Disney, IP, and "Returns to Marginal Affinity"
The paragon of a media company in 2019 is Disney. We think of this success coming mostly from its IP, but it really stems from the company’s core capability and obsession: storytelling. This excellence appeals to all age groups, almost all media/product categories, all internal business functions, and all places – from the movie theater to a family’s basement, a multibillion-dollar theme park, live shows “on ice”, and more. And while the company’s achievements here aren’t in contention, it’s still easy to overlook the company’s endless dedication to the storytelling experience. For example, Disney parks have hundreds of thousands of square feet of unseen underground tunnels and hidden doors that are never used by park goers. Instead, they exist so that park workers can to navigate the park without interrupting guests, to hide ongoing maintenance (trash is literally sucked into a network of pneumatic tubes), and for cast members to get to themed “lands” without being spotted in the wrong one (“mommy, why is Captain America on Tatooine?”) or needing to ignore patrons. Nothing is more important than the suspension of disbelief.
Disney’s IP is also far from a sufficient explanation for Disney’s success at the box office – success that is so unprecedented it continually breaks Y-axis and is now, perhaps, underhyped. The Walt Disney Company was responsible for the highest grossing movies of 2015, 2016, 2017, 2018 and 2019 (a record). It took home the top five slots in 2016 (a record), six of the top ten in 2016 (a record), the top three of 2018, and will likely have the top eight of 2019 (a record). It released the highest grossing film of all time (Avengers: Endgame) and three of only five films that have grossed $2B at the worldwide box office. In the last decade, only 36 films have crossed the $1B mark globally – 23 come from Disney. 12 of the 13 largest opening weekends in US history belong to the House of Mouse. And so on.
Disney’s storytelling culture is at the core of its three multibillion-dollar IP acquisitions over the past 15 years. Few companies are capable of retaining previously independent founders and executives after an acquisition (especially those whose skill comes from creativity rather than managerial excellence). Disney, instead, enabled them to reach even greater heights. To point, Disney’s acquired franchises have drastically outperformed those of its competitors – even when they had head starts of a decade or longer. Warner Bros., for example, has owned DC since the 1970s, and began its Harry Potter partnership in 1999. What’s more, fans often express the wish that Disney controlled even more of their favorite franchises so that their adaptations… would be better. And it’s hard to disagree. Back in 2016, Sony’s film chief said, “we have deferred the creative lead [on Spider-Man] to Marvel, because they know what they’re doing.” George Lucas, who had spent decades saying he would never sell Star Wars, has said he chose to sell Lucasfilm to Disney based on its treatment of and success with Marvel. To point, Lucas solicited no other bidders for the company – and Fox, which had distributed the Star Wars franchise for 35 years, didn’t even know about the sales process.
So, while Disney’s success is bolstered by its smart acquisitions, reinforced through hard-to-replicate structural advantages (e.g. retail presence, theme parks, multi-generational classics), it stems from its foundational obsession with storytelling. Again, this isn’t exactly misunderstood, but it’s important to understand the virtuous cycle this produces – the product of which is often labeled “brand equity”, but is perhaps better understood as “affinity leverage”.
Returns to Marginal Affinity
Businesses based around storytelling franchises (rather than “movies” or “media”) excel based on an intangible sort of operating leverage. Because it doesn’t actually “cost more” to make someone “love your content more”, but the “value of this love” is substantial, companies like Disney benefit from enormous “returns to marginal affinity”. And the more opportunities to exploit this love – and the better you are at doing so – the greater the leverage. Today, Disney leads on both.
This doesn’t mean spend isn’t an important part of establishing or growing affinity; a film needs a minimum production budget to work. But putting another $10MM into a film doesn’t make it “better” (indeed, it’s often worse). Similarly, it doesn’t cost more money for Ryan Coogler to make an A+ Black Panther script versus an A (though this can delay the film’s release). Maybe hiring a writer who can produce an A+ script costs $1MM more than one who peaks at an A-, but even here, the operating leverage is enormous. More importantly, it’s not budget that leads fans to love a film in the first place, nor budget that leads them to love a film more. As an example, consider the effect of Star Wars’ musical score. Not only does it meaningfully enhance individual scenes, but decades later, just hearing it brings about an inimitable feeling of nostalgia. There may be no single element of the James Bond franchise more valuable than its music. Even the smallest and hardest to quantify elements of a creative product will have a powerful effect on affinity – affinity that spans time, products, and failures. And it costs nothing.
