Con. Hollywood vet Don Murphy, who produced Natural Born Killers and The League of Extraordinary Gentlemen, is a regular. He's producing a live-action movie based on the 1980s anime show Transformers, which featured warring robots, each of which could turn into, say, a truck or a jet (or, in the least intimidating transformation ever, an AM/FM cassette deck). There are big names behind the flick: Michael Bay is directing, and Steven Spielberg has signed on as executive producer. Yet Murphy is hitting the fan shows to drum up support and has even been soliciting ideas on his website from Transformers aficionados: "I'm trying really hard with my message boards, which get thousands of hits a day, to appeal to the Transformers fan base: 'Is there a consensus? Is there anything you people want?' " The movie doesn't come out until July 2007, but he wants the fans to be behind him from the start.

None of this means that Western culture is going all-anime. Ledford acknowledges that interest seems to bubble up, then fall back a bit before growing again. Certainly the aging of the Pokémon generation--the first to have widespread exposure to anime at a young age--should help. Still, Ledford figures that if he can just keep up with the fans, the industry will take care of itself--and the fans will take care of ADV. "Everybody here in some capacity loves anime very passionately, or they love manga," says Ledford. "We've got businesspeople here who could care less--every company does--but you go to some of these big, mega-conglomerate media companies, and they go, 'Oh, anime is making lots of money.' But then they get into it and they don't do it right because they're not connected to the fans."

As connected as he is, one word of advice to fans looking for some early-morning face time with Ledford: He now lives in a big house in a gated community. With an excellent alarm system. And a gun.