As a manager, you must be able to identify the growth and diversification goals your organization hopes to achieve and choose the most successful ways in which to meet them, whether through mergers, alliances, or acquisitions.

The goal of this exercise is to demonstrate your understanding of different growth and diversification strategies by applying concepts to recent actions by Disney and evaluating the challenges it faces.

Read the case below and answer the questions that follow.

Case

With $55 billion in annual revenues in 2017, Disney is the world’s largest media company and is renowned for its Walt Disney Studios and the popular Walt Disney Parks and Resorts. Over the past decade, Disney has grown through a number of high-profile acquisitions, including Pixar (2006), Marvel (2009), and Lucasfilm (2012), the creator of Star Wars. All this was done with the goal of building billion-dollar franchises based on movie sequels, park rides, and merchandise. But midsummer 2017 revealed even bigger ambitions.

Disney’s Corporate Strategy Going into 2017

As a diversified media company, Disney is active in a wide array of business activities—movies, amusement parks, cable and broadcast television networks (ABC, ESPN, and others), cruises, and retailing. It became the world’s leading media company to a large extent by pursuing a corporate strategy of related-linked diversification. That is, some, but not all, of Disney’s business activities, share common resources, capabilities, and competencies.

Disney executes its corporate strategy by entering alliances and acquiring other media businesses to create theme-based franchises. The corporate strategy of creating billion-dollar franchises is Disney’s main focus, and CEO Bob Iger leads a group of about 20 executives whose sole responsibility is to hunt for them. These senior leaders decide top-down which projects are ago and which are not. They also allocate resources to particular projects; Disney has even organized its employees in the consumer products group around franchises such as Frozen, Toy Story, Star Wars, and other cash cows.

The corporate strategy around building billion-dollar franchises is certainly paying off: Disney has seen steady growth to its top line, and it earned some $10 billion in profits in 2016. Its stock rose more than 350 percent between 2010 and 2017, outperforming its rivals such as Time Warner, Sony’s Columbia Pictures, and 21st Century Fox.

Disney and Pixar: “Try Before You Buy”

To understand Disney’s corporate strategy of growing through acquisition, let’s look at one of the most successful deals in recent history: Disney acquired Pixar and then built a number of billion-dollar franchises around it. It all started with a strategic alliance. Pixar began as a computer hardware company producing high-end graphic display systems. One of its customers was Disney. To demonstrate the graphic display systems’ capabilities, Pixar produced short, computer-animated movies. Despite being sophisticated, Pixar’s computer hardware was not selling well, and the new venture was hemorrhaging money. To the rescue rode not Buzz Lightyear, but Steve Jobs. Shortly after being ousted from Apple in 1986, Jobs bought the struggling hardware company for $5 million and founded Pixar Animation Studios, investing another $5 million into it. The Pixar team, led by Edwin Catmull and John Lasseter, then transformed the company into a computer-animation film studio.

To finance and distribute its newly created computer-animated movies, Pixar entered a strategic alliance with Disney. Disney’s distribution network and its stellar reputation in animated movies were critical complementary assets that Pixar needed to commercialize its new type of films. In turn, Disney was able to rejuvenate its floundering product lineup, retaining the rights to the newly created Pixar characters and to any sequels.

Pixar became successful beyond imagination as it rolled out one blockbuster after another: Toy Story (1, 2, and 3), A Bug’s Life, Monsters, Inc., Finding Nemo, The Incredibles, and Cars, grossing several billion dollars. Given Pixar’s huge success and Disney’s abysmal performance with its own releases during this time, the bargaining power in the alliance shifted dramatically. Renegotiations of the Pixar–Disney alliance broke down in 2004, reportedly because of personality conflicts between Steve Jobs and then-Disney Chairman and CEO Michael Eisner.

After Robert Iger was appointed CEO, Disney acquired Pixar for $7.4 billion in 2006. The success of the alliance demonstrated that the two entities’ complementary assets matched and gave Disney an inside perspective on the value of Pixar’s core competencies in the creation of computer-animated features. Integrating Pixar allowed Disney to transfer and apply some of its own unique competencies including marketing, brand building, and product extensions.

