Healing Star Wars Ep. 2- evaluating success with ROI
You’re reading Episode 2 of 9 from Healing Star Wars: a broken cash cow. A data analysis of 19 franchises (+130 movies) on why Star Wars will lose out on +$20 billion — and how Disney can fix it. Read Episode 1 here.
2.1 Main research question
This episode will explore and answer the highest level, and ultimately most important, question for Disney.
Main Research Question:
“Has Star Wars Stars, under Disney, achieved operational success between 2012 and 2019?”
In 2018, the media stated that Disney had already recouped their investment. Yet weeks after that Disney’s CEO Bog Iger announced “We will take a pause, some time, and reset”.
So despite mixed opinions, this critical question is still to be answered. Being such a complex challenge, we can’t rely on simple opinion but we should use problem-solving methodologies such as Systems-Theory, Think Model or Lean Thinking,
Following the above, to answer the Main Research Question in a systematic and data-driven manner we must first answer the following 6 questions:
Question 1:
What is the metric that measures overall success?
Question 2:
What are the thresholds of metric success?
Question 3:
What is the growth model, or submetrics, that drives success?
Question 4:
What are the different possible results (sensitivity analysis) for the growth model?
Question 5:
What is the current metric performance achieved by Star Wars between 2012 and 2019?
Question 6:
How does the current metric performance measure against the different thresholds of success?
2.2 The metric that determines overall success
What metrics don’t determine overall success
To determine how successful the Star Wars franchise has been between 2012 and 2019, first we must define 1 metric that allows us to determine overall success.
That’s the North Star Metric. The single metric that best captures the core value that a product delivers to its customers. It’s the metric upon which the business will decide to either continue or pivot/reset on their current strategies.
So what is the North Star Metric that measures success for Star Wars?
As per the internet, there’s many candidates: box office revenue per movie, critics reviews, fan reviews, social media engagement, trailer views. But those are all submetrics, or input metrics.
The North Star Metric should be an overall output metric that represents the resulting health of its overall operations. If it performs well, the franchise continues to grow and thrive. If it underperforms it puts the franchise at risk of stagnation, decline or death.
That doesn’t mean the other metrics don’t matter, in fact the success of the North Star metric is dependent on the individual success of all its input metrics. But only once we’ve determined overall success of the system, can we move on to analyse the individual performance of each subsystem.
The North Star: Return On Invested Capital
Disney is a business and as such, Star Wars’ ultimate operational success is held accountable to its financial performance. Without the successful financial performance of its operations, in the long-term Disney would stop providing the additional cash needed to continue its operations.
When Disney purchased Lucasfilm in 2012 for $4b, it saw an opportunity to use it’s operational assets and brand strength to create superior returns than it would through other investments.
So the 1 metric that will determine its long term success and ensure it continued access to long-term capital to fund its operations is the ROIC on that $4b investment.
As Disney’s CEO, Bob Iger, said himself in an interview on Barrons:
“It’s all about return on invested capital. The franchises and the name value of these. There was a purpose to all of this. It didn’t just happen. It was designed.” — Bog Iger
If Disney is able to generate a strong ROIC through the revenue mix of Star Wars, it will continue to invest more money into the franchise and release more products.
But what if it doesn’t generate the expected ROIC?
The impact of achieving, or not achieving, superior ROIC
The promise of profitability
Historically any business operations that incurs short or mid-term losses does so with the promise or hope that it will be able to reach profitability in the long-term. Eg. Tesla.
To be able to incur those losses it must get the necessary cash to continue operations, whether from external or internal investment. In the case of Star Wars, Disney can provide all the capital necessary, because it’s convinced it will reach massive profitability sooner than later.
