(This is Part VII of a multi-part series answering the question: “How Much Money Did Disney Make on the Lucasfilm deal?” Previous sections are here:
Part I: Introduction & “The Time Value of Money Explained”
Appendix: Feature Film Finances Explained!
Part II: Star Wars Movie Revenue So Far
Part III: The Economics of Blockbusters
Part IV: Movie Revenue – Modeling the Scenarios
Part V: The Analysis! Implications, Takeaways and Cautions about Projected Revenue
Part VI: Disney-Lucasfilm Deal – The Television!)
In business school, as I said in my first article in this series, I was super bullish The Walt Disney Company. The Lucasfilm acquisition followed on the heels of the Pixar and Marvel acquisitions—which were already doing well—and at the time ESPN was a cash juggernaut. Strategically, they’d made a series of great decisions.
Still, those moves, while good, weren’t the core reason why Disney has succeeded so much over the last forty or so years. I believed then, and still do now, that Disney is one of the few movie studios that has a business model derived from a distinct competitive advantage. As others have written about, this competitive advantage goes back to drawings by Walt Disney in the 1950s.
Basically, while having a great content is at the center of the plan, they develop and reinforce their relationship with customers through everything else. Or, to be cynical they make their money off everything else. Walt Disney created an iconic character in Mickey, then another in Snow White, then another in Cinderella, and so on to start. Then Walt Disney (the person and the company) would monetize the characters through music and books and comics and eventually television. Then they pioneered the concept of theme parks. Michael Eisner took this approach and applied it to home entertainment and acquiring TV networks.
When I was in b-school, I took the famous chart and summarized it in economic terms thusly:
This is the simplest description of supply and demand in the marketplace, the core model at the heart of economics. Basically, along any curve, you maximize your price and quantity sold to yield the highest profit. I’ll cover this more when I write an article on “Transaction Business Models Explained!” (the sequel to my two articles on subscriptions) but for movies you basically can only charge the same price per movie ticket, regardless of movie. As a result, to maximize revenue you need to maximize customers, and hence Hollywood makes blockbusters.
Most studios stop there. But not Disney. They aren’t just selling movie tickets, they’re selling merchandise on top of that. And then, for the piece de resistance, they sell theme park admissions (and in park up-sales) in an experience they own outright. Other studios do this, but nobody does it as well as consistently as Disney.
In my adventures after business school, I’ve only become more convinced that Disney knows its business model, knows its competitive advantage and makes moves to sustain that model. They may be the only movie studio, er, “giant media conglomerate” that has a competitive advantage. To continue our series on Lucasfilm, I’m going to add in the rest of those boxes going up, starting with merchandise.
Merchandise: The Background on this Misunderstood Industry
Tyler Cowen has sort of pioneered the use of “over-rated or under-rated” for topics. So, in his honor, over-rated or under-rated:
Licensing as the savior of IP.
I would say, over-rated. Unless you’re Disney, at which point it may be still under-rated. As I put above, it may be the key to their business model. And maybe that duality is cause and effect.
Let’s start with the over-rated part. The licensing world loves to describe things in terms of their total revenue sold. When you read a news report in the trades hailing Star Wars as selling “3 billion dollars in merchandise” that’s the total amount that customers paid at the end of the day. But that doesn’t mean Disney (through Lucasfilm) collects all of that.
Far from it.
To start, the manufacturer who is licensing the rights doesn’t even collect the whole revenue, they collect about half. Whoever is the end distributor (Walmart, Target, Amazon, formerly Toys’R’Us RIP) charges usually a 100% mark up. (So if they buy it for $10, they sell it for $20.) Disney (and other licensees) get their royalty rate off the wholesale price.
The royalty rate can range, but if you want a “rule of thumb” go with 10% off the wholesale price, or 5% of the retail price. So if a product sold for $20, the licensee gets $1. I say roughly because there are a whole host of factors to put into that. Different types of products from t-shirts to stuffed animals to furniture have different royalty rates. (I avoided using the industry terms like apparel, plush and hardlines to avoid boring the audience.)
That said, you can only push royalty rates so far before something becomes unprofitable. Take apparel. That’s a very low margin business because pretty much any Joe Schmo can buy blank t-shirts and a screen printer if they wanted. If margins are already super low, a t-shirt or pajama company can only give so much away in royalties. (Kids pajamas, for example, also have a lot costs for testing to ensure they don’t hurt kids.) T-shirt companies, unlike streaming video platforms, must have costs lower than prices to stay in business.
