Disney Killed Its Games Division. When Is Big-Company Innovation Doomed to Fail?

We try to answer why, after years of investment, a big company finally decides to end an innovation effort — and whether this is a pattern common to big companies, or something only Disney does.

If anyone were writing a textbook on how big companies fail at innovation, Disney has just supplied the perfect case study.

That may sound callous, given that 300 people lost their jobs. But Disney itself mentioned the matter only in passing, in a footnote to its earnings report: in the first quarter of 2016, having shut down its in-house game development business, including the interactive toy line Disney Infinity, Disney took a $147 million write-down.

Translated, that means Disney has killed a games division it had been putting money into since 1995 (with a break along the way; it restarted in 2004 and was renamed "Disney Interactive" in 2008).

Until then, everything had looked like it was going to plan. At the Disney fan expo D23 in August 2015, for instance, Disney held a presentation just for games, and gave generous stage time to several in-house titles as well as Disney Infinity. Early this year there were even reports that Disney Infinity had become the best-selling interactive toy on the market.

So why would Disney cut a product division that looked to be on the verge of success? (Assuming success means market share.) The blunt answer might be: it wasn't making money. But that is not where this article can end. We try to answer why, after years of investment, a big company finally decides to end an innovation effort — and whether this is a pattern common to big companies, or something only Disney does.

Before you reach for Clayton Christensen's The Innovator's Dilemma, let's look at the steps big-company innovation failure usually goes through.

How Disney made games over the past 20 years

1995

Disney's games division is formally established, with 200 founding employees.

1997

Acquires Starwave, the software company founded by Microsoft co-founder Paul Allen.

1998

Acquires the search engine company Infoseek; registers the site go.com, hoping to compete with Yahoo or AOL.

1999

Disney announces that go.com's losses have passed $1 billion.

2002

Disney shuts down Infoseek and go.com in succession.

2003

Disney sells off its stakes related to go.com and Infoseek.

2004

Disney's game and interactive business starts developing games under the name Starwave Mobile.

2005

Disney acquires Living Mobile, a European game developer and publisher.

2010

Disney Interactive acquires Playdom and Tapulous to build up its mobile games business.

2011

Disney shuts down the Propaganda Games studio and lays off 200 people.

2013

Disney Interactive launches Disney Infinity; announces the closure of the Junction Point studio; the Interactive division turns a profit for the first time.

2014

Disney Interactive lays off 700 people because Facebook games are losing popularity, then shifts strategy to put more weight on licensed games.

2015

Disney Interactive merges with the Consumer Products division.

2016

Disney announces it is stopping production of interactive toys and ending all in-house game development and publishing in favor of licensing.

Step One: Ambition, and Investment to Match

Big companies always work the same way: if they can't grow a competitive product inside, they buy one.

Two years after the games division was founded in 1995, Disney had got nowhere; its 200 founding employees did not seem able to produce a single breakthrough idea. So in 1997 and 1998 Disney bought Starwave, the software company founded by Microsoft co-founder Paul Allen, and then the search engine company Infoseek (Baidu founder Robin Li, incidentally, once worked there).

What followed was a sad story. Disney spent $1 billion trying to build a product called go.com, and it ended with Disney "underestimating the content and resources a website would require."

But the story didn't end there. Disney regrouped, restarted the business in 2004 and went on a buying spree that included the developers Living Mobile, Playdom and Tapulous. If you remember the gaming boom the iPhone set off then, you can guess that these well-known companies did not come cheap — Playdom alone cost Disney more than $560 million. That money, of course, is why Disney leaned too hard on Facebook as a platform, a consequence we will come back to.

The deals also brought people. Playdom founder John Pleasants, who had been chief operating officer at EA, became co-president of Disney Interactive. The other co-president, James Pitaro, was poached from Yahoo, where he had been the vice president in charge of media. Bart Decrem, one of Tapulous's founders, became senior vice president of Disney Interactive — and it was his team that later made Where's My Water?, a hit around the world.

Disney knew nothing about video games, but judging by that lineup, it had at least found people who did to work for it. The first step toward a bright future was in place: talent, capital, and a wide market just beginning to open up.

Step Two: Something Remarkable and New

However you look at it, Where's My Water?, which Disney launched in 2011, was a remarkable product.

From Disney's point of view, every earlier game had been built on a character it already owned, like Cinderella; this time the character was new. Bart Decrem stressed the point in an interview at the time: "What we've found is that in past successful games, none of the characters came from film or TV — they were all original characters created for the game itself."

Given the players Disney was aiming at, the little alligator, Swampy, had everything a successful game needs: a cute character, moderate challenge, smooth play. Two months after launch, this $1 game topped the paid-games chart in Apple's App Store in 79 countries, with more than 3 million downloads. By March 2012, Apple said downloads in China alone had passed 25 million. And the game it knocked out of first place was Angry Birds, just as big a hit at the time.