But what happens if its later rather than sooner? 2 things can happen:
- Scenario 1: accept losses and rejuvenate until reaching profitability
For the moment, Disney decides it’s in strategic interest to continue to take the short and mid-term losses by offsetting them with profits from other business units and/or with outside investment (like they did with EuroDisney until it turned around). - Scenario 2: no longer accept the losses and recoup investment
If after continuous investment Star Wars isn’t able to reach long-term profitability, Disney might decide it’s not in their strategic interest to continue funding it. Whether because it’s putting other business units in danger or because they can use that capital more effectively elsewhere.
The Lifecycle of a Mature Product
The above 2 scenarios can be identified within the lifecycle of a mature product. If a product/business has reached the mature stage in its lifecycle, it has 3 options to recoup their investment in search of profitability:
- Rejuvenate the product (scenario 1):
By adding new products and finding new users/markets. - Harvest the product (scenario 2a):
If revejunation fails, they will harvest the product by reducing costs and continue to offer it, possibly to a loyal niche segment. - Discontinue the product (scenario 2b):
If harvesting has been depleted, they will liquidate the remaining inventory or sell it to another firm that is willing to continue investing in the product.
Examples of successful rejuvenation
Here’s some examples of movie franchises that accomplished successful rejuvenation by refreshing their value proposition and expanding into new markets:
- Fast and The Furious has been able to effectively rejuvenate their franchise consistently (after a phase of “exploit and decline”), by injecting their movies with movie stars, doubling down on their value proposition and entering new international markets. Will their 9th movie continue this trend or will they need further rejuvenation?
- The Batman franchise paused in 1997 after it’s period of exploiting was leading the brand into a decline. Then in 2005 Christopher Nolan rejuvenated the franchise and made it a massive success.
Examples of exploitation
- Lord of the Rings was a growing success that culminated in a very successful finale in 2003. In 2012 they tried to unsuccessfully rejuvenate the franchise by releasing a duology on the Hobbit, which became a trilogy in order to maximize profitability.
- Mission Impossible is a great example of solid exploitation. After pausing in 2006 due to a severe decline in interest, Tom Cruise brought the franchise through formulaic yet exciting action, and delivered consistent results in the last 2 installments.
Examples of excessive exploitation leading to decline
- Pirates of the Caribbean exploitation run quickly led to a drastic decline that has put the franchise on hold.
- Transformers was able to grow and extend their payback period by aggressively expanding into international markets such as China. But it suffered a heavy decline even through the unsuccessful rejuvenation of Bumblebee.
How exploitation misaligns stakeholder interest
If the product/business is in the Harvest or Discontinue phase, the goals of the business and the customer/user/fan are completely misaligned.
The business focus isn’t on creating the highest quality products that will please customers. Their focus is on exploiting the existing brand assets and creating just-enough products to recoup their investment or on “making a quick buck”. This just-enough mentality results in bad or mediocre products that leave fans disappointed. And although it leaves shareholders happy with more short-term money, in fact it destroys long-term value by degrading the brand.
Below are the users ratings from the above movies. It’s clear how the product quality deteriorates as interests misalign between the Studios and fans.
Now that we now the consequences of a bad ROIC, let’s understand what sort of success must Star Wars accomplish so its quality doesn’t decline and it’s put on hold again.
2.3 The thresholds of metric success
The 2 key results Star Wars must accomplish
It’s determined that for Disney to consider Star Wars investment a success and ensure its continued operations and release of new products it must achieve the following:
1) METRIC: ROI
Objective: Disney must have a return on investment on their initial $4b investment
Key Result: To be determined below
2) METRIC: Payback Period*
Objective: Disney’s payback period should allow the franchise to keep growing and not enter into a decline
Key Result: To be determined below
*Payback period: the amount of time it takes to recover the cost of an investment.
Metric 1: establishing a Key Result for ROI
To determine the success of Goal 1 (ROI), Disney will be evaluated according to the following 2 sub-criteria:
1.1) Star Wars will break-even on its original $4b investment
1.2) Star Wars will profit heavily across an extensive franchise lifetime of 40 years*
*Disney reported this in their 2013 annual report for 2013: “Intangible assets primarily consist of intellectual property based on the Star Wars franchise with an estimated useful life of approximately 40 years.”
