Disney Spent 30 Years Building Its Brand in China. Now It Has to Worry About What Comes Next | Top 15 Annual Report

A slowing Chinese economy is bad news for Disney, whose products don't come cheap.

On the analyst call after Disney's November 2016 earnings release, Chairman and CEO Bob Iger did something he rarely does: he braced Wall Street for disappointment, using the phrase "modest growth" to describe what he expected from the company's 2017 fiscal year.

In North America, with the Star Wars franchise now in theaters, Disney had already converted every piece of IP it bought over the past decade into numbers on its books. Growing much further would mean new acquisitions — but Hollywood's premium targets have all but dried up. Its other big business, cable television, has begun to shrink as digital channels keep expanding.

Shanghai Disney Resort seemed to arrive at exactly the right moment. The company recently announced that from its June 16 opening through year's end, the park drew 5.6 million visitors — "one of the fastest parks to reach 5 million guests."

Yet across all of 2016, the word that best fit the company's performance in China was probably "lukewarm."

On the bright side, beyond the park's opening, Disney brought eight films into China last year — more than any other of Hollywood's six majors. Its consumer products business was booming too, with sales up 33 percent over the year.

The bad news seemed to weigh just as heavily. Disney Vision, the smart TV box developed with Alibaba, was pulled from shelves in March. And the Star Wars films fell short of Disney's earlier hopes: The Force Awakens took 820 million yuan, Rogue One 420 million.

For nearly 40 years, Disney has worked China as an important market. As early as 1986 it teamed with CCTV to air Mickey Mouse and Donald Duck cartoons; in 1993 the magazine Mickey Mouse launched on the mainland; in 1995 The Lion King opened in China; and in 2005 Disney moved its Asia-Pacific consumer products headquarters to Shanghai.

But the uncertainty hanging over the Chinese market will keep adding huge variables to Disney's future. If that market stays as lukewarm as it was in 2016, where will Disney stand? And what role will Disney China play in Disney's larger empire?

How Much Revenue Does Disney China Bring In?

In fiscal 2016, Disney's total revenue hit $55.2 billion and net profit $9.4 billion, both records. The company did not break out figures for China, folding them into its Asia-Pacific segment. That year, Asia-Pacific brought in 8.2 percent of total revenue. Since Japan, South Korea, and other countries are also important Disney markets, China's share of Disney's overall revenue probably comes in under 5 percent.

Disney's most profitable division is now television — including national broadcast networks like ABC and cable networks led by ESPN — which brought in $23.689 billion, more than 40 percent of the total. But because the state controls the media, Disney cannot take its television business into China.

A few workarounds have been shut down too. Disney Vision was pulled, a Wall Street Journal report citing anonymous sources said, at the request of Chinese regulators. ESPN did find a chance to partner with Tencent, but the deal covers only coverage and analysis of sporting events, not a full content provider's role. So Disney's television business in China is all but negligible.

Consumer products is Disney's strongest business in China. By Shenwan Hongyuan Securities' estimate, Disney China's consumer products sales reach $13 billion, on which Disney collects licensing fees. Data from the International Licensing Industry Merchandisers' Association puts Disney's global consumer products sales at roughly $52.5 billion. Even so, licensing is not Disney's main source of income, accounting for only about 10 percent.

Shanghai Disney Resort has just opened, and full figures aren't in yet. At an average of 28,000 visitors a day, the park would top 10 million a year. The Themed Entertainment Association reports that Disney's five other parks worldwide drew nearly 138 million visitors in 2015. Factor in that Shanghai Disney's tickets aren't expensive by global standards, and that it's a joint venture, and the park likely contributes around 3 percent of total Disney parks revenue.

That leaves film. Eight Disney films were imported into China in 2016, with combined box office of about $841 million at year-end exchange rates. Worldwide, Disney released 13 films and grossed more than $8 billion. Film revenue also flows from DVD sales, television licensing, and other streams.

Pinning down China's exact effect on Disney's film business isn't easy. Broadly, though, China's contribution falls well short of 10 percent. China has almost no DVD market, and as a studio Disney keeps only 25 percent of Chinese box-office receipts — while the industry rule of thumb is that a film must gross three times its production cost to break even.

So What About the Future?

As things stand, China may not yet be make-or-break for Disney — but its value runs deeper than the current numbers. With 1.3 billion consumers, most of them barely tapped, the future may still be worth waiting for.

Some things probably won't change much. Take television: over the past four years, nothing has suggested the Chinese government plans to loosen its grip here. For some time to come, ABC's American dramas, ESPN's sports programming, and the Mickey Mouse and Donald Duck cartoons on Disney XD will have little chance of reaching Chinese viewers.

Consumer products faces fewer controls and has grown fast in recent years. By Disney's own figures, its licensing business grew by a third in 2016, taking roughly half of China's entire animation licensing market.

But even this business — which looks like easy money for Disney — has its headaches. China's animation industry has caught fire in the past couple of years, homegrown cartoon characters are multiplying, and local studios now take licensing seriously. At the just-concluded Hong Kong Licensing Show, one clear trend was that more and more Chinese companies were turning up, hoping to find brand partners.

