Three Forces Will Determine Disney’s Fate in China

One of the big stories of 2016 was the opening of Shanghai Disneyland, which went off without a hitch (well, except for the rain). Looking back, I mark the opening as the firing of the starter’s pistol in the race to become the “Disney of China”.

In many other industries, this type of winner in China is already clear. Baidu is the “Google of China.” China Mobile is the “Verizon of China.” Nike itself is actually the “Nike of China.”

So the interesting question is whether Disney will actually become the “Disney of China”? Can they match their international success as an entertainment company that combines beloved children’s movies and theme parks?

My preliminary answer is yes, but they will need to move fast. And they will need to recognize that they are at the intersection of three big and shifting China forces: rising consumers, an activist government and ruthless local competitors. Only one of these forces is probably on their side long-term.

Here’s my take on the situation:

Rising Chinese consumers are flocking to entertainment and theme parks. This force is in Disney’s favor.

Urbanization is driving Chinese into the cities, with +600 million there today and another 300 million on the way. Urban per capita income, especially disposable income, is growing quickly (in contrast to rural incomes which are largely stagnant). Overall, the discretionary spending of urban Chinese families is expanding rapidly and is now flooding into entertainment in particular.

Additionally, there is a transition underway as urban consumers move from value-based purchasing to more emotional and aspirational behavior. Basically, these urban families now have all of life’s basics (food, shelter, etc.) and are seeking out rewarding entertainment and experiences, such as trips to Starbucks and vacations in Thailand. This is one of the reasons China’s entertainment, tourism and culture markets are currently booming. You can only spend so much on food but you can have almost unlimited demand for things like travel. Both box office receipts and theme park revenue are expected to overtake those of the U.S. by next year (about $10b per year each).

Basically, selling family entertainment to rising urban Chinese households is about as good a business story as you will find anywhere today.

This is great for Disney, which is a very unique company. They will likely go after these consumers the same way they do everywhere else. They will get the children to fall in love with their movies and characters — Belle, Aladdin, Mulan and such — and build a brand image that is associated with families, happiness and something magical. This then spills over into theme parks, retail and other businesses. Beloved movies are still the primary engine of Disney’s empire.

However, an activist government is acting as both policeman and player in entertainment. This force is not in Disney’s favor long-term (probably).

In 2009, after a decade of lobbying, Chinese officials finally approved Disney’s plans to build a theme park in Shanghai, While much current discussion is about Disney’s objectives in China, what is more important is the objectives of the government in this. And these were actually clearly stated in Pudong’s “2020 development plan” (released in late 2010).

Recall, Pudong’s “2010 development plan” (released in 1990) set the course for Shanghai as a finance and shipping city, not unlike London and New York early on. And the newer 2020 plan added just one main revision to this – a new focus on entertainment and an international tourist zone in eastern Pudong. It also specified two large tracts of land for theme parks, adjacent to the Maglev line to Shanghai Pudong International Airport. The southern of the two plots was specified for Disney.

I think Shanghai Disneyland mostly got the nod because it could help the government in these larger goals. Specifically, it created a “center of gravity” for entertainment in Shanghai – and for overall development in eastern Pudong. The authorities were likely counting on Disney to import expertise and to also sort of become a training ground for entertainment executives and theme park designers and managers. This will both attract and create some of the human capital required for a world-class entertainment industry in Shanghai.

This explanation fits nicely with the fact that Shanghai Disneyland is 57%-owned by Shanghai Shendi Group, a consortium of state-owned companies including Shanghai Media Group. Shendi also holds a 30% stake in the park’s management company. This is consistent with the idea that Disney is basically injecting foreign expertise into a government-owned entertainment vehicle.

In this, the Shanghai Disneyland deal looks a lot like the deal for Oriental Dreamworks, also located in Shanghai. This film production joint venture between Shanghai Media Group, other Chinese investment companies and U.S. studio Dreamworks Animation will occupy suspiciously prime real estate on the Huangpu River. Today, Oriental Dreamworks has over 250 international-quality Chinese computer animators and has successfully released “Kung Fu Panda 3.”

The takeaway here is that while Disney’s dream is capturing the Chinese market, that is not the objective of the government, which is actively operating in this sector as both policeman and player. They are focused on the development of an entertainment industry in Shanghai. And while the government sort of needs Disney today, it is worth keeping in mind this will not always be the case.

Finally, well-funded locals, like Wanda and Alibaba Pictures, are giving chase. This force is the most worrisome.

Disney is off and running in China. But so are well-funded local competitors. Dalian Wanda Group wanted to be the “Disney of China” and came out with guns and press releases blazing last year. They planned on opening multiple theme parks and were the largest owner of movie theaters in China and the U.S. (and #2 in Australia). Although their entertainment goals have changed recently. Both there are lots of other impressive competitors. You have Alibaba Pictures, Huayi Brothers and others. The competitive picture is daunting.

However, lots of rich companies have tried to be Disney in the past and have failed. When Disney entered Europe and Japan, lots of local companies had the same ambition. And for decades, other Hollywood studios have tried to replicate Disney in the US. All have largely failed. It turns out copying Disney is pretty difficult.

Two companies have arguably had some success: Dreamworks, founded by Jeffrey Katzenberg (who previously ran Disney Animation); and Pixar, run by John Lasseter (purchased by Disney in 2006). You could also perhaps point to Lucasfilm, creator of the “Star Wars” franchise (now owned by Disney as well). But all of these are essentially pure media companies. None have replicated Disney’s combination of animation and theme parks.

I think this has a lot to do with cash flow. Creating animated (and singing) movies that children love is tricky. It takes years of work for one movie. It costs a lot of money and is “hit or miss”. If the movie is a hit, you make lots of money. If not, you probably go bust. The unpredictable cash flow makes both funding animated movie development and building large, expensive theme parks impossible for most companies. Disney’s advantage is that it already has a stable of popular characters and international operations that create financial scale and stability.

But even Disney has had trouble being Disney at times. It had great success under Walt Disney but struggled in the 1980s as its movies lost their appeal. And when the movies aren’t hits, the theme parks can suffer. New leadership took over (Eisner and Katzenberg) and a string of successes like “The Little Mermaid” and “Aladdin” followed (by Alan Menken and Howard Ashman). Disney again stumbled in the early 2000s until it bought Pixar, which made Steve Jobs the largest Disney shareholder.

So now Chinese companies are trying to be the Disney in China, which is actually really difficult. We will see if they are more successful than past attempts by other cash rich companies. Overall, it is going to be an interesting fight to watch.

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Putting these three forces together, I argue that Disney has a window of time before local competitors grow stronger (Force 3) and before the Chinese government no longer needs Disney’s expertise that much (Force 2). Thus in this window of time, Disney needs to capture the hearts and minds of Chinese urban families as fast as possible (Force 1). Being loved by Chinese consumers is likely to be their only real protection long term.

Thanks for reading, Jeff

(re-posted from Nikkei Asian Review, original article here)

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