As a result of this leverage dynamic, a 5% increase in “affinity” can, say, drive 10% more revenue and 15% more profit. Consider, for example, that while Disney’s studio revenue has grown over the past several years, its operating income has grown far faster. The leverage is profound.
We can see broader evidence of this in CinemaScore ratings, which reflect the average review given to a film by those who had seen it during its opening weekend. This score strongly correlates with “word of mouth” and therefore a film’s “legs” (the “box office multiple” reflects how many times larger a film’s final gross is than its opening weekend). Spend isn’t what drives a film from an A- to an A+ or explains a B- versus a C+, but the impact of a higher score is substantial and, as it costs a distributor nothing (ceteris paribus) for 100 people to buy a film versus 80, a greater multiple flows strongly to the bottom line.
The value of “affinity” is even stronger when applied to media products with scarcity. There’s no real cap on movie tickets or TV viewers, but Elsa dresses are finite, and theme park attendance is controlled. As a result, marginal affinity can drive substantial pricing power. Those who need to go to Disneyland aren’t very price-sensitive, nor are parents whose daughter needs an Elsa dress. Incremental love monetizes exponentially and extensively.
To this end, there’s something funny about the fact that in the digital era, Disney’s most defensible, profitable, and unique business is its most analog and costly – theme parks and resorts. And because of the scarcity of land near urban areas, not to mention “cost disease”, it’s incredibly difficult for this businessline to be replicated today. And yet, the effects are profound – and not just in monetization. How much richer can fandom be when it's also experienced in the real world and immersive? How much more ingrained is a kid's love for Disney/Pixar when once a year, they spend days hugging its characters and being encouraged by them? Fans simply cannot experience DC as they can Marvel, nor Lord of the Rings as they can Star Wars. If WarnerMedia had an incredible and popular Middle Earth park, would the Tolkien Estate have wanted to sell TV rights to Amazon? Would WarnerMedia have had an effectively insurmountable advantage in what it could economically bid for the series?
The best option for IP holders without parks is to partner with those who do. Prior to its acquisition by Disney, Fox struck a long-term worldwide theme park licensing partnership with Disney for Avatar. Time Warner licensed the Wizarding World of Harry Potter to Universal Studios, which began developing parks in the 1960s. Nintendo, too, has licensed its IP to Universal. This helps, but it still caps ARPU, limits integration, and means entrusting creative execution (both in designing the park and operating it day-to-day) to a third party. AT&T could build a theme park, of course, but it would cost many tens of billions at a time in which the company is spending even more on 5G network upgrades, spectrum and content.)
Building Marginal Affinity
So, the right frame for Disney is not really an “IP” play, but an “affinity leverage” one. And this dynamic goes both ways. Marvel Studios has clearly overperformed forecast “affinity” over the past decade and the results have been extraordinary. Over its first five years (“Phase 1”), the super-franchise released only 1.2 films per year and averaged $291MM (inflation adjusted) domestically. Since 2016 (“Phase 3”), the MCU has released 2.75 films per year and averaged $450MM per film. Only two of these 11 films grossed less than the Phase 1 average.
The MCU’s ability to increase output by 130% and unit performance by 30% stems from the brand’s goodwill the company built over its first films, which led to a constant expansion of its fandom (# of fans * affinity) and the ability to launch new mega-franchises around previously unknown characters, such as Guardians of the Galaxy and Black Panther. MCU affinity subsidized the creation of new IP.
For similar reasons, falling short of anticipated affinity can become expensive quickly. Earlier this year, Disney admitted that its newest theme park attraction, Star Wars: Galaxy’s Edge, had underperformed. Specifically, the company had overpriced admissions to the park, overestimated demand, and opened before Galaxy’s Edge’s second attraction was completed (suggesting they thought one attraction was sufficient). Clearly, audience affinity was lower than Disney estimated. In truth, Disney should probably have prioritized the buildout of The Avengers Campus attractions, which are due in 2020, 2021 and 2023 globally. Similarly, Star Wars toy sales have also dropped significantly since 2015’s The Force Awakens, with even Hasbro’s CEO attributing a disappointing fiscal quarter and year to an overestimation of demand.