Disney had high hopes for the alligator as a character, too. In the summer of 2012 an animated short starring Swampy was set to air on YouTube.

Everything was following a playbook Disney knew well: build a character, then develop films, TV shows and merchandise around it. And the success of Where's My Water? seemed to have given Disney a new way to create animated characters — not starting from film and television animation as before. Games, which had sat at the tail end of Disney's production chain, could now be a source of characters too.

Here we have to bring in another company: Xerox. Apple and Microsoft's rich neighbor back then had an even more remarkable invention: the world's first personal computer, the Alto. It was about the size of a crate, it had a screen, it was meant for one person, and a keystroke appeared on that screen within milliseconds. On the hardware side, to make input easier, Xerox also built the keyboard and a mouse you could slide and click. And there was a local network that could link one machine to others, called Ethernet.

The engineers at PARC (short for Xerox's Palo Alto Research Center in Silicon Valley) had also worked out what to put inside the machine. They began writing word-processing and image-editing software, and built a graphical user interface (GUI) instead of making people run a computer through geeky command lines. Looking back now, PARC's computer scientists drew the blueprint for everyday digital life 20 years early.

Now look at the interactive toy Disney launched in 2013, Disney Infinity: it looked like a figurine, with a chip inside that saved progress in the matching game in real time.

Less than a year after it went on sale, Disney Infinity had passed $1 billion in worldwide sales. In August 2015 version 3.0 came out; within six months the starter set alone sold close to 2 million copies, and the Star Wars sets alone brought in more than $200 million. Late last year a report said Disney Infinity was the best-selling interactive toy product, ahead of Lego, Nintendo and Activision.

Doesn't that bring back the question: if it was doing this well, why drop it?

Step Three: Big Companies Are Blind While Small Companies Grow Wild

The story has to pick up with Xerox again, so that you can see roughly what problem Disney ran into.

In 1977, Xerox chairman Peter McColough and his nine most senior deputies visited PARC to watch a live demonstration of the Alto. Robert Flegal, a computer graphics specialist at PARC, asked McColough: "I hear you just watched a software demo — what did you think?" Xerox's top executive answered only: "I've never seen a man type that fast before."

He did not understand what the personal computer meant. That is exactly why, in 1979, Xerox even let a team from Apple tour its most classified products. The world changed after that — but the company that changed it was not Xerox, whose main business was printers. The Apple engineers, who had looked up to the skill and the ideas of PARC's researchers, took the whole package home with them: the graphical interface, the keyboard and the mouse. Later Bill Gates, also drawing on Xerox's work, released Windows, a graphical operating system for personal computers.

Disney's problem is a little more complicated, because there is no evidence its executives were blind to that degree. But the two cases share something. Just as personal computers were not the main business of the printer company Xerox, games were not the main business of the family entertainment company Disney. Disney went into games only because it sensed this was a way to hold on to future consumers — and the sense was so faint that in the end it could not survive even a little skepticism from the market.

In 2013 Disney released Where's My Water? 2. It did not repeat the first game's success.

"The gaming industry changes too fast," Disney CEO Bob Iger told analysts on an earnings call. He was not wrong. In August 2012 Clash of Clans launched. A year later Supercell, the Finnish company that made it, reported full-year revenue of $892 million, nearly nine times as much as the year before. In 2014 the game was still bringing Supercell more than $5 million a day. Not long ago Clash of Clans even spun off a game of its own, Clash Royale.

Then there is Flappy Bird. This game, in which you steer a bird through Mario-style pipes, suddenly took off in early 2014. Downloads on Android and iOS together passed 50 million, and some people in the industry put the ad revenue it brought in at more than $50,000 a day. The trouble that came with the attention led its developer, Nguyen Ha Dong, to pull the game from the stores in February 2014.

While these small companies were growing fast and wild, all Disney could see was an uncertain future. It was so afraid of skepticism from Wall Street that it treated any further spending as a risk.

"We really don't have confidence that we can develop games ourselves and generate steady revenue from them," Iger added. That is how fragile big companies can be. In fact the Interactive division had already turned a profit for the first time in October 2013 — but it had made a strategic mistake, which we will come to shortly.

A Quick Digression: What Kind of Big-Company Innovation Is Doomed to Fail?

1) The product exists only as a defensive move

When Disney first went into the internet business, it was measuring itself against portals like AOL and Yahoo, while also hoping to do more with its intellectual property. Only late in its run of large acquisitions did it start hoping for a share of a fast-swelling games market.

2) It was a division that spent money, not one that made money

Between 2008 and 2013, Disney's games division ran up $1.4 billion in losses. That lowered its standing inside the company and cut the resources and the talent it could attract.

