The Economics Behind Not Releasing Star Wars Films Exclusively on Disney Plus – Part II

(If you missed yesterday’s post, click here.)

Let’s continue with where we left off yesterday. The risk for eliminating theaters and associated early windows (home entertainment and pay-per-view) is in the hundreds of millions of dollar range. So can Disney make that up by releasing new Star Wars films directly and exclusively on Disney Plus?

Part II: Calculate the value of “exclusivity” and “day and date”

Running your own streaming service could be worth all the revenue per film you exchange in box office, pay-per-view, EST and DVD sales. Maybe. The bulls like me would say, “So Disney should exchange making money in theatrical sales for losing billions like Netflix or Hulu?” Hmm. The bears would say, “Look at Netflix’s market capitalization.”

But we’re not looking at the whole platform. We’re looking at individual films. The problem is most of the ways people calculate the value for an individual title on a streaming platform are more wrong than they are right. Or let’s say “suboptimal”. Let’s review how NOT to calculate this number. (With the caution that I can/will write a bunch of articles on this)

Suboptimal Method 1: “Multiply number of people by price per month”

Let’s say 50 million people watch a Star Wars film when it releases on Netflix. (Yes, I think that’s a pretty good estimate. Call it “one Bird Box”.) So the math is:

suboptimal 1

Bingo! $550 million! We should skip the theatrical window.

Hold on. I see some problems with the math. Actually, that method is simultaneously both too high and too low.

(And I bring this up because I hear this discussion of streaming economics all the time on podcasts. I don’t know why podcasts in particular do this math, but it happens.)

First, on the, “this math is too high side”, how do we account for a customer who subscribed to the Disney platform, binges 12 “tent pole” movies, then unsubscribes? Do we have to divide by the number of films? Or what about the new Star Wars series, if a customer watched both? This is why you factor in the total value of the catalogue. So it’s too high.

On the converse side, I could be shortchanging the film. What if it acquired customers? Attracting new customers has to be more valuable, right? They aren’t just worth one month, they’re worth their “lifetime value”. A good model should account for that. And that happens to be…

Suboptimal Method 2: “Multiply number of people by CLV” (even higher)

To start this analysis, we need to estimate a “customer lifetime value”. Note, when Disney launches their service, they won’t have a clue what this is. They’ll have estimates—which aren’t much better than guesses—but they won’t know. If you have no subscribers, you lack the best data to judge retention rate. Sure, you can use Hulu’s data, but there are a host of variables you would need to account for. (Say how their price fluctuates wildly to bring in customers.)

So back of the envelope, let’s assume a new customer stays for on average two years. They pay $11 per month, and you paid $30 to acquire them through partnership bounties and direct marketing. Here’s the math:

sub optimal 2

So if Disney releases a film, and 50 million people watch, that’s worth nearly $12 billion dollars! Release 12 movies like that and then it can make 144 billion dollars!

Do you see the flaw in this logic? 

Well, the flaw is a simple one that even financial wonks in the government make: you can’t count revenue twice. If a customer’s lifetime value counts for one film, you can’t count them again. That was their “lifetime value”. This is why when people “do the math” for Netflix, they talk about new subscribers to Netflix as if they’re brand new for every movie. So they calculate paying customers for The Cloverfield Paradox, then Adam Sandler films, then rom-coms, then Christmas Chronicles and then Bird Box, and each film on its own seems to pay for itself.

For the math above to work, Disney would need 50 million additional new customers per film, which would be incredibly hard to do. Netflix is just over 130 million customers worldwide. So 600 is a big stretch. Think of it this way: the total number of potential subscribers in America is about 110 million potential customers, which is roughly the number of US households (That’s ESPN’s maximum on subscribers, for reference.)

Optimal But Really Difficult Method 3: Calculating lift and retention per film.

So how do you calculate the value of an individual film? Well, you calculate how many new customers a film did acquire and the ability of any film/the catalogue as a whole to keep customers subscribing. This requires a lot of data and calculations based on lots of observed customer behavior.

