2014 in Review: Is Disney Ready for the World's Largest Market?

Top 15 Series: Disney

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Disney: New Markets or New Consumers?

Disney's report card for 2014 is undeniably impressive: the best financial year in its history. Bob Iger, who was due to step down as CEO in 2016, has had his contract extended by two years; on his watch, Disney's total revenue has set a record four years running. You could see what the company achieved this year at the cinema, at holiday destinations and on children's nightstands everywhere. Frozen brought it more luck than it could have hoped for.

Next year the company plans a serious push into China. This year it signed a cooperation agreement with SMG, and its Shanghai theme park will soon open. Disney has to get ready for China, the world's largest market, and almost everything it faces there will be new to it.

At home in the United States, new consumers are just as big a problem. Its earlier acquisitions of Pixar, Marvel and Lucasfilm were about content; this year's deals were about new consumers. Talks to buy BuzzFeed for $1 billion collapsed early in the year. By August BuzzFeed was valued at $850 million, which means Disney's offer carried a premium of less than 20%. It was a deal Disney should not have let slip. Instead it bought Maker Studios, a producer of short videos for YouTube, and staked its future on the online business. The aim was the same as with BuzzFeed: to reach more young consumers and close the distance between Disney and this new generation of customers.

The Core Film Business Is Still the Bright Spot

Disney's year is easy to sum up in three films: Frozen, Star Wars and Big Hero 6. Its oldest and most basic business, film, is still the bright spot, and this year it mattered more than ever. Frozen took $1.27 billion worldwide, the fifth-highest gross of any film in history. Starting from the film's characters, Disney carefully built a profit stream at every link in the chain: DVDs, music albums, merchandise, theme parks. That is why it succeeded.

Frozen was not Disney's only hit this year. Guardians of the Galaxy, the year's top-grossing film ($770 million), and Maleficent, which took $750 million, were also Disney's. Together with Star Wars, due next year, they will make these two years very comfortable ones for the company.

Yet this year's results owe less to extra effort than to the "harvest" of past acquisitions, above all the purchase of Pixar in 2006. After the deal, Pixar's own Cars 2 and Monsters University disappointed both critics and the box office, and many people decided the $7.4 billion acquisition had been a mistake. But Frozen, and Big Hero 6, whose North American takings keep climbing, have shown that John Lasseter's arrival in fact rescued Disney's animation division, which had been in decline. In November Lasseter came to Shanghai with his plans and said he was fully prepared for next year.

The Theme Parks Seem to Be Pinning Their Hopes on New Markets

While the studio entertainment division grew strongly, the parks and resorts division was flat in all four quarters. Attendance at its most important parks, in the US, did rise, but Disney spent heavily on them this year. It put $1 billion into developing MyMagic+, a service system tested at its Orlando resort that collects visitor data, monitors crowds, and is meant to move people through the parks faster and make staff more efficient. Disney even hopes to use it one day in museums, zoos, airports and shopping malls. So far the results of the experiment are not obvious.

Hong Kong was no brighter. Disney's first- and second-quarter reports both mentioned more visitors to its Hong Kong park, but the city's tourism market as a whole is shrinking. Fewer mainland tourists have come to Hong Kong during recent Golden Week holidays, and according to the Hong Kong Retail Management Association, retail sales fell by an average of 30%–40% from last year. Hong Kong Disneyland opened in 2005 but made its first profit only in 2012, and most of its extra visitors came from the mainland tourism boom of that time. A falling Hong Kong tourism market is bad news for Disney.

Tokyo Disney and Disneyland Paris are opposites. Tokyo has localized well and makes money every year; most of its visitors are Japanese, and many come back again and again. Paris, plagued by budget overruns and cultural clashes, has lost money year after year and has piled up €1.75 billion of debt since it opened in 1992. This year Disney gave Euro Disney S.C.A. €1 billion in financing, but whether that will work remains to be seen.

The Shanghai park is being built now. At 3.9 million square meters, it will be twice the size of Tokyo Disneyland and three times that of Hong Kong Disneyland, with an investment of about $5.5 billion (about 34.1 billion yuan). Investors have lately taken more interest in Disney-related stocks, and many analysts estimate the park will draw 30 million visits a year and add 33.6 billion yuan to Shanghai's economy. The park will naturally lift the film business and the consumer products division too.