This thesis will only focus on “1.1) Star Wars will break-even on its original $4b investment”. So the Key Result Star Wars must accomplish is $4b.
Metric 2: estimating a Key Result for PayBack Period
In terms of payback period, ideally the faster the better. The fewer years it takes to recoup your original investment, the sooner you will start to gain profits from it, making a more desirable investment.
There’s no accepted benchmark so let’s make an initial back-of-the-napkin estimation. *
Note: calculating it accurately would take quite long and not make a meaningful difference in the result. Anyhow if anybody wants to collaborate on it let me know!
It’s confirmed that the 10-year average Return on Invested Capital (ROIC) for Disney is 12.37% and Trailing Twelve Months is 15.56% (source: MorningStar) and the Cost of Capital of cash flows for US entertainment companies is 7.61% (source: Aswath Damodaran)
Considering Disney is taking on a sizeable risk in this endeavor, we can assume it could aim to achieve between 12.37% and 18% ROIC. So the estimated ranges to evaluate Payback Period on achieving break-even are:
- Great: achieves break-even before 5 years
- Good: achieves break-even before 8 years.
- Not good: achieves break-even after 8 years.
Although externally the market expects them to do it in 2–3 years:
“I look at about a two-year timeframe to recoup the initial $4 billion,” said Robin Diedrich, consumer discretionary analyst for Edward Jones.
Grading Star Wars according to PR & Media claims
The following media reports in 2018 by CNBC or Business Insider stated the following:
“Disney bought Lucasfilm six years ago today and has already recouped its $4 billion investment. The four Star Wars feature films Disney has released since 2015 have grossed more than $4.8 billion at the box office.”.
Using their statement as the basis to grade the performance of Star Wars would result in the following:
Validating media reports: truth or PR?
Neither CNBC, Business Insider or other media have provided any evidence that validates that Disney has in fact achieved the above.
Furthermore Disney themselves haven’t made such claim or provided further evidence to prove they’ve reached brean-even with Star Wars.
Due to the potential bias and possible hidden market motives, let’s go ahead and validate this claim ourselves in the next section.
2.4 The growth model that drives success
How not to evaluate break-even
Fist let’s break down the statements made by CNBC and analyze them independently.
CLAIM 1:
“Six years ago, Disney bought Lucasfilm for $4.05 billion.”
- Analysis:
In 2012 Disney purchased Lucasfilm. - Evaluation:
TRUE - Actions required:
None.
CLAIM 2:
“The four Star Wars feature films Disney has released since 2015 have grossed more than $4.8 billion at the box office.”
- Analysis:
Although it’s true that Star Wars has grossed more than $4.8b, Gross Box-Office revenues is not the measure for evaluating break-even, that is measured against the Net Profit remaining. - Evaluation:
INCOMPLETE - Actions required:
Calculate the Net Profit generated by the Gross Box Office revenues.
CLAIM 3:
“Disney also makes money from licensing agreements and sales of merchandise, apparel and toys.”
- Analysis:
Although it’s true that Star Wars makes money from the above mentioned, there’s no details about the amount of revenues or net profit generated by those additional revenue lines. - Evaluation:
INCOMPLETE - Actions required:
Calculate the Revenues and Net Profit generated, on top of the $4.8b box office, by Additional Revenue Lines such as licensing agreements and sales of merchandise, apparel and toys.
How to calculate break-even
To correctly validate that Disney has achieved break-even on their initial $4b investment we must calculate the $ in Net Profit it must recoup from it’s complete Revenue Mix of Star Wars products.
Step 1:
Break-even = Net profit Star Wars Revenue Mix — Initial Investment
Step 2:
Break-even + Initial Investment = Net profit Star Wars Revenue Mix
Step 3:
$4b = Net profit Star Wars Revenue Mix
Step 4:
$4b = (Net profit Box Office + Net Profit Additional)
Step 5:
$4b = (Revenue — Cost) Box office + (Revenue — Cost) Additional
The Star Wars product mix
Star Wars franchise has different revenue streams. The movies are the core of a universe of revenue streams Lucasfilms has created across the years. They’re heavily complemented by several other streams such as home entertainment, toys and merchandise, books, gaming etc.
