Few developments are as well-suited to Disney as streaming. With an archive of more than 8,000 hours of content spanning more than eight decades, it was a no-brainer to offer subscribers online access to it. However, a flaw buried deep in the business model of the Disney+ streaming platform has turned it from Disney's prince charming into an ugly duckling.
Disney+ was launched in late 2019 by the media giant's chief executive Bob Iger who retired the following year and was replaced by the head of its theme park division Bob Chapek. Disney+ was seen as Iger's parting gift and the timing couldn't have been better.
Few major corporations were battered by the coronavirus pandemic in 2020 as much as Disney. Covid-19 cast a dark spell on almost all of its divisions. It shuttered the shops that sell its merchandise and the Blu-rays of its movies. It grounded Disney's cruise ships, closed its theme parks and brought the curtain down on the theaters playing its films. There was one exception to this devastation.
For a number of months in 2020, Disney was almost entirely reliant on Disney+ and it came into its own. As people were stuck indoors during lockdown, the popularity of the platform surged and was hailed as Disney's white knight. It was almost unthinkable that it could actually end up bringing the company to its knees but that is exactly what happened over the following years.
As subscriber numbers soared far beyond Disney's forecasts, the Mouse got drunk on its own success and ploughed billions of Dollars into exclusive Disney+ content. By the time it was released, there was a vaccine for Covid-19 and the pandemic had receded. Consumers were left picking up the tab for blockbuster furlough payments creating a global cost of living crisis that endures to this day. It led to people cutting their streaming subscriptions and left Disney with a loss-making platform.
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Disney's share price plummeted and Chapek got the blame. It spurred Iger to return to the top job and he was promptly thrust into two battles with activist investor Trian Partners which wanted board representation to try and bring the magic back to Disney. Trian hasn't had a happy ending in either of its attempts though, as recently revealed on this column, Disney had to take desperate measures to win.
In order to pacify disgruntled stockholders, Disney had to cut $7.5 billion of costs, including a lot of the exclusive streaming content it had commissioned. Despite this, Disney+ has burned up more than $11.4 billion of operating losses since it was launched and isn't forecast to even make a profit until the end of the year. It would have been so easy to prevent this from happening.
In order to see the significance of the flaw at the heart of Disney+ we need to go back further than even the launch of the platform and instead start with the birth of Subscription Video On Demand itself. Ironically, the United States Postal Service played a key role in the emergence of this cutting-edge service.
In August 1997, tech entrepreneurs Reed Hastings and Marc Randolph founded a subscription-based mail-order DVD sale and rental business based in Scotts Valley, California. It had a simple USP which was that customers didn't need to return the DVDs they rented. The catch was that until they did so they couldn't rent any more and in the meantime the business collected their monthly subscription fees without needing to pay any postage.
That business was Netflix and by 2009 it was shipping 900 million DVDs a year to more than 10 million subscribers, accounting for around 1.3% of all mail in the United States. Its subscriber numbers peaked at 14 million in 2011 but that was just the start of the story. Four years earlier, the company had taken advantage of advancements in technology to launch a groundbreaking SVOD service which streams media over broadband internet. It was far from an overnight success.
In its early days, Netflix only had 1,000 films available for streaming, compared to 70,000 on DVD. The technology was so far ahead of its time that it took years for widespread broadband adoption to catch up with it. However, when it did, the popularity of its platform surged past its mail-order business taking it to its current tally of 260 million subscribers. Traditional media companies didn't see it coming.
In an interview with us for the Mail on Sunday, former Disney chief executive Michael Eisner explained that "Reed Hastings, who is a genius in this area, took selling DVDs by mail and said 'well, our real name is Netflix. We want to stream them now.' Nobody thought of that. Several companies had the ability to buy Netflix early for nothing." They ended up regretting it as Netflix is now the world's biggest media company by market capitalization with a value of $275.3 billion. It needed more than just streaming to get there.
