Good afternoon.
To remind you, The Medium identifies a few key trends each fiscal quarter that reveal the most important tensions and seismic shifts in the media marketplace. The key trends help you answer a simple question: "What's next for media, and where's it all going? How are the pieces lining up for business models to evolve, succeed, or fail?"
Read the three key trends The Medium will be focused on in Q3 2023. This essay focuses on "Legacy media companies are throwing in the towel on their bets to own the consumer relationship in streaming and beyond".
Addendum: After Monday’s mailing, a subscriber suggested it was not clear how I imagined ESPN’s DTC app being integrated into Xumo.
Xumo is an over-the-top (OTT) play for aggregating third-party streaming services. It aims to solve a pain point for streaming consumers by making “search and discovery across live, on-demand and streaming video seamless and incredibly simple for consumers.” In Comcast’s Xumo Joint Venture with Comcast and Cox, it licenses its Xfinity Flex streaming platform, Flex-operated devices and associated voice-controlled remotes to those partners. Comcast also contributes its smart TV business (XClass) and free ad-supported streaming service Xumo to the venture.
I was envisioning a Disney partnership with Comcast making ESPN+ a default across all Xfinity devices — X1 linear and Flex broadband set top boxes— or over 32 million TV and/or broadband households. Add in Charter’s reach (30 million) and Cox’s (6 million), and you get 68 million as the potential reach.
After Disney CEO Robert Iger told CNBC’s David Faber that Disney’s linear business “may not be core” to the entertainment giant, the question is what the implications of that statement may be for Disney (NOTE: Disney staff were worried by these implications, enough to have a meeting with Iger on Monday).
Nominally, it would lose some or all of $8.5 billion, its 2022 annual operating income for the Linear Networks. That has provided a healthy cushion for Disney’s overall business, and especially the $4 billion in losses from its Direct-to-Consumer division. With those losses, the Operating Income generated by its Disney Media and Entertainment Distribution segment is nearly halved.
Ideally, any sale would recoup a multiple of that operating income in the form of cash. One question is who will value those assets enough to pay that multiple. Or, as The Wall Street Journal’s Joe Flint analogized on Twitter yesterday:
“If you don't have a lawn, there isn't much reason to own a lawnmower. And everyone who has a lawn wants to tear it out.”
The other question is whether Disney's DTC business can reach profitability in 2024, a promise made to investors over the past three years. It was reported last week by multiple outlets that “some Disney executives have expressed doubts about whether the company can hit that target” by 2024. So, a sale of its linear networks would force both the management team and the board into an outcome where they would need to solve for both the loss of 50% their operating income without streaming, and the future of their DTC business after having under-delivered.
The continued loss of $4 billion per year is not an option, especially given that Disney has $10B in cash and at least $9B of that is owed to Comcast in January 2024.
How should Disney evolve under these circumstances? Here are three different attempts at an answer.
Key Takeaway
Let's assume the outcome where Disney has sold off its linear networks and is flush with billions of dollars in cash. Iger will need a playbook for Disney’s post-linear chapter. Does Netflix, EA or former CEO Bob Chapek's Disney Prime vision offer the best playbook?
Total words: 2,500
Total time reading: 10 minutes
Netflix’s Subscription-only (or now, primarily) Model
One answer lies in trying to duplicate Netflix’s business model. Yesterday, Netflix announced an operating profit of $1.8B for Q2 2023 — almost 50% of Disney’s total losses in 2022 — and a target operating margin of 18% to 20% by the end of 2023. Almost all of its revenue is driven by subscriptions, with advertising revenues from an estimated 4 million to 5 million subscribers in countries where it has launched its Basic with Ads tier.
Any Disney executive from Iger on down who is betting on DTC being profitable is betting that global demand for Disney+ will be similar to global demand for Netflix, and therefore it will scale like Netflix as it expands to more territories (Netflix is currently in more than 190 countries and territories, just under 2x the 109 territories that Disney is in).
But that bet has confronted a few obstacles. The first and most notable is that demand for Disney+ has flattened in recent quarters both in the U.S. (down 100K subscribers from FY Q1 to FY Q2) and internationally (3.7% growth since October 2022). It also has lost 9 million subscribers in India after losing the bidding for the streaming rights to Indian Premier League cricket last year. Viacom18 won those rights, and the increased competition from Viacom18 — which is now the new streaming home for HBO content in India — suggests subscriber losses will continue.
