Should Disney Divest ESPN?

Dan Loeb, (Source: CNBC)

News reports this week indicate that activist investor Dan Loeb has written a letter to Disney's leadership team, calling on the firm to make a series of strategic changes. Specifically, Loeb recommended a divestiture of ESPN. He also recommended that Disney accelerate the planned acquisition of Comcast's 33% stake in Hulu, and then for Disney to integrate Hulu into its Disney+ streaming service.  Disney's leadership has rebuffed Loeb's attempts to push for change.  

The ESPN recommendation certainly has triggered a lively debate.  Students will find this question an interesting one that goes directly to the heart of many core corporate strategy concepts. On the one hand, ESPN has been a cash cow for Disney for years. According to CNBC, "Disney is making more money from cable subscribers than any other company solely because of ESPN. ESPN and sister network ESPN2 charge nearly $10 per month combined, while Disney requires pay TV providers to include ESPN as part of their most popular cable packages."  Moreover, ESPN+ has become an important part of Disney's efforts to offering streaming options for customers.  ESPN+ has had limited content to date, but perhaps, Disney will eventually offer customers an opportunity to stream all Disney and ESPN content in a true over-the-top option for those wishing to cut the cord.   

Imagine having all Disney cable channel content, all ESPN cable channel content, and all Disney/Hulu streaming content available directly to customers who don't want to purchase cable.  Disney has been reluctant to make this type of aggressive move, in part because the firm continues to generate a ton of cash from fees secured through cable TV subscriptions.  Moreover, Disney would anger cable television partners greatly if it circumvented them completely and went directly to customers.  Still, as more and more people cut the cord, the calculus there may change, and Disney may pursue a complete over-the-top solution for customers.  

On the other hand, in corporate strategy, we typically argue that multiple businesses should only be owned and operated under one roof if they pass two tests:  the better-off test and the ownership test.  The better-off test asks whether significant economies of scope exist, such that ESPN has a stronger competitive advantage because it is owned by Disney.   Loeb argues that it is not obvious ESPN has a more powerful advantage because it is part of the Disney corporate family.  For example, in his letter, he writes, "“ESPN would have greater flexibility to pursue business initiatives that may be more difficult as part of Disney, such as sports betting."  Moreover, the synergies between ESPN and other parts of Disney do exist, but they are not nearly as substantial as, for example, the synergies between the theme parks and the movie studio.  

The ownership test asks whether the corporate parent needs to own a particular subsidiary to actually achieve key benefits of collaboration.  Could another organizational arrangement (ranging from market contracts through strategic alliances or joint ventures) be more efficient and effective than full ownership?  Here too Loeb argues that ESPN may not pass the ownership test.  He writes, "We believe that most arrangements between the two companies can be replicated contractually, in the way eBay spun PayPal while continuing to utilize the product to process payments.”  In other words, ESPN could still work with Disney and its portfolio of companies without being fully owned by the corporate parent.   This argument reminds me of one criticism back when Disney purchased ABC in the mid-1990s.  Some analysts pointed out that Disney already collaborated closely with ABC on events such as the Disney Sunday night movie of the week on ABC (which Michael Eisner would introduce).  The analysts then argued that Disney could pursue more of those types of partnerships and collaborations without having to spend billions to acquire ABC. 

The debate will be fascinating to watch.  The key point here is that Disney should not necessarily own ESPN simply because the subsidiary is profitable.  It also should not necessarily divest ESPN simply because cord-cutting is reducing subscribers at the sports network.  The longer strategic view should be driving this decision with a focus on these two critical corporate strategy tests.  

Should Disney Sell ESPN?

The Wall Street Journal reported this morning on Disney's quarterly earnings announcement, noting that the news disappointed investors.  "Declining income at ESPN continued to overshadow quarterly results at Walt Disney Co., with the sports powerhouse posting lower advertising and subscription revenue that dragged company earnings below Wall Street expectations."  These results continue a multi-year slide in subscriber numbers at ESPN, as many American consumers "cut the cord" - ending their cable television subscriptions.   Some people estimate that ESPN has lost more than 10 million subscribers in the past several years.  

