Walt Disney Co. is in the business of marketing happiness. Its animated movies promise happily-ever-after fairytale endings, and Disneyland is purportedly the Happiest Place on Earth. But the media conglomerate’s recent decision to pull all of its Disney and Pixar films from Netflix and put them into its own paid streaming service has led to many unhappy fans. “This is a huge blow to Netflix users and Disney lovers who don’t want to have to pay double to access the content we love!” states a petition with 15,000 supporters urging Disney to change its mind.
Cable TV operators also aren’t happy, because they are paying content providers like Disney big bucks for shows that may also be available outside of the TV bundle. Disney’s ESPN, the most expensive cable network, will be launched as a beefed up direct-to-consumer streaming service, too. “We’re telling them, ‘Why are you coming to me asking for a certain amount when you’re giving it away free on your website or going direct to the consumer at a cheaper price than what you’re giving me?’” said Matt Polka, president of the American Cable Association, in an interview.
Such reactions to Disney’s decision underscores the risk it is taking by becoming the exclusive online distributor for its beloved animated films and certain sports content. Starting in 2019, the newest Disney and Pixar films will no longer be found on Netflix but will reside in a new Disney-branded paid streaming service that goes directly to consumers. It would include the upcoming Toy Story 4, the Frozen sequel and a live-action The Lion King. Subscribers also can access the Disney and Pixar film library, as well as content from the Disney Channel, Disney Junior and Disney XD. (Marvel and Lucasfilm movies are being negotiated.)
Disney is also creating a streaming service in 2018 for its ESPN sports content, which will carry about 10,000 live games a year including Major League Baseball, National Hockey League, Major League Soccer, Grand Slam tennis and college sports. That’s why it bought a majority stake in video streaming firm BAMTech. Until now, much of its video streams are chiefly available only with a paid subscription via another distributor, like Netflix or Hulu. Now Disney is becoming the distributor. “I would characterize this as extremely important — a very, very significant strategic shift for us,” Disney CEO Robert Iger said in an earnings conference call.
Is Disney making the right move? Wharton marketing professor Peter Fader says his initial reaction is that it’s a mistake. “That’s old school,” he says. “You have to be really, really careful about doing things you think are protecting your content, but it’s actually putting it at risk.” He cites Viacom’s lawsuit against YouTube in 2007 for letting users upload TV shows like Comedy Central’s “The Daily Show” without consent. They settled in 2014 without any payment. “Everyone was pulling stuff off YouTube [saying,] ‘They don’t have a right to distribute our content, and we’re not making money on it,’” he says. “Now they’re all back.”
“Disney will learn in a relatively short amount of time that they’re better off building something desirable rather than circling wagons.” –Peter Fader
In the age of digital consumption, Disney’s relationship with its fans would only improve if it makes it easy for people to find its content on any platform they prefer. “You want people to choose to be there,” Fader says. If Disney wants fans to pay for the new video services, there should be compelling content and benefits to make it worthwhile. Take Amazon Prime. It offers videos but also free 2-day shipping and other perks. Shoppers flocked there. “People are going to go to the platforms they want,” he adds.
While it’s good that Disney is experimenting with paid streaming, pulling out of Netflix to push people toward the new service isn’t the way to go. “You can’t force people to go elsewhere. They’re just going to change the content they’re consuming,” Fader says. Instead, “the burden is for these companies to come up with a business model that will enable them to benefit from losing control of their content.”
Predicts Fader: “Disney will learn in a relatively short amount of time that they’re better off building something desirable rather than circling wagons — and it will be in their very best interest.”
How Disney Got Here
Knowledge@Wharton High School
Disney is facing pressures from subscriber declines and soft broadcast network ratings, which depress advertising revenue. ESPN, Disney’s most valuable cable channel, has seen subscribers dip to 88 million in December 2016 from more than 100 million in 2011, while the Disney Channel and Freeform network lost about 4 million in the past three years, according to a Bloomberg Intelligence report. “The launching of streaming services can help Disney address these declining audiences that are increasingly turning to digital platforms to consume content,” the report said.
Disney does operate a paid video streaming service in the U.K. called DisneyLife. But it had to cut prices since performance was “tepid,” according to Bloomberg Intelligence. Some analysts say that the company is right to try again. “Disney not moving forward on its own would be a mistake given the changes in the ecosystem and similar direct-to-consumer launches from most of the company’s peers,” said a JPMorgan analysts’ note, although it had more reservations about an ESPN offering. Added a Needham & Co. report: “We believe every content company must follow CBS into the direct-to-consumer channel business to maintain growth.”
In Disney’s latest quarter, operating income for its cable channels fell by 23% and broadcasting was down by 22%, according to a regulatory filing. The two make up the company’s Media Networks group, which accounts for more than 40% of total revenue. Disney said operating income fell due to declines at ESPN and ABC. But overall, revenue for the group fell only 1% as higher affiliate fees — what it charges the likes of Comcast and DirecTV for the right to carry its channels — and revenue from services like Netflix helped offset the loss of viewers and decline in TV advertising.
Affiliate fee increases have long been a sore point for cable, satellite and telecom — or pay TV — operators. Media companies that own cable networks typically hike rates in the high-single to double-digit percentages, says Polka. These rates are assessed on a cable operator’s total subscribers, regardless of how many actually watch the channel. Analysts said ESPN charges around $7 per subscriber per month — far above the second most expensive channel, which is TNT at $1.82. In contrast, Hallmark Channel reportedly charges 8 cents. For their part, content companies say they assess higher affiliate fees due to the rising costs of producing shows and acquiring expensive sports rights.