And as films, like theme parks, are mostly fixed costs, the results of declining affinity are significant. 2015’s Episode VII grossed $2.07B and delivered a $780MM profit, while 2017’s Episode VIII grossed $1.33B (↓36%, well short of expectations) and netted $418MM (↓46%). 2016’s Star Wars Story: Rogue One pulled in $1.05B gross and $320MM in profit, while 2018’s Star Wars Story: Solo failed to cross $0.4B (↓62%) and lost $77MM. Struggles to build affinity in China have been particularly significant. Despite substantial investments in local marketing, Star Wars just hasn’t taken off. 2015’s Episode VII did $124MM, 2016’s Rogue One achieved $70MM, 2017’s Episode VIII did $43MM, while 2018’s Solo hit only $17MM.
I’ve written previously about the managerial mistakes I think Disney made with Star Wars and why. One of the challenges here is that just as affinity picks up momentum, the reverse affect occurs, too – which I call “accrued disappointment”. Whether it’s a movie, album or book, unit sales in media are typically referendums on prior releases. In 2016, for example, DC boasted about the irrelevance of critical reviews and exit polling after Batman v. Superman (27% Rotten Tomatoes, B CinemaScore) and Suicide Squad (a barely known franchise in the DC universe that also earned a 27% and B) opened to massive $166MM and $134MM grosses. Two years later, DC’s signature film, Justice League (40%, B+), cratered with $93MM despite starring the three most popular DC characters (Batman, Superman and Wonder Woman). We saw a similarly precipitous decline with Fox’s X-Men. Goodwill surrounding 2011’s First Class (86%, B+, $353MM) superpowered 2014’s Days of Future Past (90%, A, with a then-franchise record $748MM). Goodwill around this film then helped float the dreadful Apocalypse in 2016 (47%, A-, but $544MM), which then sunk the even-worse Dark Phoenix (23%, B-, $252MM), which lost $100MM+. Netflix’s Marvel Defenders series, meanwhile, was defeated by the fact that each season was bloated and overlong; eventually, audiences started tuning out.
Notably, the arguments around “accrued disappointment” and “affinity” also speak to the dangers of subverting audience expectations rather than indulging them. At the core of Disney’s Star Wars: Episodes VII-IX, for example, is former hero Luke Skywalker’s disillusionment with the Force, with the entirety of The Force Awakens trying to find Luke after he fled his newfound Jedi Order for ascetic solitude. And when he’s finally confronted in the opening moments of The Last Jedi, he promptly throws away his lightsaber and walks away without saying a word. Later, after rejecting a request to help the Resistance, he says, “You think what? I'm gonna walk out with a laser sword and face down the whole First Order?” This is, of course, the single thing fans want most (and have been waiting for since 1983). And when Luke does face off with the First Order, he turns out to be a force-powered hologram. He wasn’t immune to ATAT blasters, nor faster than Sith aspirant Kylo Ren, but instead performed a Jedi trick. Avengers: Endgame, meanwhile, is very mindful of fans’ wants and expectations. There’s the odd moment of subversion, such as Fat Thor (though he still fights and kicks ass), but the film is mostly about paying back the preceding 21 films. If Avengers: Endgame had been styled as The Last Jedi, Captain America would have tried to pick up Mjölnir, but failed (instead, he picked it up and created the most audience thrilling moment of the film).
A good storyteller must constantly challenge and shift audience expectations – otherwise there’s no surprise. But to subvert, you have to then delight by an equal (if not greater) amount. And the more (or longer) you subvert, the more precarious the execution and the more endangered the affinity.
The Bear Case for Disney Affinity
Regardless, if there’s a bear case for Disney in the years to come, it’s that relative affinity will decline. It’s well known that Disney’s revenues (especially in its motion pictures group) will drop substantially in CY 2020, 2021 and 2022 as compared to 2018 and 2019, but a reduction in affinity would be far more consequential.
While the current heights of the Marvel Cinematic Universe were themselves hard to imagine years ago, it seems likely the future will be more modest. The MCU’s two central characters, Iron Man and Captain America, have exited the franchise. The third lead, Thor, doesn’t have a film due till 2022 (five years after his last). In addition, the franchise’s recent performance was supercharged by the fact that it was the explicit culmination of a 22 film arc. It will take years for Marvel to build equivalent audience investment – and even then, it’ll be attempting to do something again, rather than something never seen before.