As Eisner explained, Hastings "created a business strategy and that was buying everybody's library. Everybody agreed to sell their library to him which was probably a mistake for them but they made a lot of money on it and it kept a lot of companies afloat."
In 2014, Disney got in on the action when it announced that it would spend $200 million over three years filming four Netflix series based on its Marvel super heroes characters Jessica Jones, Luke Cage, Iron Fist and Daredevil. This culminated in a team-up miniseries called The Defenders, but it didn't stop there as a sequel series to Daredevil recently wrapped filming in New York City. The difference is that this time it will be exclusive to Disney+.
When media companies began to realize that they should get in on the streaming game they pulled their content from Netflix and launched their own direct-to-consumer platforms. Disney didn't do it by halves.
In December 2017 Iger stunned the media industry by announcing a $71 billion deal to buy 21st Century Fox. It gave Disney the movie rights to super hero squads the X-Men and the Fantastic Four as well as control of streaming service Hulu and adult-focused content such as The Simpsons and Family Guy. This diversified Disney's content making it appeal to a wider audience of potential streaming subscribers.
As Iger revealed when he announced the deal, "One of the most exciting aspects of our Fox acquisition is that it will allow us to greatly accelerate our DTC strategy, enabling us to better serve consumers around the world." Two years later at the MoffettNathanson Conference he reiterated this and added "the lens that we analyzed 21CF through was with an eye toward eventually launching DTC businesses." It was an costly way to do it and this was only the start.
One of the USPs of Disney+ is the depth of its library which has more that 13,000 shows on it in 39 languages. That's the majority of Disney's back catalogue but it doesn't stop there. Disney also puts new releases on the platform a matter of months after they play in theaters which makes it a force to be reckoned with.
Previously, customers had to pay theaters repeatedly to see the same new movie multiple times. But on Disney+ they can watch it as many times as they like for around the same monthly cost as a single theater ticket. What's more, for that price they don't just get access to one new Disney movie, they get access to all new Disney movies and pretty much its entire back catalogue. It may sound like Disney was cannibalizing its own business but it only gets around 50% of theater takings whereas it keeps 100% of the Disney+ subscription revenue so there was method behind its madness.
At a starting price of $6.99 per year, subscriptions sold like hot cakes and Disney+ had 10 million sign-ups on its first day alone when it launched in November 2019. It far outstripped projections of 14.3 million by the end of the year and the trend continued in that direction. It hit 60 million subscribers after eight months and 100 million after 16 months which was more than Disney initially forecast to have within five years. Then came a disturbance in the force.
Cracks in Disney+ started to appear soon after the pandemic began receding. Disney's first major release was its Marvel movie Black Widow which had its release delayed by more than a year due to the pandemic. When the movie finally came out in July 2021, Disney took the controversial decision of releasing it simultaneously in theaters and on Disney+ where subscribers could access it for a month at an additional charge of $29.99.
The National Association of Theatre Owners blasted the decision and blamed it for a 67% fall in box office receipts in the movie's second weekend, making it Marvel's worst performer in that period. It also infuriated the movie's leading lady Scarlett Johansson whose contract gave her a cut of the theater takings which were dented by the simultaneous streaming release. It led to Johansson suing Disney with sources telling The Wall Street Journal that she had lost more than $50 million because of Disney's release strategy.
Although the suit was eventually settled, it exposed the damage that streaming could do as it competes directly with movie theaters. In its rush to launch its own streamer, Disney principally had its eye on seizing 100% of the takings. It didn't bank on streaming generating blockbuster losses and jeopardizing theater sales thereby leaving it with less than it had before.
Instead of being satisfied with its spellbinding performance, Disney doubled down and commissioned dedicated Disney+ shows and movies, spending $33 billion on content in 2022 alone. Driven by ego in a bid to attract more subscribers than Netflix, Disney upped the ante and it didn't pay off.