But still we can estimate. Of the hypothetical 50 million viewers of a new Star Wars film, let’s say that film “acquired” 1 million customers and encouraged 500,000 to stay with the service. With our CLV from above and a new “retention value”—it won’t be as high as CLV since they’ve been in the service longer—you get something like this:

Suboptimal 3 v02.png

Now that’s both reasonable and getting pretty close to our gap described above (remember we need at least $350 million in lost gross profit). So if you just squint and imagine 2 million acquired customers and 1 million retained…

…but wait. It’s really hard to acquire that many subscribers. Look how long it has taken Netflix. And even if 5 million brand new people watch a show, you have to attribute their viewing for all the things they watch. That’s why I lowered it to something like 1 million people, which is still really high. Morever, all of this is just guess work, unlike box office revenue, which we know pretty well.

Not to mention, there is still a huge flaw in the above calculation.

See the value for a service like Disney isn’t how many total customers are attributed to signing up or staying with a streaming service. That’s true for a movie even if it isn’t brand new, exclusive and day & date. In other words, what we really need is the “marginal benefit” for the Star Wars films, and the above calculation is the absolute benefit. Moreover, at first, sure, exclusive movies will have huge customer acquisition value, but that will drop off rapidly as customers are acquired. Disney needs a strategy that works for films rolling out over years.

So that means we’re back to…

Optimal But Data Required Method 4: Just use comps

This is why, if you can, the best models are based off what people actually pay for things. Meaning, we don’t need to do this calculation ourselves. We know Netflix is already doing it. They’ve already judged that the Disney films are worth $300-$400 million per year to acquire and keep customers. They’ve done that analysis above. 

In other words, our SVOD calculations make this look really hard. It’s not impossible—with the right attribution, sure, the Star Wars films could be worth more on streaming—but the numbers are really big. (Remember, a 400% premium over what Netflix currently pays.)

Part III: Add in the “qualitative” factors

Still, even after all the numbers, we can think that certain factors will make up the difference. These factors–if we believe them–mean that our models don’t apply because we’ll over perform them so strongly. So I’ll review them, and we can weigh them to ask, “do these get us over that huge hump above?” If our answer is that, in most cases, Disney would be able to get nearly as much streaming value for not launching exclusively as for maintaining theatrical distribution, well Disney knows what they need to do. 

Pro-Streaming Qualitative Variable: Launching day-and-date shows you’re “all in” or “serious” to customers.

This is the primary argument, from what I can see, against releasing in theaters. So it’s up first. My argument? It really doesn’t matter to customers. Customers are wildly uneducated about the future of entertainment. They don’t follow the trades, even as The Hollywood Reporter, Variety and Deadline (with other content focused websites) bring the knowledge closer than ever to customers. Being “serious” doesn’t really influence what shows customers watch. They use services they love and watch great content.

Pro-Streaming Qualitative Variable: Continuing with theatrical releases will “devalue” straight-to-streaming releases.

This is probably true, but if anything, would help Disney further make its case that its Star Wars and Marvel films are more “premium” than movies going straight-to-streaming, mimicking the “straight-to-video” epithet of the 90s. So its films will continue to dominate news stories about dominating the box office, further increasing their value. So it’s actually a “pro” for releasing in theaters.

Pro-Streaming Qualitative Variable: If a movie bombs at the box office, it won’t have a chance on streaming.

In my mind, this is the primary driver behind Netflix keeping its movies away from theatrical releases. That said, I see two arguments against this. First, good movies spread because they’re good. Lots of people watched Bird Box because they heard it was good. Sure, it started with prominent placement, but if people had hated it, Netflix would have moved it and it would have plummeted in viewing. (Like Mowgli say.) Second, movies bombing or underperforming at the box office has never discouraged those same films from second lives on pay-per-view or premium TV channels. Sure, all out disasters don’t get any additional marketing. But even middling movies get newfound life on second windows.

Pro-Streaming Qualitative Variable: If customers see it in theaters, they’re less likely to subscribe to Disney Plus. 

In other words, Disney in cannibalizing viewers. This just doesn’t hold up to scrutiny. Obviously, not every subscriber to TV sees every film in theaters. Netflix and theatrical film going are NOT complete substitutes. Sure, Netflix viewing substitutes for some theatrical attendance, but not 100%. And so does cable, and Disney sells all its movies there too. Further, in the case of super-hits—like Star Wars or Avengers or Black Panther—super fans watch them multiple times. I sure did/do. So Disney will still get the benefit of those rewatches on its streaming platform.