A useful comparison is the pressure Google's experimental projects put on its accounts. Former chief financial officer Patrick Pichette said: "I don't need to spend too much time on these experimental projects, like caring about a self-driving car." To avoid becoming nothing but a money machine while keeping its ability to innovate, Google announced a restructuring last August: experimental units such as self-driving cars, life sciences and the smart home were spun out as separate subsidiaries which, along with the original Google, became part of a holding company called Alphabet.

3) The product was too far ahead of its time and too experimental

The VR craze has only taken off in the past year or two, but Nintendo built the first virtual reality hardware, the Virtual Boy, back in 1995. The technology was not ready, and in the end it sold only 140,000 units.

4) The company was protecting assets and technology it already had

Kodak had developed digital photography in the 1990s. But its traditional film business mattered more to it, and so Kodak put more of its energy and money into film. Having missed digital photography, Kodak eventually filed for bankruptcy under pressure from Samsung and Sony.

Nokia, likewise, spent billions of dollars as early as 1992 on research into smartphone technology — mobile email, touchscreens, faster wireless networks — and in 2004 set up a group to build multimedia services for smartphones. But feature phones were Nokia's most important business. In 2006 the smartphone business was folded back into feature phones.

As Christensen wrote in The Innovator's Dilemma: "Well-managed companies frequently fail precisely because the management practices that made them industry leaders also severely impede them from developing the disruptive technologies that ultimately consume their markets."

5) Dependence on the old system left them blind to new audiences

In the smartphone market, Nokia missed the fact that services were what sold a smartphone, and chose to work with Windows Phone, a system with fewer apps and less finished software. Nokia's market share shrank by 90% in two years.

6) The result of all this is that they lose their read on what the market wants

Xerox built the earliest personal computer and still had no idea what needs a personal computer could meet. It was IBM that saw what fast computing would change: business users needed data storage, companies needed office work done, households wanted entertainment. Together those needs gave rise to a $24 billion industry.

Step Four: The Original Innovation Somehow Became Unimportant

The tragedy of Disney's games division was in fact settled on its first day. It did not exist to remake the games industry, or to serve family entertainment, or even to contribute revenue. It existed only to support Disney's operations and to create IP (intellectual property) — otherwise, in the division's early years, it would not have kept reaching for characters it already owned to build unoriginal casual games.

Look back at Disney's two core mistakes. One was that after buying Playdom in 2010 it put too much of its game business on Facebook. In March 2014 Disney Interactive announced it was cutting 700 jobs because Facebook games were losing popularity, and decided to put more weight on licensed games instead. That was the first step into caution.

The second mistake — which cannot entirely be called a mistake — was Disney Infinity itself, the product that had earned Disney a decent reputation. Announcing the end of the business, Disney gave its reason as "stagnant growth in the interactive toy market and high development costs."

Disney Infinity was not especially advanced; it was nowhere near console hardware from Sony or Nintendo. But a shrinking market meant more risk to profit, and, more to the point, Disney was never a hardware company. At a moment when everything looked like added risk, killing the product looked like cutting losses. Xerox, which missed the personal computer, took in just $4.6 billion over the past year, with net profit of only $200 million. Its market value of $9.84 billion is a world away from Apple's $544.5 billion or Microsoft's $413.5 billion. To this day the company is still only a copier company.

Kodak is worth another mention. Its sales now run $2 billion a year; in 1990 they reached $19 billion. Because it worried that the digital technology it had developed would eat into its film technology, Kodak handed the chance to upend the whole industry to Sony, Samsung, Canon and Nikon, and became the one that got upended.

Disney is in much better shape by comparison. All it has cut is a side branch. Its other businesses — film, television, toys, theme parks — still look healthy. Ending in-house game development is no great matter for a company like this, and the money lost sits well inside what a company with more than $50 billion in annual revenue and more than $14 billion in profit can absorb.

The only real pity is that Disney has said goodbye for good to the lively, "not-quite-Disney" part of itself — Swampy and Disney Infinity, things that could surprise consumers but could never satisfy Disney and Wall Street.

Appendix: Where did "big-company disease" show up in Disney's games business?

• Wrong positioning. The people who pay for games are mostly teenagers and adults, but most of Disney's games were aimed at young children.
• No pull with the talent it needed. If you are an engineer or a young designer, you are more likely to pick Google or a startup than a big media conglomerate.
• A vast bureaucracy. The video game Epic Mickey took six years to plan, because a single character in it needed sign-off from several layers of management. In that time the platform they had chosen, the Nintendo Wii, lost popularity, and they also missed the Thanksgiving shopping season.
• Too few resources. Insiders said that because the Interactive division could not move the stock price, it had little say internally and could not draw talent from elsewhere in the company.
• It never learned the new skills. Jessica Reif Cohen, a senior analyst at Merrill Lynch, said that for a traditional media company, going digital calls for a completely different set of skills.
• Divided attention. Every year Disney Games had to develop so many different projects that it had no capacity left to make polished ones — even its most successful series, Kingdom Hearts, saw its quality slip for the first time.