Pretty much everything that could go wrong for Disney did go wrong. Taxes soared as governments sought to claw back the massive furlough payments made during the pandemic. At the same time, inflation surged due to the war in Ukraine and local factors such as Brexit in the United Kingdom. Meanwhile, consumers were still wary of returning to cinemas due to the risk of catching covid. However, they weren't stuck indoors any more so they had less of a need for streaming subscriptions and less money to pay for them.
This perfect storm was magnified for Disney because its flagship Marvel franchise has an inter-connected storyline across more than 40 shows and movies. It means that if fans miss one of them they may be more reluctant to watch the next for fear that they won't understand it. This led to Disney having to put disclaimers at the start of some of the shows saying that prior knowledge was not required but of course by the time that was necessary, Marvel was fighting a losing battle.
The content deluge cost Disney dearly, both financially and in its quest to dethrone Netflix. The number of Disney+ subscribers has fallen from a high of 164.2 million in September 2022 to 149.6 million at the end of last year whereas Netflix has almost double that at 260 million. Meanwhile, Disney's streaming losses ballooned driving down its stock price by more than 40% from its peak of $201.91 in March 2021.
Chapek had already attempted to stem the red ink by launching a cheaper ad-supported Disney+ subscription tier and even offered subscribers discounts on hotels at Walt Disney World in Florida. It wasn't enough to save his job.
Earlier this week Iger revealed to business network CNBC that Disney didn't anticipate losing so much money on streaming. "We ended up losing a lot of money on that, more so than we expected initially. Part of that was because we were chasing sub growth and not as focused as we needed to be on the bottom line. I came back and the losses were around $4 billion a year. It was clear that that was not sustainable and not acceptable and the goal was first let's reduce those losses." It wasn't tough to see where to start.
As we revealed, Disney spent more than $500 million just on Marvel's Moon Knight, Secret Invasion and Loki Season 2 streaming series which were essentially given away free to Disney+ subscribers along with all the other content. It is a bone of contention which the actor Seth Rogen alluded to when he told Variety that he is "personally distressed by not having any sense of how successful these shows and movies we make for streaming services are."
Iger cut down the upcoming Disney+ content slate and, according to recent filings, he is targeting $4.5 billion of annualized entertainment cash content spend "primarily from slate / volume reductions and lower spend per title." He also put the emphasis back on exclusive theater releases to protect that lucrative revenue stream. Iger essentially undid the mess he created as a number of these costly streaming shows, such as Moon Knight, were given the green light under his watch. The cost cuts were followed by an even more drastic decision.
Bringing Disney full circle, Iger pulled content from Disney+ enabling it to be licensed to other platforms. The culled content even included the original series Willow which cost Disney more than $100 million to make as we revealed. Again, discussions about developing the series began under Iger's watch.
The Disney+ series Ms Marvel even ended up on Disney's own linear ABC network. In the third quarter of 2023 alone Disney recorded a $1.5 billion impairment charge for pulling the content. It doesn't get more ironic that the costly content which began development discussions under Iger was then pulled by him leading to a tremendous impairment charge.
Disney isn't the only studio which took this approach. Warner Bros. Discovery pioneered it by pulling dozens of titles from HBO Max for tax write-offs or to loan out to Free Ad-Supported TV (FAST) services. Paramount Global followed suit while downsizing its Showtime platform. The studios realized that some titles are more valuable earning ad dollars on FAST platforms than they are sitting in a SVOD library.
Disney is still trying to find its feet with its streaming platform and just last month began offering Hulu through Disney+. Iger told CNBC this week that there are more developments to come.
"We need the technological tools to lower churn and create more stickiness. It's things like recommendation engines, getting to know our customers better. We need to reduce the cost of marketing. We need to reduce the cost of customer acquisition to get the margins up.
"Obviously, I think we have to program more smartly, particularly outside the United States, which is to pick the markets where we could really move the needle and program with really strong local programming. We have had some success there. We need more success.
"Password sharing is something else. In June we will be launching our first real foray into password sharing. Just a few countries and a few markets but then it will grow significantly with a full rollout in September."