This news raises a key question for me:  Should Disney sell ESPN?   That question may shock some people, as ESPN has been a substantial contributor to Disney's total net income since it was acquired as part of the Disney acquisition of Capital Cities/ABC two decades ago.   However, Disney's corporate strategy has evolved considerably since that time.   During the second half of Michael Eisner's tenure as CEO, Disney diversified well beyond the businesses that leveraged the animation studio as a central asset (acquiring ABC, owning baseball and hockey teams, etc).  However, during Bob Iger's tenure, characters have become the driving force of the corporate strategy once again.   The three major acquisitions during Iger's tenure have focused on expanding the character portfolio, so that Disney can leverage those characters across multiple platforms (i.e. Pixar, Marvel, and Lucas Films).  In many ways, Iger has returned Disney to its roots.   Below you will see famous chart created by Walt Disney himself to describe synergies at the company.   One has to ask:  How does ESPN fit into this chart?   Absent major synergies, and facing a long term disruption to ESPN's business model, might Disney be better off divesting the business unit?   Alternatively, Disney has to take a hard look at reinventing the business model at ESPN, rather than tweaking the strategy.   A reinvention seems necessary given the long term trends regarding cord cutters.   

ESPN: Does Any Other Firm Rely As Much on Non-Consumers?

Fox's Outkick the Coverage blog has a terrific detailed analysis of what ails ESPN these days.   Blogger Clay Travis dissects Disney's recent 10K filings to understand precisely how many subscribers and how much revenue ESPN has lost in recent years, as more consumers "cut the cord" with respect to cable television.   Travis determines that ESPN  and its sister channels have lost 7 million subscribers in the past two years.  That loss amounts of a decline in revenue of roughly $700 million per year.  Travis points to cord cutters as the crux of the problem.  He notes that ESPN has tried to hold onto customers by focusing on live sports programming that is difficult to access without cable television.  However, those pricey contracts for events such as NFL games have increased ESPN's fixed costs tremendously.   ESPN has been reducing its workforce to offset the decline in revenue, but that strategy has its limits.   

The most interesting aspect of the blog post, though, has to do with the analysis of ESPN's customers vs. non-customers.  Here's Travis on the dynamics of cable subscriptions:

When Outkick wrote an article about its business challenges back in July, ESPN sent a statement that included the following data:  "More than half (54%) tune into ESPN in the average month and almost two-thirds (65%) tune into ESPN over the course of a quarter."  If that's true then around 48 million cable and satellite subscribers watch ESPN every month. That's a very big number. But it also means means that 44 million cable and satellite subscribers pay $6.60 a month for ESPN and don't watch it in an average month. That means every month ESPN is pocketing $290 million off cable and satellite subscribers who don't watch the channel. Over the course of a year ESPN makes over $3 billion a year off consumers who don't watch ESPN.  Eventually isn't your Aunt Gladys going to realize this?

I'm not sure that I can think of another company that makes as much money off of people who don't actually consume its product.  The implication of this statistic is significant.  It means that going direct to consumers will be challenging for ESPN, much more challenging than for an organization such as HBO.   The paying subscribers of a direct-to-consumer ESPN subscription will have to pay a substantial enough sum to offset the loss of revenue from non-consumers who currently pay for ESPN even though they don't view it.  HBO doesn't face this problem.  ESPN's high fixed costs make this challenge very daunting indeed. 

Another Crack in the Cable Bundle: Streaming Showtime?

During CBS' earnings call yesterday, CBS CEO Les Moonves reported that "CBSN" - a streaming service launched in 2014 - had exceeded the firm's expectations.   He went one step further and suggested that the company would launch a streaming service for Showtime in 2015.  Of course, HBO announced a streaming service several months ago, but they indicated that the price would be equivalent to what customers pay when subscribing to HBO through their cable company.  Could Showtime move more aggressively and undercut the price available through the cable providers?   If so, it would represent the boldest step yet to undermine the cable bundle.   

The big question still remains: What will Disney do?   They own a huge amount of content that is very attractive to consumers  - all the Disney-related children's programming plus all the ESPN-related sports programming plus the ABC-related news and entertainment products.  If Disney follows Showtime and HBO, then cable providers will begin to feel a great deal of pressure.  Of course, the key question will still be:  When will someone offer streaming at a price BELOW the fees paid through the cable providers?  Each firm, of course, wants to be careful not to "kill the golden goose" i.e. to cannibalize their own profitable business in partnership with cable providers.  However, at some point, the market will tip. The opportunity available from "cord-cutters" will be attractive enough to convince some firms to move more aggressively.   Which firm will act like Apple did when it launched the iPad and the iPhone?  In those cases, Apple was willing to eat its own lunch rather than allow a rival to eat it (i.e. the iPhone cannibalized the iPod and the iPad cannibalized laptop sales).   Most firms in a wide range of industries resist cannibalization, and for that reason, are often late with regard to reacting to disruptive innovations.  Will entertainment companies be different in this case? 