The second is reflected in an argument that Netflix management made in yesterday’s letter to shareholders:
“We focus on engagement because it's the best proxy we have for satisfaction. It’s also closely linked to retention, an important driver of our business. Key for Netflix members is the variety and quality of our content, with the understanding that quality is in the eye of the beholder. We’re often asked “what is a Netflix show?” The answer is one that super serves the audience, leaving them highly satisfied and excited for more…. The combination of content variety and personalization means that each person easily finds titles they will love.
We learned the importance of variety back in the DVD days, and it’s become even more important with streaming. Because if you aspire to serve hundreds of millions of people all around the world, you can’t program for one set of tastes or sensibilities. You need to invest across genres, cultures and languages.”
Disney’s bet on streaming contrasts with this description in two key ways. First, Disney management believes “hundreds of millions of people all around the world” will pay a monthly subscription fee for Disney’s “core brands and franchises”. Range matters less than owned and original IP. The stalled growth of Disney+ internationally, and also data from Nielsen’s The Gauge in the U.S. (2% of consumption on TVs, or 25% of Netflix’s consumption) both suggest that they may have overestimated that demand. Disney management also has recently struggled with the question of the value of “general entertainment” content to complement its core brands and franchises.
Second, Iger rejected personalization on Disney+ —“I think if people are clicking on Mickey Mouse, they mostly want Mickey Mouse” — while it was being constructed. Together, both strategic decisions have left Disney+ unable to deliver “the combination of content variety and personalization” that helps people to “easily find titles they will love.”
Disney owns *a* solution to this pain point in Hulu, which has a personalization algorithm that is arguably the third best in the marketplace behind YouTube and Netflix. Disney will be buying out Comcast’s share of Hulu in January 2024, and Iger has said Hulu will be integrated into Disney+ to provide more variety for Disney+ users. It is unclear what will happen to the Hulu platform after January 2024 (and I have argued should replace BAMTech as the default technology because it solves for personalization). Therefore, it is hard to imagine successfully duplicating Netflix’s success in a subscription-only streaming model.
The “Disney Prime” Solution
Disney generated $19.6 billion in DTC revenues in 2022, or 62% of Netflix’s $31.6 billion in 2022. It has achieved that scale in only three years. Until Wall Street started focusing on profitability over growth, that figure had been rewarded handsomely (a stock price high ($190) that was just over 2x its current price ($87).
Part of Disney’s problem now is that, as above, it has quite a few self-imposed obstacles in the way of achieving a Netflix-like success story of profitability and global growth in streaming. Another part of the problem is Iger’s bullish vision for streaming may be too conservative: consumers may not want streaming, alone, from Disney (a challenge I wrote about in May’s “The ARPU of Storytelling”) .
That insight lay at the heart of former Disney CEO Bob Chapek’s “Disney Prime” vision, which he laid out at last year’s D23 Conference, and which (still) may be another potential path for Disney’s evolution.
As I wrote in May’s “The ARPU of Storytelling”:
“Disney was selling D23 attendees — who are the most passionate Disney fans —that Disney+ was not just a streaming service, but a means of access to deeper and more exclusive engagement with the Disney brands and ecosystem.
But, from the perspective of a single subscription fee, all the upside of this story can get lost easily. In the case of ticket sales to Disney theme parks exclusive to Disney+ subscribers, what is the ARPU? Is it significant enough to matter? How is that different from the ARPU of Disney+ subscribers who purchase merchandise?"
Effectively, for the “Disney Prime” vision to work, both the P&L and investor reporting would need to be rethought. The story being told through one subscription revenue stream was more analogous to Amazon Prime subscription revenues — reported in its Subscription Services segment — than as a conglomerate of a Theme Parks business and media distribution business. Former Disney CFO Christine McCarthy was reported to have been unwilling to follow Chapek down this path, and Iger rejected the strategy as “marketing” shortly after returning.
That all said, Chapek’s consumer-first, retail-first insight was that Disney consumers already had a long list of goods and services they acquired directly from Disney. If a Disney+ membership and Amazon Prime-like program could drive marginal engagement, then that growth could be captured in both Disney+ subscriptions and other line items like Parks & Experiences merchandise, food and beverage (a $6.6 billion business in 2022). So, a 10% to 15% increase in engagement in that line item, alone, would generate up to $1 billion in marginal revenues in one line item, alone, and at a 30% net margin.
That is a better outcome for shareholers than continued streaming losses.