Acquisitions Ever After…

In 2009, Disney turned to acquisitions again. The acquisition of Marvel Entertainment for $4 billion added Spider-Man, Iron Man, The Incredible Hulk, and Captain America to its lineup of characters. Marvel’s superheroes grossed a cumulative $15 billion at the box office, with The Avengers bringing in some $2 billion. In 2012, Mickey Mouse’s extended family was joined by Darth Vader, Obi-Wan Kenobi, Princess Leia, and Luke Skywalker when Disney acquired Lucasfilm for more than $4 billion.

In 2014, Disney acquired Maker Studios, a YouTube-based multichannel network, for $675 million. Under Disney, Maker Studies is no longer focused on providing some 60,000 YouTube creators with support by promoting their channels and selling ads. Rather, Maker now has marching orders to focus on no more than the top 250 YouTube content creators with large followings. The goal is to build billion-dollar franchises in the new on-demand TV space. One of Maker Studios’ early success stories was YouTube megastar PewDiePie, who at one point had the most successful YouTube channel and for many years was one of the highest-profile stars on YouTube. In 2017, however, Disney cut ties with PewDiePie following his posting of videos in which he made inflammatory remarks, not in line with Disney’s values.

Building Billion-Dollar Franchises

After taking the reins, CEO Iger transformed a lackluster Disney following a decade or so of inferior performance by refocusing it around what he calls franchises, which generally begin with a big movie hit and are followed up with derivative TV shows, theme park rides, video games, toys, clothing such as T-shirts and PJs, among many other spin-offs. Rather than churning out some 30 movies per year as it did before Iger, Disney now produces about 10 movies per year, focusing on creating box-office hits. Its annual movie lineup is dominated by such franchises as Stars Wars and Marvel superhero movies and by live-action versions of animated classics such as Cinderella and Beauty and the Beast. The biggest Disney franchises that started with a movie hit include the Pirates of Caribbean (grossing more than $4 billion), Toy Story (over $2 billion), Monsters, Inc. (close to $2 billion), Cars (over $1 billion), and, of course, Frozen (over $1.5 billion).

The 2013 animated movie Frozen (made by Walt Disney Animation Studios run by Pixar execs Catmull and Lasseter) has grossed over $1.5 billion, making it the most successful animated movie ever. To further build its Frozen franchise, Disney is working on a sequel of its animated movie hit for release in late 2019. It has spun off several shorter films and is now also a Broadway musical. It offers much merchandise and is a dreamlike ride through the fictional world of Arendelle at Disney World’s Epcot Center, replacing a previous attraction that had grown stale.

The Star Wars franchise, however, is clearly the crown jewel in Disney’s lineup of billion-dollar franchises. The 2015 Star Wars sequel The Force Awakens grossed over $2 billion on the big screen, making it the third-highest grossing movie ever, after Avatar and Titanic.

Intergalactic Finance: The Star Wars Franchise Is Worth $10 Billion

The numbers generated by the Star Wars franchise do seem fantastic. First, consider just the movies. Although The Force Awakens grossed over $2 billion in box-office receipts on a budget of about $260 million, NYU finance professor Aswath Damodaran estimates the final gross receipts of the 2015 Star Wars sequel to be $10 billion.

How One Movie Grosses $10 Billion. Professor Damodaran extrapolated add-on revenue by using historical data, so he could project anticipated revenues not just from The Force Awakens but also from other announced sequels in the pipeline. Here is how a simple version of his model plays out, based on reported box-office receipts for the 2015 sequel of roughly $10 million. Note that add-on revenue is computed using a multiplier (shown in parentheses) of box-office receipts.¹

Box-office receipts: $2 billion

Streaming revenue (1.2): $2.4 billion

Toys and merchandise (1.8): $3.6 billion

Books and eBooks (0.2): $0.4 billion

Gaming (0.5): $1 billion

TV shows and other (0.5): $1 billion

Thus the total gross receipts for The Force Awakens are $10.4 billion.