Let’s define the Star Wars Product Mix within the following 2 categories:
- Box Office Revenues
The core driver of revenues. - Additional Revenues:
Further revenue streams that are generated because of the success of Box Office. For Star Wars, this can currently be broken down into the following 5 sub-categories: Streaming/Video, Toys & Merchandise, Books/eBooks, Gaming and TV Shows/Other.
Star Wars Revenue Strategy fits perfectly within Disney’s Overall Business Model. In the near future, Disney will extend Star Wars revenue lines into existing business models (ie. Star Wars themed Disney Parks) and into new business models (ie. Disney +).
How to estimate the Total Revenue Mix?
- Total Box Office Revenues
Can be calculated with high reliability, as this data is publicly available at websites likes The-Numbers or Box Office Mojo. - Total Additional Revenues
On the other hand, the data generated by Additional Revenues isn’t publicly available so we need another way to estimate it.
The best source to estimate Star Wars Additional Revenues is a 2015 post by Aswath Damodaran, Professor of Corporate Finance and Equity Valuation at the Stern School of Business.
In “Intergalactic Finance: Valuing the Star Wars Franchise”, Professor Damodaran calculates the historical revenues generated by Additional revenue lines in the last 40 years stemming from the revenues generated by Box Office.
So in order to estimate the Additional Revenues, we will multiply the Total Box Office revenues by the Historical Contribution Margins from the Additional Revenues.
According to his biography:
“Professor Damodaran has 23 published works on equity valuation, corporate finance and investments. He is also widely published in leading journals of finance, including The Journal of Financial and Quantitative Analysis, The Journal of Finance, The Journal of Financial Economics and the Review of Financial Studies.”
Due to his world-renowned status as an industry expert, I consider his data to be the most reliable approximation until Disney decides to share its real data.
Star Wars Historical Revenue Mix
Professor Damodaran’s calculations for Star Wars revenues from the past 40 years are:
As seen below, Box-Office revenues only account for 20% of all generated revenues. The fact that $6.7b in box office has generated an additional $26.8b is what makes Star Wars the most profitable franchise of all time.
This means that historically, for every $1 generated in the box office, Star Wars has generated an additional $3.99.
Updating Historical Values According to New Trends & Business Context
Using the above historical data as the basis for my analysis, I’ve decided to create a range of scenarios that take into account the possible impact on results due to the following reported downward trends reported by Bloomberg, Fortune and BMO Capital Markets.
Sources:
- With ‘Star Wars’ Toys, the Force May Be Strong, But Retail Sales Aren’t
- ‘Star Wars’ Toy Sales Fall in 2017 as Movie-Tie Fatigue Sets In
- Disney’s 2018 Annual Report Sees Star Wars In Decline
a) Declining results within Toys & Merchandize industry:
“The September bankruptcy filing of Toys “R” Us Inc., which makes up about 15 percent of the market, added to the challenges for “Star Wars” sales growth this year”.
“Playthings based on the Star Wars saga were down in 2017 despite a new film, “Star Wars: The Last Jedi,” in December during the all-important holiday-shopping season.”
b) Weaker pull due to competition and faster decline of demand
“There are so many screens now; kids aren’t just at the movies,” Johnson said. “A movie doesn’t have the same resonance it used to.”
“Adult collectors, who grew up with the brand, are still buying a lot of merchandise when the toys come out, but demand dies down afterward, according to Johnson.”
c) Weaker resonance of new Star Wars characters
“The latest installment, “The Last Jedi,” didn’t include many new memorable characters beyond those introduced in the preceding film, Johnson said. That left fans looking for newness elsewhere this year, leading to weaker results than expected, he said.”
d) 2-year negative growth for Disney’s Consumer Products & Interactive Media
“Consumer Products & Interactive Media segment saw growth until 2015. But ever since then revenue and earnings decreased again.”
