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Disney's own digital divide

The company's failure to capitalize on the digital revolution in entertainment is a key factor in the company's vulnerability to the hostile takeover bid by cable giant Comcast.

    Disney's own digital divide

    By Jim Hu, John Borland and Mike Yamamoto
    Staff Writers, CNET
    February 11, 2004; 4:30 PM PST

    The widely publicized breakup of Walt Disney's 13-year partnership with Pixar Animation last month was cast, in much of the media, as a personal spat between Michael Eisner and Steve Jobs, the larger-than-life chief executives of the two companies.

    But beneath the public vitriol--Jobs called recent Disney films "embarrassing," among other things--are deep problems within the Magic Kingdom that are far more serious than studio backlot fodder for Hollywood gossip columns. Disney's failure to capitalize on the digital revolution in entertainment is a key factor in the company's vulnerability to Wednesday's hostile takeover bid by cable giant Comcast.

    "The concern is that they are turning out the lights on Pixar without having turned them on at Disney in computer-generated animation," said David Mantell, a stock analyst who specializes in the cable and entertainment industries at Loop Capital Markets. "I think there's some concern about Disney not having developed their digital prowess."


    What's new:
    Critics say Disney has lost its technological edge while expanding into other areas, leaving it open to attacks such as Comcast's $66 billion takeover attempt.

    Bottom line:
    Comcast and other rivals believe that they could do better than Disney in managing its digital direction.

    More stories on this topic

    To those familiar with its history and culture, the weakness in digital technologies reflected a loss of core values on which Walt Disney founded the company. Since the 1928 release of "Steamboat Willie," one of the first cartoons with synchronized sound, Disney has always been a leader in technological innovation.

    Critics say the company has lost that edge while expanding into other areas, leaving it open to attacks such as Comcast's $66 billion takeover attempt. The importance of Disney's digital properties was underscored in a letter sent to Eisner on Wednesday from Comcast CEO Brian Roberts.

    "As you have expressed on several occasions, one of Disney's top priorities involves the aggressive pursuit of technological innovation that enhances how Disney's content is created and delivered," he said. "We believe this combination helps accelerate the realization of that goal--whether through existing distribution channels and technologies such as video-on-demand and broadband video streaming or through emerging technologies still in development."

    Disney's wrong turns
    It is not surprising that Comcast and other rivals believe that they could do better than Disney in managing its digital direction. Disney has engaged in a series of mistakes in the transition from analog to digital technologies in the past several years, ranging from the Internet to animation advancements. Fundamental gaps in the company's understanding of digital trends became apparent when the Internet began its explosive growth in the mid-1990s.

    At a time when much of the medium's mainstream popularity was attributed to its openness, Disney decided to take the opposite route and build a proprietary service accessible by paid subscription. At the center of Disney's early online strategy was a site called "Daily Blast," complete with "D-mail" and other branded features, which was to become a major entertainment portal aimed at youths but never took off.

    The company then joined the rush by other media conglomerates to own a universal Web portal, an expensive undertaking that led to the acquisition of Internet properties at premium prices. In 1998, it acquired Web development company Starwave and then bought a controlling stake in fledgling search engine Infoseek for $465 million.

    The two deals culminated in the creation of the Go Network, a portal that Disney hoped would challenge Yahoo, America Online and MSN for online dominance. But similar to competing online ventures such as General Electric's NBCi and Viacom's MTVi, floundered. Disney eventually shut down's operations in January 2001, laid off 400 employees and took a non-cash writeoff of $790 million.

    "They tried to get in the portal business. Was it a good idea? I don't know," said Mike Slade, former chief executive of Starwave and now a venture capitalist who has advises Jobs on marketing and strategy. "Part of the problem is it's a big company, so it took a long time for it to become successful. The things they did right was through leveraging the things they already had."

    Even with such high-profile miscues online, however, it was the undoing of Disney's virtual monopoly in animation technologies that was arguably its most serious failure in the digital realm. After all, if Disney had remained focused on its basic strengths, Pixar may never have been able to succeed independently.

    Instead, in a classic reversal of fortunes, Pixar was the one holding all the cards in its final negotiations with Disney, having produced its biggest recent hits, including "Finding Nemo," "Monsters, Inc.," and the "Toy Story" series.

    Since 2000, Pixar has been responsible for 45 percent, or more than $1 billion, of the operating income reported by Disney's movie studio, according to estimates by the investment firm Lehman Brothers. Much of Disney's increase in video and DVD sales last quarter can be attributed directly to "Finding Nemo," which was the top-grossing movie last year, bringing in $792 million at box offices worldwide.

    And boding ill for any revival of a relationship, Jobs was deeply critical of Disney in a conference call with analysts after the decision to walk away. "Not even Disney's marketing and brand could turn Disney's last two animated films into successes," Jobs told analysts. "Both bombed at the box office."

    Recognizing the need for improvement, Disney has decided to stop its traditional hand-drawn animation in favor of computer-generated works. In addition, the company has shown its willingness to invest large sums in state-of-the-art animation in the past, spending $175 million to produce "Tarzan" in 1999 and $140 million to make "Treasure Planet" in 2002.

    But that production investment hasn't always translated to success at the box office. "Treasure Planet" grossed far less than analysts had expected, prompting some to predict that it would be the worst financial showing ever for Disney's animation studio.

    Comcast to the rescue?
    Enter Comcast, the would-be knight that saved the kingdom. In a conference call with investors early Wednesday morning, Roberts introduced Steve Burke, vice president of Comcast's cable division and formerly a 12-year veteran of Disney's executive ranks.