Licensing, the way Disney sells consumer goods, will be another source of growth. Each year the company picks characters from a few hit films to promote as long-term merchandise, such as Mickey, Snow White and the Toy Story toys, while products tied to other films appear only during a short promotional window. The theme park will drive licensing as well.

How Well Does Disney Know China?

Hollywood makes hundreds of films a year, but only 34 can enter China on a revenue-sharing basis, and even that quota is only two years old: before 2012 it was 20. Most films are kept out. Lionsgate's The Hunger Games: Mockingjay – Part 1 was due to open in China at the same time as elsewhere, but its Asian release has been called off and postponed, for reasons that are unclear. A company like Disney, which promotes happiness and wholesome family values, naturally runs much less risk of rejection. This year's big films, Frozen, Guardians of the Galaxy and Maleficent, all played in China, and Big Hero 6 already has a release date. But Disney has more to consider.

Another studio, Universal, has had a bumpy ride with its own China project, the Universal Studios park in Tongzhou, Beijing, where construction started this year. Feasibility work began around 2001, but the project stalled when it failed to win approval on grounds of "cultural invasion"; it was revived only this year. A few months ago, the audiovisual programming department of SAPPRFT, China's broadcasting regulator, also issued a "review first, broadcast later" rule that requires imported online series to pass censorship before they go online. That will get in the way of Tencent's exclusive streaming deal with HBO. If Disney wants to do big things in China, it has to understand all of this.

Disney films were showing in China as early as 1930, but the company's road into the country has been rough, and only this year has it arrived in full. From the founding of the People's Republic until a decade after reform and opening began, Disney was silent in mainland China. Only after 2005 did many Chinese people notice that Disney existed as a huge media conglomerate. Much of what Disney meets in China from here on will be new to it.

How Well Does Disney Know the Future?

Beyond these outside forces, Disney has a question of its own: does it understand the consumers of the future? Its old weak spot, Disney Interactive, improved this year but still trails the other divisions in revenue. That is another worry for Bob Iger, who has sworn that Frozen will keep making money for the next five years. Tomorrow's consumers may no longer sit in cinemas or in front of televisions. They may be looking at phones and computers, and they love games. Next to the more traditional businesses of theme parks, studio entertainment and consumer products, the interactive division may be the one most tied to the future.

In March the division cut 700 jobs, about 26% of its global staff. Disney merged its mobile and social games businesses and decided to halve the number of games it releases each year. The division has lost more than $1 billion in recent years, and Playdom, the games company Disney bought for $563 million in 2010, was hit as well. Luckily a sandbox game called Disney Infinity kept the division's results respectable this year.

Disney needs bigger moves, whether a new advertising strategy or more appealing products, and the starting point is understanding what future consumers want.

So Disney Wants to "Face the Audience More Directly"

"The theaters own the customers, not us," Disney CEO Bob Iger said in a media interview this month, voicing his concern. "They're Walmart's customers, not Disney's."

Disney already knows it must work out how to reach the consumers of the future. Buying Maker Studios, the YouTube short-video producer, this year should eventually bring it closer to them; for now, that is the move open to it. Disney wants to deal with audiences more directly, and through Maker Studios to reach young people directly, learn more easily what content they want, and bring what they like into its own products faster. That is the usual way a company thinks about future consumers.

This year Disney also launched Disney Movies Anywhere, an app that lets people take out their phones and watch Disney, Pixar and Marvel films whenever they like, another step toward its audience. The logic is plain enough: cutting out middlemen and dealing with consumers directly is good by any measure. But how to get consumers to choose its products in the end is the problem Disney will have to solve.

Disney's Big Events of the Year

1. Frozen sells and sells

In March, Frozen sold 3.29 million DVDs and Blu-rays on its first day, topping Nielsen's top 20 US home video sales chart and outselling the other 19 titles combined three times over. In May the princess dolls sold so fast that Disney announced purchase limits. In August the soundtrack's sales reached 2.696 million copies, making it the best-selling album in the US for the first half of the year, and its single ranked fifth among US singles. So far the film, which cost only $150 million, has grossed $1.2 billion.