Moreover, pay TV operators have limited ability to pick and choose what channels to buy, although they’ve gained ground and are allowed to offer cheaper, smaller TV bundles. Typically, a big content company would tie access to a popular channel to the purchase of a bundle of other networks as well, Polka says. This practice has led to a proliferation of multiple versions of a single cable network. Local TV stations also charge pay TV operators ever-higher fees to retransmit their signals. Both of these contribute to higher bills for the consumer.
“It does seem likely that the future of content consumption will be app-based streaming services rather than traditional cable TV.” –Shiri Melumad
These high fees, poor customer service, the wide availability of broadband, rise of free or affordable online video, and consumer viewing habits shifting towards mobile have led many to cut the cord. In 2016, cable operators alone lost 1.3 million U.S. subscribers, says Wharton marketing professor Shiri Melumad. “This transition away from the ‘cable era’ is partly attributable to a 40% rise in cable costs over the past few years, combined with worsening dissatisfaction with cable providers’ customer service,” she notes. Fewer subscribers mean less affiliate fees to media companies.
What has been saving cable and telecom companies is their broadband service, which consumers must have in order to stream their entertainment. They’re also moving into providing home security and other ancillary services. But Fader says they shouldn’t take their position for granted because a new technology could come at any time to supplant them. One possibility is 5G wireless. “It’s going to take a while to roll it out but it would have huge amounts of capacity for carrying data,” says Gerald Faulhaber, Wharton professor emeritus of business economics and public policy. “5G is going to be a game changer.”
The More, the Merrier
Today, 11 million U.S. households subscribe only to streaming services, and the number is projected to grow to 15 million by 2020, Melumad says. Meanwhile, the number of people who have never subscribed to cable TV continues to grow. “All of this in spite of the fact that streaming services still cannot provide all of the content available in standard cable packages,” she says. “It does seem likely that the future of content consumption will be app-based streaming services rather than traditional cable TV.”
Media and tech companies are figuring this out and jumping into the streaming video business. Apple reportedly is the latest to enter the fray, joining Netflix, Amazon Video, Hulu Plus and Hulu Live TV, CBS All Access, HBO Now, Google’s YouTube TV, YouTube Red, DirecTV Now, Dish’s Sling TV, Showtime, Comcast’s Streampix, fuboTV (Fox and Scripps are investors), PlayStation Vue, PGA Tour Live, WWE Network, Turner’s FilmStruck, Nickelodeon’s Noggin and others. Verizon is planning to launch a service as well.
Will there be room for Disney? “The streaming services space is becoming more and more crowded,” notes Josh Eliashberg, Wharton marketing professor who studies entertainment industry strategies. “It is my belief, however, that content is king. Disney has a lot of content with very broad appeal, for the U.S. as well as global markets. So I anticipate that Disney will grow the pie as well as obtain a decent share of it. That is, assuming a competitive pricing scheme, I expect to see some consumers switching into Disney from other streaming services.”
Indeed, a new survey shows that 23% of Americans would likely subscribe to the Disney service, according to Morning Consult, a news and market research firm. The service will be even more popular among millennials — 36% are keen on buying it and more than half would add the plan to their other subscriptions. Already, four in 10 millennials today are paying for two to three streaming services. However, they are getting tired of the fragmented video market: 57% say there are too many services, and 73% wish all their shows were available on one service.
Netflix Will Be All Right
As for Netflix, analysts think it will fare just fine without Disney and Pixar content. Viewing of these movies “likely accounts for a single-digit percentage” of total viewership time on Netflix, and “we do not expect Disney’s departure to have a material impact on subscriber numbers,” said a JPMorgan report. The market concurs. The day after Disney’s late-afternoon news, Netflix shares fell by 1.4% while the media giant dipped 3.9%. As an award-winning content creator with 100 million global subscribers, “Netflix has now become a big deal,” Faulhaber says.
“The streaming services space is becoming more and more crowded.” –Josh Eliashberg
And Netflix isn’t sitting still. On the same day as Disney’s news, Netflix revealed that former CBS talk show host David Letterman is coming out of retirement to create a new 6-episode series for its platform. Days later, Netflix announced that it has hired away a top Disney producer, writer and TV show creator: Shonda Rhimes, who is behind such hits as “Scandal,” “How to Get Away with Murder” and “Grey’s Anatomy.” And a day before Disney’s bombshell, Netflix announced its first-ever acquisition: Millarworld, the comic book publisher behind such franchises as “Kick-Ass” and “Kingsman,” which were made into movies.
This year, Netflix is expected to spend $6 billion on content, of which $2 billion is budgeted for original programming, according to Bloomberg Intelligence. That compares with $4 billion total for Amazon, $3.9 billion for CBS, $3.6 billion for NBCUniversal and $2 billion at HBO. Netflix is aiming to develop 40 original movies in 2017, which is far more than the 15 to 20 on average for major Hollywood studios. Netflix is prioritizing growth over profits, for now. Free cash flow has been negative since 2012.
The reasons for Netflix’s success is summed up by a recent BTIG report: The company has “permanently altered consumer tolerance for disruptive video advertising, shifted consumers toward binging a series vs. watching live week-to-week, put a spotlight on the poor price/value relationship of the large multichannel bundles with so many channels you have no interest in watching and led us to live in a recommendation-driven world powered by data/algorithms.” Netflix grew by streaming older content licensed from Hollywood. Ironically, the report said, this created a “monster” that’s now threatening Hollywood’s financial future.
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