In addition, Marvel’s forward slate contains fewer films per year and is comprised of significantly less popular characters and IP. It will be nearly a year after the last film in the “Infinity Saga”, Spider-Man: Far From Home, until another MCU title launches. And this title, 2020’s Black Widow, focuses on one of the least popular of the original Avengers and is set in between films the audience has already seen. It’s then another six months until Marvel releases its next film, The Eternals, which is based on virtually unknown IP. The next title is Shang-Chi and The Legend of the Ten Rings, based on another little-known Marvel superhero, followed by a sequel to Doctor Strange (the lowest performing of Marvel’s last four films that focused on a new MCU character). It’s not until H2 2021, two and a half years after Avengers: Endgame, that a major sequel with a large fandom is released (Thor: Love and Thunder). And not for nothing, the DC universe seems to have finally hit its stride after years of languishing.
Over the next few years, Star Wars will also transition from having one major film release per year, to having only a single TV series. While Disney has suggested that a temporary pause/reduction in “Star Wars” content is good for the franchise’s overall health, it’s hard to imagine affinity for the IP will grow during this period.
And at Pixar, it looks like the next two to three years will consist of original films, not sequels to existing IP like Toy Story or The Incredibles. This is good in the sense that it allows Disney to generate new IP (and Pixar has done this several times already), but Disney isn’t prepped to exploit it right away. It takes time to build theme park attractions and scale merchandise sales, among other things.
The Bull Case for Disney Affinity
Still, there’s reason for optimism. For one, Disney’s storytelling expertise and existing franchise affinity provides an outsized chance that its original IP and spinoffs will work. Guardians of the Galaxy, for example, proved that Marvel is capable of turnings the most obscure and odd title into a major franchise. It will be hard for The Eternals to replicate this level of success, but the precedent is there. Similarly, Black Panther shows how a successful adaptation of a diverse character such as Shang-Chi might perform.
It’s also worth noting that the Marvel Cinematic Universe itself was built on runner-up IP. Marvel Studios would almost certainly have built around Spider-Man (the most popular comic book character in the world), X-Men, and Fantastic Four (“Marvel’s First Family”) if it had the choice, not then-unknown characters such as Hawkeye, Thor and Black Widow. But it didn’t and built an empire all the same. There’s no better case study on the power of quality storytelling. And to this end, the popularity of Doctor Strange has grown substantially since his 2016 debut.
In addition, there’s the possibility the Disney+ Star Wars TV series, The Mandalorian, becomes a Walking Dead or Game of Thrones-level hit. There’s no reason affinity can’t be built (or build most) via television rather than film. And Disney+ will be making spinoff series for Star Wars, Marvel and Pixar (such as Monsters, Inc.).
More broadly, Disney+ is essentially a toolbox for affinity maximization, rather than just an SVOD service. Through it, Disney will be able to know precisely (and for the first time ever) each of its customers – from which characters and franchises they like, how much, and how often. This will enable Disney to make not just better content decisions, but also to better optimize for individual fan affinity through bespoke upsell and cross-sell promotions. Put another way, Disney+ will allow the company to increase the “attach rate” of ancillary Disney products to the average Disney fan, and grow unit pricing of these additional sales. What’s more, the company will be able to do so without retail/re-sellers/distributors that have historically taken a cut of such transactions, such as Fandango or a travel agency.
But most important is how Disney+ will allow Disney incubate and cultivate fan affinity in new ways. Through series such as WandaVision and Ms. Marvel, the company will be able to grow awareness of and love for lesser-known/beloved characters without needing to release films that need to hit $500MM just to break even. What’s more, a multi-hour series is likely a more effective way to build affection for characters who don’t fit “instantaneously cool archetypes” or benefit from pre-existing name recognition. Certainly, it’s hard to do this when these characters are crammed into the margins of much larger films.
Furthering this strategy is the fact that Disney won’t need to ask consumers to spend more money or leave their homes to watch these shows: they can watch them anywhere, anytime and at no marginal cost. This has the potential to rapidly grow the value of Disney’s IP stores (Iger has long spoken about Marvel owning 5,000-6,000 characters, but fewer than 2% have real value today). And with Disney already reaching the point in which the theatrical market can’t absorb more hit Disney films without cannibalizing other Disney films, it needs a new channel.
All of which is to say, Disney+ is both a new opportunity to exploit affinity and an opportunity to grow it. And as with much of Disney’s storytelling empire, no other competitor will be able to replicate it.
Matthew Ball