Pro-Streaming Qualitative Variable: You’re thinking “US”, Netflix is thinking “world”

This is fair. It’s a big world. Sure, getting 600 million subs is impossible in the US, but there are 6 billion people worldwide! However, while it’s a big world, it’s not an equally rich world. And the entire Middle Kingdom is blocked off from US streaming for the time being. When you factor in what each customer can actually pay, well your CLV drops way down. Which means you need even more people. Factor all this in, and yeah it’s a big world but we can make decisions territory by territory to maximize our revenue.

Pro-Theaters Qualitative Variable: Even if theaters “break even” it’s a tremendous marketing resource.

Essentially, this is what theatrical film going does now. Films rarely break even just by releasing in theaters. In essence, they pay for huge marketing campaigns in the theatrical window. This makes them must see and boosts word of mouth. And Disney is great at marketing. This means its movies will continue to have an awareness boost over 90% of Netflix original films, where Netflix can’t afford to do a similar marketing campaign.

Pro-Theaters Qualitative Variable: Other windows pay more than one monthly streaming price.

Really, this is the main thing I can’t get past. If you take a family of four to the theater, again, Disney is making half that value from the tickets. What is that? $60 dollars in Los Angeles and New York now? Same if the family goes multiple times. (Hello Frozen 2.) Even pay-per-view is less expensive than a streaming service, but if you buy multiple movies? It adds up. Moreover, in all those cases, the family would still probably have a subscription to the Disney streaming service. If people are willing to pay you two or three times for the same piece of content, why wouldn’t you?

Pro-Theaters Qualitative Variable: This isn’t a “one time only” decision.

This isn’t a decision Disney is making now-and-forever. At some point, they could always launch films non-exclusively in theaters. Or when they decide that pay-per-view is no longer worth it, they can make it non-exclusive there, or end it. You can decide how much you’re making per window, and maximize that revenue each year. 

Conclusion: This is tough, but Disney is making the right argument

Basically, I can’t get past the math up front. Disney makes about $200 million dollars for the streaming rights for a big huge hit like Star Wars. Is being exclusive to a streaming service—even one they own outright—worth 4.5 times that in the best cases? I just don’t see it. Even if they could cut way back on marketing as a cost savings. Moreover, the films will still make it to the streaming service, just after a six to nine month hold back, bringing with them their customer’s data and customer’s lifetime values. And that’s roughly 80% of the value, in my opinion, anyways. Exclusivity isn’t worth 4.5 times that. That’s much too high.

I’ll be honest, doing this made me more sympathetic to the “straight to streaming” argument. Customer Lifetime Value can be a huge number, meaning a much smaller volume of people watching can make the difference. And that number of “hey for 600 million people we can make billions” is really, really sexy. The challenge, as I hope I laid out above, is that double counting and saturation make it a lot harder..

Look at it this way. Disney made $7.6 billion at the global box office. It kept half that, roughly, or $3-3.5 billion. If it can launch a streaming service that breaks even—a big if, I’ll grant you—wouldn’t it rather have that $3 billion than not? That’s what Netflix loses in cash each year, and double what Hulu loses. So yeah, they would.

(Appendix: Of course, a lot of what I wrote here is clearly at odds with the strategy and finances of the most successful streaming services, Netflix and Hulu. I’d add Amazon Prime/Video/Studios but they aren’t broken out as a separate line item in Amazon’s 10K so I don’t know their financial performance specifically, and don’t even have enough numbers to guess. The obvious implication here is I think Netflix mangles some of their economic calculations, and hence strategy. But I need to write up and explain some of those thoughts in future articles.)

[Update May 2019 – Two of the sub-section titles were modified as I reflected on this article. The third method was originally called “suboptimal” but it really is a good way to judge the impact of content, if you have the data. So it’s just hard, and I updated. Also, it will be used frequently when valuing content in my Game of Thrones vs Lord of the Rings vs Chronicles of Narnia series.]

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