Valuation of a Franchise. By coincidence, Damodaran ultimately values the entire Star Wars franchise at the same amount—around $10 billion. He therefore concludes that Disney’s $4 billion price tag for Lucasfilm was a good investment. Again, the astonishing valuation of the franchise—or the reveal of the likely true gross receipts of a new film in the franchise—is explained by Disney’s ability to build revenue on top of billion-dollar franchises through product extensions and add-ons. The Star Wars empire has a far reach in many corners of commerce, let alone in the galaxy.

Clouds on Disney’s Horizon

While things have been sunny in Southern California, where Disney is headquartered, there are clouds on the horizon, which is to say Disney has been facing a number of potential challenges.

Risks of Relying on a Few Big Franchises. Disney’s approach is risky. What if the pipeline dries up? That is, how sustainable is an acquisition-led growth strategy? Not many media companies remain of the same caliber as Pixar, Marvel, or Lucasfilm.

Losing Originality. Critics worry that focusing on billion-dollar franchises hampers Disney’s originality. Moviegoers could write off Disney’s offerings as too predictable.

Problems on the TV Side. Roughly half of Disney’s profits come from its TV networks ESPN, ABC, and others. Yet that industry is in disruption. People spend more time and sometimes money watching content online via YouTube, Netflix, Hulu, and other streaming services than ever, and they watch less TV. This means the numbers of TV viewers and of cable subscribers are in decline.

Underperforming Acquisitions. Disney’s acquisitions have not been uniformly successful. While it won big with franchise-based studios Pixar and Lucasfilm, the company has also lost money and focus with the acquisition of technology companies. Examples include online video producer Maker Studios (2014) and social gaming company Playdom Inc. (2010).

Issues of Succession. Who will succeed Robert Iger as CEO? He was the architect of Disney’s corporate strategy of building billion-dollar franchises and implemented it to reach new levels of growth. Appointed in 2005, he originally planned to step down in 2015. Most recently he extended his tenure until 2019. With no clear internal candidates to take over the mantle as CEO, Disney has no heir apparent.

These challenges were suddenly cast in a new light when Iger announced a strategic shift.

Iger Joins the Disruption

In the second half of 2017, Iger announced that Disney would launch two streaming services similar to Netflix. One service would focus on ESPN’s audience and start in 2018, the other on Disney’s huge catalog of original content and start in 2019.

An ESPN Streaming Service

While the ESPN service will focus on ESPN’s audience, it will not cannibalize the existing ESPN stations. The ESPN streaming service will carry new sports content that extends the ESPN cable content—if you already subscribe to ESPN on cable, you will be able to also watch the cable events over the streaming service.

This decision may reflect the importance that cable companies place on the ESPN sports channels as their single biggest draw overall, their “must-have” component of the cable offering. But the cable companies were increasingly frustrated by rising costs, especially as the costs affected viewership. ESPN, often the most expensive part of the cable bundle, accounts for over $8 per month of cable charges even when distributed across all subscribers, by some estimates.

Cable companies wanted Disney to rein in fees because subscribers were growing more restive and some had already jumped ship. ESPN at its peak had 100 million subscribers, but it has lost close to 12 million subscribers in the past five years. And cable companies feared such a loss was just the beginning of a subscriber revolt, with subscribers demanding ESPN become unbundled from cable packages.  

For 2019: A Franchise Streaming Service

While the proposed ESPN streaming service may not adversely affect ESPN channels, the decision to create a streaming service for many of Disney’s blue-chip franchises has much greater potential, with special impact on Netflix.

Iger has announced that Disney will be pulling most of its movies from Netflix over the next two years. Some analysts see this move as reducing the value of Netflix to subscribers. However, others see the pulled content as relatively minor. First, Disney has not yet decided whether it will pull its Marvel or Star Wars movies from Netflix, and second, none of the Marvel series (think the Marvel Defenders, Jessica Jones, and Luke Cage) will go because they are co-productions with Netflix.

Technology Is Key

To make this streaming happen, Disney is making one highly focused technology acquisition. Last year it acquired a third of BamTech—which supplies streaming services for HBO and many sports events—and has an option to buy a controlling interest.