Online Experimentation at ESPN

The Wall Street Journal has an interesting article today about ESPN's efforts to experiment with online video offerings via its WatchESPN app for smartphones and tablets.  You can watch games live via the WatchESPN app, but you must be a cable subscriber to do so.  What about the "cord-cutters" - i.e. the young people who have never bought cable television subscriptions, or who have terminated their cable television in favor of simply having Netflix and other modes of viewing programming of interest to them?  Those folks can't take advantage of WatchESPN.   Why not?   Well, it's all about worries regarding cannibalization.   Sound familiar?  Most incumbent firms facing disruptive threats are fearful of embracing innovations that might cannibalize their core business.  Of course, they often end up in a situation where someone else just comes along and eats their lunch, after they spent years worrying about eating their own lunch.  Here's an excerpt from the article:

Mr. Skipper, a 59-year-old former Spin magazine executive who took the helm of ESPN in 2012, acknowledged a "dissonance" between its instinct to disseminate its content as widely as possible and the usage restrictions designed to safeguard the core television business. "There's no denying there's a certain element of protection and defense," he said.

How worried should ESPN be?  Well, the article cites the fact that the firm lost approximately 1.5 million subscribers between September 2011 and September 2013.   In other words, cord-cutting is a real phenomenon that is beginning to put pressure on ESPN.   Will it cause them to embrace an even bolder business model?  Well, the article notes that HBO is considering selling separate subscriptions to its HBO app for smartphones and tablets (i.e. subscriptions for those who are not purchasing HBO already via their cable company).  If HBO takes the plunge, I would expect others to follow. ESPN will face pressure to move in a similar direction.   Who moves first?  It will be interesting to watch.  

ESPN Faces New Competition

The Wall Street Journal reports that ESPN is launching a significant advertising blitz in support of its "SportsCenter" franchise.  For the first time, ESPN will be advertising the program on other platforms besides its own networks. 

What has triggered the new campaign?  Clearly, the launch of Fox Sports Network and its flagship nighttime news and highlights show has caused some concern in Bristol (headquarters of ESPN).   ESPN, in fact, faces a number of new rivals.   NBC and CBS both now have cable sports channels, and many of the regional sports networks run their own nighttime news and highlights shows to compete with ESPN SportsCenter.

What's caused all the new competition to emerge?  In my view, television networks have focused even more intensely on sports in recent years, because live sports draws young audiences in a world where those young viewers can access other programming content via DVR, Netflix, HBO, the web, etc.

At this point, many of the competitors offer shows that do not look and feel dramatically different than SportsCenter.  The real threat will come if someone figures out how to differentiate successfully.  Beyond that, the threat to ESPN comes as much from substitution as it does from imitation. What do I mean by that?  A preoccupation with new rivals should not preclude ESPN from thinking about the fact that many young people can learn about scores and watch highlights from their tablets and smartphones, and therefore, may be less likely to watch SportsCenter than in years past.  ESPN has done a great job of offering other ways of accessing content, but of course, there are a plethora of options out there for news, scores, and highlights.  Just in the way that SportsCenter made the sports segment on local evening news fairly irrelevant, now digital platforms may be putting a dent in SportsCenter.

Bill Rasmussen: Founder of ESPN - Great Entrepreneurial Story

Why ESPN should embrace crowdsourcing

In the National Football League, statisticians have compiled a measure called "passer rating" to evaluate quarterbacks since 1973. Many people have criticized this statistic since it's inception. This year ESPN invested a great deal of time and effort to develop a better measure that they call "total QBR.". They unveiled the rankings of QBs based on this measure in a TV special recently. They argued that this rating includes a much better evaluation of how QBs perform in key situations.

Interestingly, ESPN did not disclose the actual formula and methodology for compiling the rating. I think this was a mistake. These days so many statistics experts love to dissect sports. They would love to sink their teeth into this rating. If ESPN embraced crowd sourcing, they could create a contest whereby many people could compete to refine and improve the measure. They could offer a special prize for the winner - think one day at the firm's Bristol headquarters complete with a lunch with a top ESPN personality. Such a contest wouls be very inexpensive to run, but it would have many benefits. It would engage many rabid sports fans, who are ESPN's core customers. The contest would specifically build connections with stats-obsessed fans. It could yield a better measure. Moreover, being open about the method could enhance the acceptance and use of this new rating by fans, media folks, and teams. Think of the hoopla that they could create and the attention it would draw.

ESPN - The Beginning

I'm reading Tom Shales and Jim Miller's entertaining book about ESPN - Those Guys Have All The Fun. In it, Bill Shanahan - an early employee - comments on how ESPN invented a new brand of TV. He points out how fortunate it actually was to be in an out of the way place like Bristol, CT. Many disparaged Bristol. However, He said that they were not surrounded by "industry wisdom" - and that was a huge blessing. I think it's a terrific point. Being distant from the existing players in your industry might help you go against the grain and think differently about the industry.