Disney: More Video Game Control Means More Profits

The winding evolution of video games--the oldest of today's popular interactive platforms--is anything but child's play, which explains why Walt Disney Co. is ramping up to claim its share of an anticipated $47 billion global video game market in 2008.

The keeper of the Magic Kingdom has decided to earmark $350 million annually to shift its focus from licensed to self-published video games. At a time when the DVD and pay TV recycling of films and television content is waning, Disney is searching for ways to perpetually mine its many brand franchises.

Disney's goal is to capture about 70% of the net revenues from the sale of a self-published video game, compared with a 5% return currently generated through the licensing of its brands to external developers. The model is similar to the fully owned leveraged platforms it maintains at its Pixar films and Disney Channel properties during the past two years.

The path Disney has taken to arrive at this broader commitment, through its Disney Interactive Studios, is almost as fascinating as its future video game prospects.



Disney will rapidly ramp up next year by concentrating on the lower-end, low-cost Nintendo DS and Wii platforms, relying on titles such as "Turok" and "Pirates of the Caribbean," according to Lehman Brothers analyst Anthony DiClemente. Disney invested an additional $130 million in its internal video games division in fiscal 2007 and will invest an additional $170 million in fiscal 2008. The company will likely double its annual video game investment through acquisitions, although the creation of its wholly owned video empire should preclude it from having to purchase a major video game company. Disney purchased four specialty video-game product companies over the past several years: Climax Racing, Avalanche Software, Fall Line Studios and Propaganda Games and Junction Point Studios.

They were acquired to contribute to the video game activities of Disney Interactive Studios, which posted a loss of $10 million on revenues of $242 million in 2006. Overall, Disney, which reported spending $170 million developing its in-house video game studio in fiscal 2006, ramped to roughly $250 million in fiscal 2007. It's expected to spend about $350 in fiscal 2009--$245 million of which will be used to develop games based on current animated or live action properties. An additional $70 million will be allocated to new IP titles such as the recently released "Spectrobes" series.

Disney's top 2007 video game units include "Cars," "At World's End," "Ratatouille," "Hannah Montana," "Spectrobes," "High School Musical" and "Pirates of the Caribbean."

The primary catalyst for the strategic shift has been the best-selling games based on its Pixar properties, which are developed and published by THQ under a contract Disney is not expected to renew. DiClemente provides the simple math that demonstrates Disney's easy decision to take complete control of its video game activities to ensure much better profits.

A "Cars" video game priced at $40 generated about $32 million in gross revenues based on sales 800,000 units. Of that amount, the retailer and distributor would keep $10.4 million, and THQ would realize $21.6 million in net revenues. Disney would receive only about $1.08 million in total license fees. If the same game was self-published, Disney would receive the entire $21.6 million, or 1900% more revenue. "By maintaining strict cost controls and developing for low cost categories, Disney has the opportunity to generate incremental margin benefits for its Consumer Products division," DeClemente said in a recent report.

"As most of Disney's self-published video game releases are designed on a far smaller scare, we believe that less than 500,000 units sold could potentially result in profit contribution. We believe Disney's Nintendo DS releases are produced for less than $5 million, and sell at a rough price point of $25," DiClemente said.

Disney has successfully moved to full ownership to similarly capture more of the profits generated by other of its niche businesses, such as ESPN cable sports and youthful entertainment programming, as well as musical plays.

Disney's video game expansion comes at an interesting time, when Nintendo, Microsoft and Sony are locked in a battle for video game console market share, while the video game field is crowded with new and old players.

As constant as the video game arena has been over the decades, it is renewed with innovation. Nintendo's Wii not only revived the company's stature--it catapulted the sector into a new interactive phase. Despite recent technical glitches with its consoles, Microsoft has created a viable competitor with its X-box game player. Disney has relied on its Fall Line Studios in particular to successfully develop pre-teen games for Nintendo's handheld DS and Wii systems, which are more inexpensive to cater to than Microsoft's Xbox.

Disney has its eye on the in-game ad revenues that are becoming more routine and lucrative. The successful dynamics of in-game ad revenue are tied to the number of hours that games are played, the number of connected consoles, available advertising inventory and how it is utilized. Disney's character, film and television brand franchises are conducive to sustained and repetitive play, according to Bernstein Research. Although Disney has refrained from advertising on its children's cable channel, it could find agreeable ways to integrate it into video games, tying it to its many consumer products and cyclical content. Disney's success in coordinating with console manufacturers, such as Nintendo, and its full-proof connection with the popular Guitar Hero crowd assure it certain growth in the video game sector, analysts say.

Disney's foreign connections and established business presence--from theme parks to content--also will give it a leg up in the hot video game arena. DiClemente says Disney is likely to outsource much of its basic development work to Eastern Europe, India and Russia. However, creative work for top-level game development will likely to remain in the United States in order to keep costs low in its interactive studio division.

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