EA’s Play, Watch, Create and Connect
This story of marginal engagement also echoes the story EA CEO Andrew Wilson has been pitching to investors, as I highlighted in Monday’s essay:
EA sees Gen Z and Gen Alpha consume media across four behaviors: "play, watch, create and connect.” They envision Gen Z and Gen Alpha as “an audience that will represent 4 billion people by 2030 and 45% of the workforce and have tremendous buying power.” Wilson has framed the challenge as “in a world where we have 600 million or 1 billion players engaging with us for 1.5 hours a day: What could we offer them that would get 10 more minutes, 15 more minutes?”
As Wilson explained to the Goldman Sachs Communacopia + Technology Conference last September, these four behaviors reflect “the expansion of the definition of games”
Play = interactivity
Watch = watching the game itself and watching the context of content around the game
Create = answering the consumer need of “how can I create in that world”
Connect = deeper connections with the people who are “most special to you”
EA’s business operates at a fraction of the scale of Disney’s:
its current market capitalization is $37.2 billion, or a quarter of Disney’s $159 billion;
its annual revenues in FY 2023 were $7 billion, or 8% of Disney’s $82.7 billion; and,
Its operating income in FY 2023 was $1.3 billion, or 11% of Disney’s $12.1 billion.
It has built multiple sales channels around its games business, including “live services associated with these games, such as extra-content, and subscriptions that generally offer access to a selection of full games, in-game content, online services and other benefits.”
The bulk (75%) of its $7.4 billion in annual net revenues comes from these live services. So, “10 more minutes, 15 more minutes” of engagement can directly impact net revenues. It is not as diverse or financially impactful as Chapek’s “Disney Prime” vision. It operates at 40% of the annual scale of Disney’s streaming business. But, it is a marginally better model if one believes
The vision for Disney+ is too conservative with streaming, only, and
The retail-first, consumer-first logic of EA’s live services is a model for creating new revenue models for engaging with Disney content.
The challenge in mapping EA’s model to Disney’s streaming model is that we have yet to see consumers be willing to spend more within a streaming app, or companies attempt to monetize them more within the app. Netflix offers mobile games within all of its subscription tiers, including its most recent, now lowest-price Basic with Ads tier. If there are basically three buckets to how Netflix defines whether an offering has moved the needle — growth, engagement or reduced churn — it appears to define the value of mobile games to the latter two.
But, as I wrote on Monday, for Disney to pursue a similar strategy is limited because “Disney's retail-first, consumer-first future seems limited in large part because its management team simply has no background in the business models of the medium.” Moreover, it has failed to execute against the “play” element — it closed down Disney Interactive in 2014 — and the “create and connect” element — its $500MM investment in YouTube multichannel networks Maker Studios failed to get traction within Disney, and failed in 2016.
That said, EA has seen revenues from live services grow 137% since 2021 with this strategy. So, putting these concerns aside, the model is worth considering or even partnering with EA to deliver additional services to Disney+ consumers.
The Elephant(s) in the Room
This all said, an elephant in the room is Disney’s loss of $4 billion in operating income annually. That loss could be as high as $12.5 billion if Disney opts to sell all of its linear networks business.
Cash flow matters most, and there are no obvious ways that “Disney Prime” would solve for that pain point. Nor does anything in EA’s discussion and presentation of its business in its 10-K or earnings call offer an obvious value proposition for solving Disney’s pain point. EA offers marginal, if not more hypothetical, solutions, at best.
That said, let’s assume the outcome where Disney has sold off its linear networks and is flush with billions of dollars in cash. If Iger remains bullish on streaming and needs to drive growth, he will need a playbook and both Disney Prime and EA offer viable foundations for building out Disney’s post-linear chapter. The only caveat is he would not be the right CEO for that outcome. But that would not matter: any outcome where he has successfully pivoted the business and left his successor flush with cash would be a good outcome for shareholders.
That said, the second elephant in the room is Disney’s track record of three successive digital businesses — if one includes Disney’s bet on streaming — failing to become viable business models within Disney’s operational culture and ecosystem. The best business model remaining within the Disney ecosystem after a sale of linear networks will be its Parks and Experiences business.
That ultimately may be why Bob Chapek focused on Disney Prime. Because the message from EA is that the next generation audiences are paying to engage more with content, and Disney+ does not offer that. They are also paying EA to connect with other players via gameplay and enabling creating content to put into the gameplaying worlds EA creates. Disney+ does not offer that, either.
But Chapek believed Disney consumers would engage more deeply within the Parks and Experiences business with Disney+-driven incentives more than they would adopt digital services offered by Disney. Although he never said it out loud, Chapek seemed to be conceding that Disney’s track record in digital was never going to produce the business that Iger envisioned. Ironically, an outcome of selling the linear networks may lead Disney more towards the future that Chapek envisioned than Iger originally envisioned.