Can Disney demand higher royalty rates? Yes, up to that point above. Disney is the current king of the licensing game. Hence, they demand more shelf space game at traditional retail outlets, nearing a monopoly position on the store shelves that still exist in Walmart and Target. One of the things the Star Wars acquisition did was give Disney additional power to demand shelf space in the boys section. With this power, it can crowd out competitors.
That’s why I call this “over-rated”. If you own the rights to kids IP, and want to get into the kids merchandise business, don’t use Disney as your model. Don’t even use Nickelodeon. It’s a crowded space and you won’t be Disney unless you routinely release billion dollar movies and have well attended theme parks.
The General Performance of Star Wars Merchandise – Toys
Before the acquisition, one of the few independent brands that could even dream about competing with Disney was Lucasfilm. Star Wars has always done well in the licensing and merchandise game. In 1978, after Star Wars exploded at the box office, the Star Wars toys basically created the idea of movie-driven merchandise. (Before that it was TV-driven merchandise. Look up Davy Crockett raccoon fur hats, also a Disney thing.)
Lucasfilm continued to do well even with the prequels, but under Disney’s management and three HUGE films, how much higher has toy and apparel and all licensing revenue gone? Let’s continue with our theme: Lucasfilm merchandise sales, over-rated or under-rated?
In 2015, the story was all The Force Awakens. It was gigantic. So we would have said, “under-rated”. Disney was selling more toys than it knew what to do with. Well, I take that back, it knew what to do: sell more toys! Hasbro signed a big extension with up front money for Disney for about $224 million over ten years. One analyst projected Disney would sell $3 billion in 2015, growing to $5 billion in 2016.
Then, by 2018, Star Wars wasn’t selling. That was quick. This didn’t make as many headlines, but slipped into Hasbro’s earnings call earlier this year as it said that licensed toy sales were down 21%.
One of the problems with Star Wars merchandise was the adult collector market. On the one hand, it’s great to have a bunch of adults buying kids toys; on the other hand, they can grow bored by it. By the third film the enthusiasm had worn off. My theory is new trilogies prompt collectors to surge, then they realize everyone is collecting the stuff and it peters out.
(If you’re curious, the picture headlining this post is a small sample of Star Wars licensed merchandise I have in my office.)
For kids, I think there was also such saturation of Star Wars toys following the first film. For stores, they purchased the roughly the same volume of goods they did for Rogue One as they did for The Force Awakens. They weren’t ready for the downturn in demand. As others have written, Rogue One aldo didn’t lend itself as well to toys given that it was more adult focused.
The General Performance of Star Wars Merchandise – Multimedia
Star Wars is also a “multimedia” juggernaut, selling books, comic books and video games. Those brand extensions have also done really well and then come back to earth in the same fashion. Take comic books. When Marvel relaunched the series with the new Star Wars #1 (the original Star Wars #1 came out in the 1970s), the book did over 1 million in total sales, making it the biggest comic book sale since 1993. Since then, the comics have dropped back to earth. In July of 2018, for example, the top Star Wars book sold 60 thousand units. Great, but not like that initial number.
Video games are the same story. When EA released Star Wars: Battlefield, it did 14 million in unit sales. The sequel to Battlefield, released last fall in 2017, saw tremendous customer backlash as EA was pushing a lot of in game purchases, which customers hate. Sales weren’t as strong, around 10 million or so from what I’ve seen. So in general we’ve seen a trend: tons of interest after The Force Awakens was released, that revitalized the whole franchise, and now we’ve returned back to earth.
Star Wars book have continued to do well, as they have since 1995 when Lucasfilm published the Timothy Zhan Heir to the Empire series (or “The Thrawn trilogy”) and essentially jump started the Expanded Universe. Since the Disney acquisition, it’s unclear if the book sales have taken a new leap, or just continued at the same rate.
Calculating Specific Revenue Projections
Unlike the feature film portion, the L&M calculations will be fairly straightforward: we’ll try to find total retail sales, and assume Disney collects about 5% off that, based off the calculation I put at the front. If we can find out how much Star Wars merchandise was sold in total sales, we can see how much money Lucasfilm-owned-by-Disney can make.