Early Days

It is too early yet to tell how this shift in strategy will play out. But what is clear now is that in the face of various issues noted above, Disney under Iger has decided to increase its independence in unsettled media markets. Instead of fighting the disruption, Disney is joining it.

ENDNOTE

1. This assessment uses the simple and generic model taken from Aswath Damodaran’s 2015 blog posting that generated the 2016 Forbes article. Specifically this computation uses the multipliers to apply to box-office receipts of movies in the pipeline. Compare Damodaran, A. (2015), “Intergalactic finance: Valuating the Star Wars franchise,” Musings on Markets[blog], December 28, at http://aswathdamodaran.blogspot.com/2015/12/intergalactic-finance-valuing-star-wars.html, and Damodaran, A. (2016), “Intergalactic finance: Why the Star Wars franchise is worth nearly $10 billion to Disney,” Forbes, January 6.

Sources: This MiniCase is developed for the purpose of class discussion. He gratefully acknowledges research assistance by Amey Sahasrabuddhe. It is not intended to be used for any kind of endorsement, source of data, or depiction of efficient or inefficient management. All opinions expressed, all errors and omissions are entirely the author’s. Revised and updated: August 1, 2017. © Frank T. Rothaermel.

Barnes, B. (2017), “With Disney’s move to streaming, a new era begins,” The New York Times, August 9; Schwartzel, E., J. Lublin, and D. Cimilluca (2016), “Disney considers offer for Twitter,” The Wall Street Journal, September 26; Fritz, B. (2017), “Walt Disney pressured by sagging ESPN performance,” The Wall Street Journal, February 7; Fritz, B. (2017), “Disney extends CEO Robert Iger’s tenure to 2019,” The Wall Street Journal, March 23; Fritz, B. (2017), “Disney’s Iger isn’t about to let go as CEO,” The Wall Street Journal, May 16; “ESPN is losing subscribers but it is still Disney’s cash machine,” The Economist, May 6, 2017; Fitz, B. (2015), “How Disney milks its hits for profits ever after,” The Wall Street Journal, June 8; Damodaran, A. (2016), “Intergalactic finance: Why the Star Wars franchise is worth nearly $10 billion to Disney,” Forbes, January 6; Catmull, E., and A. Wallace (2014), Creativity, Inc.: Overcoming the Unseen Forces That Stand in the Way of True Inspiration (New York: Random House); “Superman v Spider-Man,” The Economist, January 15, 2013; “Disney buys out George Lucas, the creator of ‘Star Wars,’” The Economist, November 3, 2012; Isaacson, W. (2011), Steve Jobs (New York: Simon & Schuster); “Marvel superheroes join the Disney family,” The Wall Street Journal, August 31, 2009; Paik, K. (2007), To Infinity and Beyond!: The Story of Pixar Animation Studios (New York: Chronicle Books); and various Disney annual reports.

15a. Disney’s current relationships with Pixar...

Disney’s current relationships with Pixar, Marvel Entertainment, and Maker Studios represent the implementation of which corporate strategy?

1. corporate diversification

2. economies of scale

3. backward vertical integration

4. horizontal integration

5. forward vertical integration

Which of the following is likely not a reason Disney was eager to enter its initial strategic alliance with Pixar?

1. strengthen the competitive position

2. assess critical complementary assets

3. hedge against uncertainty

4. learn new capabilities

5. enter new markets

Disney’s decision to launch two new streaming services is an example of which type of corporate diversification strategy?

1. redeploy and recombine existing core competencies to compete in markets of the future

2. build new core competencies to protect and extend current market position

3. pursue unrelated diversification

4. build new core competencies to create and compete in markets of the future

5. leverage existing core competencies to improve current market position

Disney appears to have made acquisitions mainly in pursuit of

1. access to new markets and distribution channels.

2. the means to preempt rivals.

3. a way to avoid principal-agent problems.

4. access to new markets and distribution channels and access to a new capability or competency are both correct.

5. access to a new capability or competency.

Answer rating: 100% (QA)

Pixar Marvel Entertainment and Maker studio all are the high profile assets of the Walt Disney Pixar ... View the full answer