All of them will become Disney's rivals. Take Fantawild, the studio behind the Boonie Bears franchise: children can watch Briar Bear and Bramble Bear on television and catch a new feature film every year. When a child picks out a new school bag, whether it's the one with Briar Bear or the one with Mickey Mouse is anyone's guess.

Film looks like a place where Disney could break through. In theory, the memorandum China and the United States signed — allowing 34 revenue-sharing foreign films a year — was due to expire in 2017, and under World Trade Organization negotiating principles, the Chinese market could open further to Hollywood.

Yet China's overall box office stalled in 2016, clouding that outlook. Whether growth can hold up at all is now in doubt. And if it can't, the roughly $800 million Disney earned at the Chinese box office this year may already be the ceiling.

Even if growth continues, Disney won't necessarily reap the rewards. The film markets in first- and second-tier cities are largely saturated, and almost all new screens are going up in third- through fifth-tier cities — where moviegoing habits seem to differ. According to Entgroup's 2015 white paper on "small-town youth," audiences in those cities lean toward romance and comedy, and they are likelier than big-city moviegoers to choose domestic films over imports.

The $5.5 billion Shanghai Disney Resort naturally carries enormous expectations. Compared with Disney's other overseas parks, Shanghai is larger than Hong Kong — sparing it the problem of being too small to draw crowds — and it has faced none of the protests against cultural intrusion that greeted Paris. So far, first-year attendance of 10 million is roughly on par with Tokyo Disneyland's opening.

But set against Tokyo's opening, several factors weigh against Shanghai. Tokyo Disneyland opened in 1983, in some of Japan's fastest-growing years; China's economy today is far less buoyant, and steadily downgraded GDP forecasts suggest the road ahead won't be smooth.

If China keeps slowing, Shanghai Disney Resort — a pricey day out, where a family of three can spend 2,000 yuan — could take a hit. After Japan's bubble burst, Tokyo Disneyland's attendance held flat at around 16 million for several years.

Another threat is rising nationalism. Wang Jianlin once vowed that Wanda would keep Disney from turning a profit in China for ten to twenty years, and the boast won plenty of support. In the comment sections under major news coverage, lines like "Wanda's parks are more Chinese — fawning over foreign stuff is out of date" and "Disney, get out of China. Nobody go. Die, you Americans" were not hard to find.

To a large degree, Shanghai Disney Resort's future is not in its own hands.

Disney Is Surely Beloved in China — But Which Disney?

A month before Shanghai Disney Resort opened, Wang Jianlin told CCTV's Caijing program: "We're no longer in an age when people go wild for Mickey Mouse and Donald Duck. Trotting out the same old IP with no innovation just won't work."

The remark is unfair in one respect: Mickey Mouse and Donald Duck don't stand for the real Disney of today, which also owns Star Wars and Marvel's superheroes. But Wang's words may capture the first impression many Chinese have of Disney — Disney is Mickey Mouse, is Donald Duck, is Snow White.

Jin Tao is vice chairman of the Shendi Cultural Development Research Institute, a think tank advising the Shanghai International Resort district where Shanghai Disney sits. In a speech, he cited a market survey Disney ran a few years ago: more than 70 percent of locals knew the plots of Snow White, The Lion King, Cinderella, and Mulan; more than 60 percent of would-be customers were 45 or older; and of 40 Disney cartoon characters shown to young local white-collar workers, only 14 on average could be named correctly.

He also cited a survey by the Shanghai Consumer Council and the Shanghai Academy of Social Sciences: "More than 60 percent of would-be customers were 45 or older, which indirectly reflects the decline in Disney's appeal and recognition among Chinese children today."

"Disney and its products are well known in China, but the emotional bond is weak," Jin concluded. "In fact, for many Chinese people today, their sense of Disney is still stuck thirty years in the past." That thirty-year-old image has two defining traits: it is dated — Mickey Mouse and Donald Duck stand for Disney; and it is childish — only children like Disney.

That clashes sharply with how Disney sees itself. On its Zhihu page, Disney calls itself a family entertainment company with six major brands: Disney, Pixar, Marvel, Lucasfilm, ABC, and ESPN. Of these, Disney China's marketing leans hardest on three — Disney, Marvel, and Star Wars.

The mismatch probably traces back 30 years. When Disney first entered China in 1986, the images it pushed were Mickey Mouse and Donald Duck — for a simple reason: back then, Disney had nothing else to show.

Everything that followed revolved around them: the Mickey Mouse magazine, the Little Dragon Club TV show, every kind of merchandise. After 30 years of cultivation, Chinese consumers naturally came to equate Disney with Mickey Mouse.

Starting in 2005, Disney bought Pixar, Marvel, and Lucasfilm one after another and pushed hard to develop their films. Naturally, it also hoped to introduce Iron Man, Captain America, Jedi knights, and Darth Vader to Chinese audiences.

But in an age of ever-richer entertainment, simply catching Chinese consumers' attention is already hard enough — and these new arrivals have shallow roots.