Disney could make more or less than 5%, but on average I bet they end up there. Also, they have a huge SG&A staff to run L&M—I mean thousands of people—and I’m not going to account for that explicitly. We’ll leave SG&A for the “put it altogether section” at the end of the novella I’m writing. (Current word count is 25,000 words if you’re curious.)
But even if the calculations are easy (5% of total revenue!) the total revenue estimates can be hard. Take this fun thing I came across:
– In 2015, an analyst boldly claimed Stars Wars would do $3 billion in sales.
– In 2012, the Hollywood Reporter reported that Star Wars did $3 billion in sales.
Even after three years of growth and a new movie…sales were flat? This is the challenge with licensing revenue. No one publishes their data like box office, so we have to make some assumptions. If you have access to some databases (like NPD point of sales data) you can refine your estimates or at least rate for size. Even then, coding different products can throw off the analysis.
But you’re not paying me to say this is tough. Well, you’re not paying me anything. Still, you want me to tell you how to estimate these sales.
The biggest challenge is one similar to the challenges I addressed when I described Twitch’s numbers of viewers compared to Netflix and HBO. There are a lot of way to describe licensing sales, and articles often do so in blaring headlines without properly defining their terms. Here are the biggest categorizations that you need to sort through when reading an article on licensing or merchandise sales:
– Time Period: Lifetime sales or the most recent year?
– Location: The US only or globally?
– Categories: Sales of video games, books, toys, apparel or all of it?
– Retail revenue versus royalty revenue: Is this the amount sold at stores or collected by licensees?
Let’s start historically. I found three different articles speculating on how much Lucasfilm has made off Star Wars merchandise since the first movie launched in 1977. Again the number have a big range:Star Wars moves hundreds of millions per year in merchandise, not even factoring in inflation. Also, the Daily Beast article further supports our rule of thumb: for his initial deal, Lucas and Fox split 5% of retail sales.
How have sales grown since then? Well, it’s tough to say. Multiple articles touched on the fact that Star Wars helped grow total licensed merchandise sales in 2015 and 2016. Disney itself reported strong earnings in its Consumer Product division in those years as well.
Unfortunately, I’ve only actually come across one person who estimated their total licensing revenue, and it’s from 2015. Morgan Stanley’s Benjamin Swinburne in the middle of 2015 forecast the $3 billion in licensing revenue in 2015 number from above, with it peaking to $5 billion in 2016. As far as I can tell, every other article on Star Wars licensing since then has just repeated his projections. So we don’t really have a “crowd sourced” opinion, we have one opinion repeated multiple times. (I did find a Statista article with CPG sales for Star Wars in America, but it doesn’t have a source, so I’m not using it.)
We don’t have any other projections.
Yet, we do have multiple sources pointing to the downturn in Star Wars sales in 2017. These include Hasbro and Disney earnings reports (partner toy sales down and consumer product division sales down, respectively). One data firm that tracks shipping containers noted that Star Wars shipping containers were down. This estimate had containers down by 50% in 2017 compared to previous years.
This is where I’ll have to make some assumptions. I definitely think Star Wars did at least $3 billion a year in total retail sales globally, and think The Force Awakens pushed it up higher for the one year buzz factor. Then, I think it dropped back down. The $3-5 billion range makes sense for the number one franchise in total sales. I’m still adding the Hasbro $225 million royalty promise on top of the royalty rate, because I think that was the price of business with Disney.
Also, I modeled the video game sales only for the two Star Wars: Battlefront games given how well they did and they are much higher value than, say, mobile games, right now. I assumed $60 unit price, of which Disney collects 5% (like other licensing deals) and sales of 14 million and 10 million units respectively, with a third sequel in 2020 doing 10 million in sales. I didn’t factor in in-game purchases.
With all that, here’s my year by year model:On the bottom line, you may look at the $3 billion in total revenue and say, “Wow, that’s three-quarters of the entire value of the Lucasfilm deal.” That’s true.
Of course, if you’ve been reading this entire series, than you know by now that we need to discount for the time value of money, or in this case the “weighted average cost of capital” which for entertainment is 8%. When we compare our numbers to the 2012 acquisition price, we need to account for how money is more valuable in the present than in the future. (And also the risk of investing in entertainment, versus say government bonds or the S&P 500.)
So, according to these estimates, did Disney make money on the deal? Yes, $1.76 billion in adjusted revenue off $3 billion in total revenue. Again, this deal keeps looking better and better for Disney.
Next time, we’ll finish off the revenue streams as we head to the theme parks.