Estimating Additional Scenarios for Revenue Mix
Using the Historical Revenue Mix and the above set of observations, I’ve estimated a possible range of scenarios for Revenue Mix performance.
Industry margins and Tax rates
Lastly in order to calculate Net Profits from Gross Revenues, I’ll use the following variables as reported by Professor Damodaran:
- Average operating margins of the movie business: 20.14%
- Operating margins of the toy/merchandise business: 15%
- Tax rate: 30%
2.5 Growth model sensitivity analysis to reach break-even
Now let’s reverse-calculate the Pre-tax Profit and Revenues that Star Wars would need to generate in order to keep Profits of $4b and reach break-even.
Using the different Revenue Mix scenarios, the different objectives Star Wars would have to achieve are:
In order to have a Net Profit of $4b and break-even Star Wars would have to generate over $5.7b total pre-tax profits, segmented into $1.4b-$2.9b Box Office and $2.8b-$4.2 Additional.
And to arrive at the above pre-tax Profits , Star Wars would have to generate $33.3-$35.7b in Total Revenues, segmented into $7.1b-$14.5b Box Office and $18.7b-$28.6 Additional.
2.6 Evaluating break-even for Star Wars
Now let’s calculate the current Box Office Revenues Star Wars has generated between 2012–2019 and compare it to the above calculations.
Required Box Office revenues to reach break-even
To recap, we’ve established above that to achieve break-even Star Wars would have to generate the following Box Office revenues:
Actual Box Office revenues 2012–2019
The 4 Star Wars movies released until now have generated the following Global Box Office Revenues:
Break-even evaluation: Required vs Real Box Office
Below is the comparison between the required Box Office revenues that Star Wars should generate to break-even versus the real Box Office Revenues.
It can be concluded that the current performance of Star Wars hasn’t yet managed to achieve the required revenues to reach break-even in neither the Historic cases nor the Estimated cases.
Below are the results plotted on the y-axis:
And below are the results plotted on the x-axis:
How much more Box Office required to reach break-even?
In order to reach break-even Star Wars should generated an additional $2.1b to $9.5b (+30.1% to +65.6%) more in the Box Office.
How much more Profit required to reach break-even?
Star Wars requires between $1.2b to $2.6 additional profit to reach break-even.
Adding end of 2019 revenues
Episode IX- Rise of Skywalker
We also have to include incoming revenues for the rest of 2019. Specifically, for Episode IX- Rise of Skywalker.
The last movie of the Skywalker saga is predicted to create between $1b-$2b, with estimations based on historical performance pointing towards $1.5b.
Taking this into account, it’s still unlikely that Star Wars will hit break-even with the release of Episode IX as it would still require an additional $656m to $8b in Box Office Revenues.
It would still require between $350m to $2.2b additional profit to reach break-even.
Star Wars Galaxy Edge Theme Park
Although it’s very likely that Disney will gain a very good amount of additional revenues from the launch of its new Star Wars Galaxy Edge theme parks parks, the reports indicate it has invested an additional $2b in their construction, delaying the payback period for Disney even longer.
2.7 Grading Star Wars according to the data analysis
Let’s revisit our original Main Research Question:
Main Research Question:
“Has Star Wars Stars, under Disney, achieved operational success between 2012 and 2019?”
Using the data analysis as the basis to grade the performance of Star Wars, the answer is the following:
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STAY TUNED FOR THE NEXT EPISODE OF “HEALING STAR WARS: A BROKEN CASH-COW”
Episode 3: increasing system performance of old model
Key research question:
What are the available growth levers Disney could work on to increase performance?
Topics explored:
I’ll break down Disney’s performance system, outline the different options they have to increase revenues according to local and global sensitivity.
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