Disney ditches Netflix in search for rich new kingdoms

Is content still king?

It was Bill Gates of Microsoft who declared it so in 1996, but the proposition has been repeated so often by Disney executives that it could have served as the company’s corporate slogan.

When AT&T announced its plan to take over Time Warner 10 months ago, Disney’s chief executive, Robert Iger, said the deal proved yet again that “content is king.”

So Disney’s abrupt strategic shift just two weeks ago sent shock waves through Hollywood, Silicon Valley and the telecommunications industry. The company said it was buying 42 per cent of the internet distributor BamTech for $ 1.6 billion (U.S.) — bringing its stake to 75 per cent — creating its own direct-to-consumer streaming service and severing its lucrative licensing deal with Netflix for Disney-branded content in the United States.

“Is the network — the platform — now most important?” asked Michael Olson, the consumer internet analyst who covers Netflix for Piper Jaffray.

The idea that content is king has long rested on the notion that distribution — in whatever form it takes — is a low-margin commodity and the biggest share of profits flows to the creators of original programming, who can sell to the highest bidder.

In keeping with that philosophy, Disney made its biggest bets on intellectual property, acquiring Pixar ($ 7 billion), Marvel Entertainment ($ 4 billion) and Lucasfilm ($ 4 billion). Those bets have paid off handsomely for shareholders.

But as internet streaming disrupts channels such as cable and broadcast, Disney now appears to have set its sights on distribution — and a potential new revenue source.

There’s no question that the internet generally, and Netflix specifically, upended the traditional content-distribution supply chain and caused profound changes in the entertainment industry. As the New York Times has reported, Google, Apple and Facebook are moving aggressively into Hollywood’s turf, preparing to spend billions to create original programming, as Amazon did before them.

These technology giants already have huge user bases and large wallets. In July, Netflix said that it had achieved a larger-than-expected increase in subscribers, who total 104 million, and that it was reaching about half of U.S. households.

“Anyone who wants to compete directly with Netflix or the full spectrum of competitors who are getting into this space had better be ready for a long, hard fight and have very deep pockets,” Olson said. “They have the money to spend on content and they already have huge direct-to-consumer user bases and traffic.”

Netflix got where it is today in part by licensing Disney’s popular children’s offerings and Disney- and Pixar-branded films. Neither company has disclosed what Netflix pays for those rights, but analyst estimates range from about $ 220 million to $ 300 million a year.

As long as Netflix was primarily a distributor, it posed no threat to Disney, and offered a revenue source to complement Disney’s cable channels and movies. Investors cheered when the licensing deal was announced in 2012.

But Netflix went from partner to competitor by spending heavily to create its own programming — especially in the coveted children’s market long dominated by Disney.

Next year Netflix is adding a new animated series based on Dr. Seuss’s Green Eggs and Ham, with Ellen DeGeneres as executive producer. It also has a deal with DreamWorks Animation for 300 hours of new children’s programming.

“Disney served its purpose,” Olson said. Now, Netflix “has reached a critical mass of content and users where it doesn’t really need Disney anymore.”

And it’s hedging its bet. For now, Disney’s Marvel and Star Wars programming remains on Netflix. The most common criticism I heard wasn’t that Disney was trying to create its own direct-to-consumer model, but that it had waited too long.

Still, nearly everyone agreed that if anyone can pull it off, it’s Disney — and only a few others.

“After Disney, the possibilities drop off pretty precipitously,” Olson said.

As Creutz put it in a research note, Disney’s move is putting “a very settled and successful part of the business model” at risk and “more aggressively pushes the traditional content business into terra incognita.”

Olson agreed. “If anyone can do it from a content perspective, it’s probably them, because of their unique brand awareness,” he said. “But they’re coming from way behind.”

But Kevin A. Mayer, Disney’s head of corporate strategy and business development, told me that his company’s move wasn’t a Disney vs. Netflix issue, but just the first step in a long-term growth strategy for Disney. “We can both do really well,” he said. “There’s no zero-sum game here.”

Although it may seem a paradox, Mayer says he believes Disney’s move into direct-to-consumer distribution — not to mention the tech world’s rush into original programming — demonstrates that “content is everything these days.”

Unlike the old world of cable and broadcast, “the barriers to entry for an over-the-top provider are pretty low,” he said, meaning a provider that distributes content directly to consumers through the internet. “All the consumer is buying is content, not the apparatus to deliver it. Netflix is only as good as its content and its brand. We’re already good at both.” (Netflix officials declined to talk to me for this column.)

In short, from Disney’s perspective, Mayer said, “content is more king than ever.”