It has already had a magic touch as Disney's DTC division improved its operating income by 86% year-on-year in the first quarter of 2024 with filings adding that it is "aiming to deliver double digit profit margins in the future."
That is only part of the picture though as Disney still needs to recoup the $11.4 billion of accumulated losses generated by the platform so far. Netflix reached profitability in 2016 and had a 21% operating income margin in 2023. Assuming that Disney+ hits a similar level from the start of next year - and there is no guarantee of that as Iger told CNBC he expects double digit profit margins "eventually" - it could still take more than three years for the platform to clear its accrued losses.
Disney+ has generated average annual revenue of $17.1 billion so far, though this could decrease as although its top line has been growing, it has been driven by a torrent of new content which is slowing down under Iger. A 21% margin would yield annual operating profits of $3.6 billion bringing Disney+ close to break even in three years.
Meanwhile, Netflix seems set to generate even more profits and this highlights an inherent difference between the two platforms which is at the heart of the flaw with the Disney+ business model.
Netflix mitigated risk in two key ways. Firstly, in its early days it focused on licensing series made other studios which is obviously considerably cheaper than producing them internally. This also enabled it to decide not to renew them for a second series if the shows didn't attract enough viewers in their first run.
Secondly, and crucially, in its early days Netflix wasn't a studio so it wasn't creating content for release in theaters and therefore wasn't competing with its own clients.
Things have changed since then as Netflix' massive profits have enabled it to create its own content and take more risks by streaming movies which may or may not be successful. Disney acted like it too was in this dominant position right off the bat.
The flaw in the Disney+ business model is quite simple – the production of exclusive streaming content. No matter how much it costs to produce, exclusive streaming content is a gamble because Disney incurs the expense in advance so it is too late to avoid it if the content bombs. What's more, as with all streaming content, it isn't possible to attribute subscriber fees to specific content making it tough to calculate return on investment. That's not all because if the content is pulled Disney also incurs an impairment charge.
In contrast, if studios only put content on their streaming platforms which has already played theatrically or has already been broadcast on television it would be a whole new world.
That way the studios would not be competing with their key clients as theaters would get new movies first. Studios would get their 50% slice of ticket sales and could therefore attribute revenue to each production as usual. There would also be no risk of studios paying for costly productions which don't pay off.
That's not to say that Disney shouldn't produce exclusive streaming shows. It should but they should be sold to dedicated streaming platforms like Netflix so that they directly generate revenue for Disney. Conversely, this would enable Netflix to continue managing its budgets. If the audience of the shows declines, the streamer would not need to renew them for another season.
If Disney had taken this kind of approach at the outset it could have enjoyed all the benefits of its streaming platform and it may have never made a loss. Its dedicated Disney+ content costs would be zero and before any exclusive shows got the green light they would have revenue booked against them from the streamers that commissioned them, just like Disney's original four Marvel shows had from Netflix.
It's important to note that Disney is far from the only studio that fell foul of this by producing exclusive content for its streaming platform. However, Disney took the biggest risks because of the staggering sums it spent. Crucially, it did so despite knowing that it couldn't attribute specific subscription revenue to the content it created. At the same time, Disney+ was competing at a bargain basem*nt price point with theaters which are amongst its parent's biggest clients.
Netflix faced none of these hurdles but this didn't stop studios from trying to take it on directly as they were so blinded by a desire to beat it. To coin a phrase from Jeff Goldblum's Ian Malcolm character in Jurassic Park, the studios were so preoccupied with whether or not they could take on Netflix directly, they didn't stop to think if they should.
It appears that despite burning up more than $11 billion of losses on Disney+, the Mouse still hasn't learned its lesson. In his recent CNBC interview, Iger said "Netflix is the gold standard in streaming and they have done a phenomenal job in a lot of different directions. I actually have very, very high regard for what they have accomplished. If we could only accomplish what they have accomplished that would be great."
Now, more than ever, what Disney needs in order to succeed in the streaming marketplace is some of its famous creativity rather than continuing a cat and mouse game with Netflix which has cost it dearly.