Iron Man reached China in 2008, so it has been here ten years at most; Star Wars less than two. Next to Mickey Mouse and Donald Duck, who became household names over 30 years through every imaginable product, these newer members of the Disney family are far from standing for Disney in China.

So in the first year The Force Awakens was out — when Star Wars merchandise hit an estimated $5 billion to $6 billion in global sales, by analysts' reckoning — Disney's consumer products arm in China was still led by Mickey Mouse and Donald Duck. The two Star Wars films, The Force Awakens and Rogue One, together took only about 1.2 billion yuan in China, a sliver of their $3 billion worldwide gross.

Mickey Mouse and Donald Duck may have been Disney China's biggest asset, but as Disney's own product range grows more varied, they may also be costing it opportunities.

For one, they are aging the brand — "dated" and "childish," in Jin Tao's words. For another, the very success of Mickey and Donald makes it hard for Disney China to shift resources toward Marvel and Star Wars; the pair remain the lead images for its consumer products arm in the year ahead.

Disney is trying to turn this around. In television ads for Shanghai Disney Resort, it showed young people drawn to the roller coaster "Tron Lightcycle Power Run" — precisely to make the case that the park is for all ages. But once word spread that Universal Studios was breaking ground, the old refrain returned: Disney's parks are childish, and adults are better off at Universal. Shedding the "childish" label may take Disney a long time.

How Disney Became a Symbol of American Culture

Disney became a symbol of American culture because it caught a moment.

Disney was founded in 1923, but in its early animation-only days it never ranked among Hollywood's eight major studios. Its chance came only after World War II. In 1950, Disney teamed with Coca-Cola to start airing cartoons on NBC. In 1954, it premiered the program Walt Disney's Disneyland on ABC, which became one of the longest-running shows in American television history.

This coincided with the baby boom: the children born in great numbers from 1945 on had grown old enough to watch cartoons. Add the fast postwar spread of television, and Disney delivered Mickey Mouse and Donald Duck straight to the boomers, became part of their "childhood memories," and cemented its place with them.

The two parks Disney later opened on American soil caught good timing too. The 1955 Disneyland in California, like the TV shows, arrived just as the boomers were growing up; the 1971 Walt Disney World in Florida caught them as they began raising children, giving families a new form of entertainment.

Disney rose to power just as the baby boom generation did. Because of their sheer numbers, the boomers wielded enormous influence — and by catching this generation, Disney turned itself from a fringe Hollywood player into one of today's six majors.

That kind of moment simply cannot be repeated in China.

Bob Iger Has a Year Left. What Disney Is He Leaving Behind?

In mid-2018, Bob Iger, Disney's current chairman and CEO, is set to retire.

In the decade-plus since he took over in 2005, Disney has set revenue and profit records nearly every year. His formula has been a steady run of acquisitions — Pixar, Marvel, Star Wars — each franchise releasing film after film while merchandise, parks, and games pushed Disney's results higher. But as he nears the exit, fresh crises are surfacing.

With the rise of streaming services like Netflix and Amazon, the cable television business that ESPN represents has begun to slide. Nielsen data show ESPN had 90 million subscribers as of this September, down 10 percent from its peak.

In early August this year, Disney announced it would buy a one-third stake in BAMTech for $1 billion and launch a streaming service under the ESPN brand. It was Disney's largest acquisition since it bought Lucasfilm in 2012.

BAMTech is a company Major League Baseball set up to handle streaming broadcasts. It holds not only streaming technology but also the rights to baseball games and to NHL hockey.

In theory, the BAMTech deal has promise. If it goes smoothly, ESPN could rise above an ordinary cable network to become a sports content operator, sparing itself trouble like the tripling of NBA rights prices in 2014. From that angle, an ESPN backed by BAMTech could be worth far more to Disney.

Beyond cable television, the companies Disney bought have hit their own ceilings for growth. The Star Wars reboot was a runaway success, with product sales nearing $10 billion.

But that success stayed within its existing markets. In North America and Europe, the people who grew up with Star Wars embraced the reboot with almost no resistance. In China, its commercial value still has a long, long way to go.

It's not that Disney hasn't worked hard to promote Star Wars in China — it's that building a Star Wars market there from scratch demands enormous money, effort, and time, while the payoff will run far below what established markets return.

Through Iger's decade-plus running Disney, one thing has never changed: Disney is still that family entertainment company, and everything it does is meant to keep consumers buying Disney's content — and consuming it through Disney's own channels.

From that angle, the good news is that Americans spend more on entertainment every year. According to U.S. Department of Commerce data, total spending on entertainment goods and services grew from $877.8 billion in the first quarter of 2014 to $1.018 trillion in the third quarter of 2016.

The flip side is that the heart of the family entertainment business remains the steady supply of high-quality content that draws spending. Over the past decade Disney managed this through acquisitions — but as suitable targets grow scarce, the pressure falls ever more heavily on Disney's own capacity to innovate.

If that capacity falls short, and Disney pins more of its hopes on new markets like China, the crisis may already be close.

Infographic: Feng Xiuxia