    "In the last five years, the Disney animation business has declined significantly. We think Disney should be No. 1 in animation. Animated films are the heart and soul of the company," said Burke, who would presumably play a senior role if the merger were to go through. "Our goal would be to again place Disney animation in the center of the company."

    Regardless of its concern with Disney's heritage, at least some media industry analysts say Comcast would do far better in developing its digital technologies and businesses.

    "Comcast has failed to get mainstream networks to offer popular content on VOD tiers. This would change," Forrester Research wrote in a report. "By including mainstream Disney content, including ESPN and ABC network shows, Comcast could 1) make VOD a popular destination, rivaling broadcast television and 2) develop an advertising model that benefits both Comcast and its network content partners."


    Comcast could use its proposed takeover
    of the entertainment company to jump-start
    video on demand and other services.

    Ironically, Disney's most significant contribution on a technological issue may have been an initiative that put limits on the distribution of digital content. Disney has for years been among the chief skeptics of releasing films to online or other digital markets without ensuring that strong antipiracy protections would block copying. The company was one of the original backers of unsuccessful legislation that would have required all computers and other digital devices to include strong antipiracy technology .

    As a result, it has been slow to move toward basic online distribution for its films, although recently it has allowed some content to be released through the CinemaNow and MovieLink video on demand services. Instead, the company has pursued its own idiosyncratic technological vision.

    The company has distributed some of its films on DVDs that self-destruct 48 hours after being unwrapped, an experiment aimed at competing with traditional video rentals, but those have proven difficult to market. Disney has also created a video-on-demand service called MovieBeam, which is designed to deliver digital video content to TV set-top boxes over the airwaves, rather than cable.

    Earlier this week Disney and Microsoft announced an alliance that was short on specifics but would at the least see the entertainment company license Microsoft's digital rights management tools for distribution of its works. Executives said the two companies also planned to work together on ways to speed up distribution of film and other content online and to portable devices, among other topics.

    Many of Disney's distribution technologies would bypass cable altogether, a fact that has not escaped the notice of Comcast and other pipeline companies. Disney's detractors say the company's adversarial relationship with the cable industry has done more harm than good for all parties involved.

    Disney has had run-ins with almost every major U.S. cable provider, leading to accusations of unfair dealing on both sides and frequent blackout threats. One such threat became reality in 2000, when Time Warner dropped Disney's ABC local affiliate stations after a license dispute. The programming was later reinstated amid regulatory scrutiny over Time Warner's then-pending merger with America Online.

    Two years later, Disney got involved in a fight with satellite TV provider Echostar, also over ABC programming. At the height of the disagreement, Echostar accused the media giant of threatening to oppose its proposed merger with DirectTV unless Disney got a higher rate for its shows. Disney denied the charges.

    If Comcast succeeds in its bid for Disney, the deal could go a long way toward finally realizing the potential for all broadband networks. To date, content companies and broadband providers have been stuck in a chicken-and-egg cycle that has delayed significant expansion of high-speed systems.

    "In the last six months, more people are coming up to us and suggesting broadband applications for high-speed Internet, whether that's ESPN for broadband or Xbox Live or voice-over-IP or video chat or a variety of broadband-only applications," Roberts said at a recent industry conference. "We could do 50 megabits if there's a market for that, or 100 megabits."

    CNET's Evan Hansen contributed to this report.

    Disney highlights

    Walt Disney and his brother Roy start The Walt Disney Co. in a small office in Los Angeles.

    Disney's first full-length animated feature film "Snow White and the Seven Dwarfs" premieres at an estimated cost of $1.5 million.

    Disneyland theme park opens in Anaheim, Calif.

    Walt Disney World opens in Orlando, Fla.

    Michael Eisner becomes chief executive officer and chairman.

    Disney releases hit "The Lion King," which goes on to become the biggest animated movie of its time and spawns major initiatives in toy licensing, video sales and even a Broadway stage show.

    Disney announces plan to purchase Capital Cities/ABC for $19 billion.

    Disney says it will incur a charge of more than $800 million to shut down its Web portal Go.Com.

    Roy Disney, nephew of the company's founder, resigns as vice chairman and begins bid to oust Eisner. Roy Disney's board ally, Stanley Gold, resigns a day later in support.

    Source: Reuters

    Comcast highlights

    Founded by Ralph J. Roberts, Daniel Aaron and Julian A. Brodsky with purchase of 1,200-subscriber cable system in Tupelo, Miss.

    Company is renamed Comcast Corp. from American Cable Systems and incorporated in Pennsylvania.

    Purchases 50 percent of Storer Communications, making Comcast the fifth largest cable operator.

    Enters the cellular telecommunications field with the purchase of American Cellular Network Corporation.

    Comcast combines its cellular properties with those of Metrophone, tripling the population area served to 7 million.

    Acquires Maclean Hunter's U.S. cable operations to add 550,000 customers and become the third largest cable operator with approximately 3.3 million customers.

    Purchases a 57 percent stake in QVC and assumes management of the world's leading electronic retailer.

    Microsoft invests $1 billion in Comcast.

    Comcast Interactive Capital Group created to make technology and Internet related investments.

    Comcast completes its $50.8 billion acquisition of AT&T Broadband, creating a company that serves 21 million video customers in 41 states, with 6.3 million digital video customers, 3.3 million high-speed data customers, and 1.3 million cable phone subscribers.

    Source: Comcast