1. Disney teams up with SMG

Disney has formed a long-term partnership with Shanghai Media Group (SMG) covering TV creative development, film co-production, content distribution and joint marketing. The Toonmax cartoon channel and a nature documentary, Born in China, are also in development.

1. Disney's parks launch the MyMagic+ wristband

Disney spent $1 billion developing the MyMagic+ service system, tested at Walt Disney World in Orlando to collect visitor data and monitor crowds. It hopes to extend the system later to museums, zoos, airports and shopping malls.

1. Disney builds its Shanghai park

The first phase covers 390 hectares, with planned investment of 29.5 billion yuan. Construction is scheduled to finish on January 30, 2015, and the park could be complete as early as National Day (October 1). In November Disney unveiled plans for themed hotels, a large shopping, dining and entertainment district and leisure areas around the park, and began recruiting performers.

1. Star Wars: Episode VII news and the publicity push begins

Industrial Light & Magic set up a London studio dedicated to the film's visual effects, and trailers, filming locations and other details have come out one after another. It is Disney's most important film of next year.

1. BuzzFeed talks collapse; Maker Studios bought

Maker Studios is a short-video supplier on YouTube that makes and distributes videos for 55,000 channels worldwide, with 5.5 billion views a month. Disney executives said they hope to turn it into a brand like Marvel. Before this, Disney had negotiated to buy BuzzFeed for $1 billion, but the talks failed.

1. Disney reorganizes its interactive division

Disney Interactive cut about 700 jobs, roughly 26% of its global workforce. Disney also merged its mobile and social games businesses and decided to halve its annual game output. Disney Interactive has lost more than $1 billion in recent years; its return to profit in the past two quarters is mainly thanks to Disney Infinity.

What's Coming Next Year?

What can we expect from Disney next year? Star Wars.

That is the obvious answer. Star Wars is the main event after Disney's $4.05 billion purchase of Lucasfilm, and this year it has released a trailer, app games and other material to build excitement. George Lucas's original Star Wars came out in 1977 and grossed $770 million, a phenomenon in its day, and over many sequels the series has built up a huge army of fans around the world. With six years since the last installment, the franchise is plainly a gold mine Disney has yet to fully work. Oh, and there is Avengers: Age of Ultron, which many people are waiting for.

In animation, as John Lasseter explained during his November visit to Shanghai, Disney and Pixar both have new films next year, including the original-concept Inside Out and The Good Dinosaur, the princess film Moana, and a new sequel, Finding Dory.

The Shanghai park opening will be another priority next year. In November Disney unveiled plans for themed hotels, a large shopping, dining and entertainment district and leisure areas around it. These include Disneytown, a 40,000-square-meter pedestrian district; the 800-room Toy Story Hotel; and Treasure Cove, the first island-themed land in any Disney park. Construction is scheduled to finish on January 30, 2015, and the park could be complete as early as National Day.

Disney Has Found Its Direction, but It May Need More Luck

Judging from this year's acquisitions, its film slate and its reorganizations, if the company is truly ready for the consumers and markets of the future, then this year's strong results are only a run-up. Bob Iger will not step down until 2018, and the board and investors are confident he can do more in the next two years. Consumers who spend more and more time online or on their phones, along with Chinese consumers, will be the hard problems Disney faces next year. Beyond its big studio rivals, Warner, Fox, Universal, Sony Pictures Entertainment and Paramount, outside money coming into the industry poses some threat too, such as Hasbro's failed attempt to buy DreamWorks Animation. But that is not what the company needs to worry about most.

It also has to keep innovating, and this year it did not lack for innovation. One example is Hyperion, the rendering technology already used on Big Hero 6. It makes the light in animated films look more natural, it will become the basis of Disney and Pixar animation from now on, and it is raising the technical bar for the whole industry. Here, Disney still leads the field.

The Top 15 are: Apple, Google, Baidu, Alibaba, Tencent, Amazon, Disney, McDonald's, Starbucks, Nike, Xiaomi, IKEA, Uniqlo, Wanda and Vanke. This list will change as the companies, their markets and the trends around them change. We will follow these companies, and their competitors and partners too.

For why we set up the Top 15 reporting project, read this article, which we think turned out pretty well.