A Network in Search of a Solution

James Pitaro moved his chair away from the computer screen and took a deep, calming breath. Pitaro had just finished his first full year as president and co-chair at sports programming giant ESPN. Pitaro began his career in 1999 at a then-hot startup named Yahoo before moving on to run Walt Disney Company’s interactive division. He was the first outsider to run for CEO since ESPN’s founding in 1979.1 Pitaro spent 2018 on the rollout of ESPN+, an interactive app that provided subscribers with premium and exclusive sports content for $5 a month. The network had lost over 13 million subscribers since its peak of 99 million in 2011, and the app represented ESPN’s first serious attempt to bring extensive content to mobile platforms.
As Pitaro prepared for his review with Disney CEO Bob Iger, he knew that a supplementary app—one designed to keep subscribers tethered to their cable connections—could not be the network’s sole response to a continually changing broadcast landscape. He wondered what to recommend as the next steps to maintain ESPN’s market dominance, given the current situation at ESPN and Disney. Three pillars defined that situation: the actions of his predecessor John Skipper, the business model of ESPN, and the moves into streaming media led by ESPN’s parent, the Walt Disney Company. Trying to navigate through these complex issues created its own stress, and Pitaro hoped a series of deep breaths would allow him to focus on how ESPN would sustain its leadership position.

John Skipper

John Skipper took the helm at ESPN in 2012, just as ESPN began losing subscribers in large numbers. Skipper resigned in December 2018, citing his need to deal with a substance abuse problem. Skipper believed that subscriber losses would subside and not constitute a serious threat to the network. During his watch, Skipper continued to invest heavily in new content. ESPN expanded and extended its contract with the National Basketball Association in 2014. Under the old deal, ESPN paid $485 million to the league each year for the right to broadcast games. The new contract paid the NBA $1.4 billion per season starting in 2016.2 Many people criticized ESPN for overpaying for the broadcast and online rights to professional basketball. By 2018, programming costs, the contracts to carry sports programming, hit $4.7 billion a year, double what they were 5 years ago.3
As a manager, Skipper never built strong relationships with Disney executives, which left the Connecticut network isolated from strategy discussions at Disney’s California headquarters. Skipper’s critics claimed the CEO had “politicized” ESPN since taking control in 2012. Sports reporting covered an important and changing part of the American social landscape, a microcosm of race relations and political divisions that defined the country in the second decade of the twenty-first century. On-air talent weighed in on these social issues, but many saw the network articulating a clear “liberal” position. In 2017, SportsCenter host Jemele Hill engaged President Donald Trump in a very public Twitter exchange, with the president noting
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“ESPN is paying a really big price for its politics (and bad programming).” Hill responded by calling the president a “white supremacist.”4 Many inside and outside the halls of ESPN wondered how the network could find a better balance between social issues and sports reporting. Some wondered if a politically oriented ESPN would drive away more subscribers.

The Business Model
Fundamentally, ESPN faced a twenty-first-century version of the fable about the goose that laid golden eggs. Exhibit 1 displays ESPN’s estimated earnings from affiliate and advertising revenue from 2015 to 2018. Affiliate revenue (the fees paid by cable affiliates and individual subscribers for the network feed) constitutes five of six revenue dollars at ESPN. ESPN in turn contributes about 75 percent of Disney’s Media Networks affiliate revenue, and the $2 billion in advertising revenue represents 28 percent of the corporate total. ESPN’s annual cable revenues are golden eggs, and both Disney and ESPN have been leery about any moves that would kill the goose. Actions that take eyeballs away from cable put the golden goose at risk. It took ESPN three years, from 2015 to 2018, to settle on an app (ESPN+) that complements, but will never substitute for, ESPN on cable.
Skipper and Iger didn’t want to kill the golden goose, but they proved quite willing to see how many golden eggs the goose would produce each year. Net subscribers fell roughly 6 percent bet- ween 2015 and 2018, from 92 to 86 million. To counter that loss, the network raised its subscription fees. In economic terms, ESPN exploited the price inelasticity among cable consumer. ESPN raised subscriber fees a total of 30 percent since 2015. Its $7.54 basic fee for cable viewers in 2017 was
$1.50 higher than the next most expensive offering (Fox’s YES Network that covered the New York Yankees). ESPN was by far the most expensive network.
Total subscribers fell over the period by 6.5 percent; however, revenues grew 18 percent over the four years. The top line looked good, but the additional $1.5 billion in revenue did not cover the increases in programming costs, somewhere around $2.4 billion. Advertising revenues had been flat since 2017. The net result: ESPN contributed more dollars to Disney’s topline, but fewer to the bottom. The network was less profitable.

Disney Corporate Moves
ESPN was not alone in dealing with the potential disruption of streaming video; its corporate parent, the Walt Disney Company, faced the same set of challenges. It appeared to Pitaro, from his perch running Disney Interactive, that Bob Iger and his team had not yet figured out how the larger company would respond to a world filled with video streaming services, from Amazon to YouTube. Disney announced in 2017 that it would no longer offer its huge film library on Netflix, and in late 2018 the company unveiled its own streaming service that would come online sometime in 2019.5 Pitaro saw this as a big bet because network-owned streaming services had struggled. For example, CBS All-Access had 8 million subscribers as of 2019, while Netflix served 136 million people.6
Could any network, even ones with massive film and TV libraries, offer the breadth of programming offered by Amazon and Netflix? Disney might be able to compete if it included its huge film and TV catalog and programming from ESPN. The challenge for Disney, however, would always turn back to the golden goose problem. Consumers could sign up for Netflix for around $13 per month, and a subscription to Amazon Prime cost $10 per month. In 2018, ESPN and its associated networks (ESPN2, ESPNU, and the SEC Network) cost almost $10 per month. Could Disney profitably offer all of its other content for $3 per month? How much would customers pay for a unique Disney streaming service, with or without ESPN?
Disney had engaged in a number of acquisitions to gain the resources it needed to compete in the streaming market. In 2016, the company invested $1 billion in Bamtech, a streaming video producer that operated the backbone of Major League Baseball’s online offering. That billion gave Disney a 33 percent stake. Iger plowed in $1.5 billion more in 2017, for an additional 42 percent.7

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EXHIBIT 1 ESPN in 2019, Selected Financial Data

Year
ESPN Fee
Other Channels
Total Affiliate Revenue
Subscribers Monthly Revenue
Annual Revenue
Growth
Advertising Revenue
2014 $6.10 $1.34 $7.44 94,600,000 $703,824,000 $8,445,888,000 $1,950,000,000
2015 $6.55 $1.40 $7.95 92,000,000 $731,400,000 $8,776,800,000 3.92% $2,100,000,000
2016 $7.21 $1.49 $8.70 89,000,000 $774,300,000 $9,291,600,000 5.87% $2,200,000,000
2017 $7.54 $1.52 $9.06 87,000,000 $788,220,000 $9,458,640,000 1.80% $2,200,000,000
2018 $8.06 $1.61 $9.67 86,000,000 $831,620,000 $9,979,440,000 5.51% $2,200,000,000
2019 ESPN+ $5.00 1,200,000 $ 6,000,000 $ 60,000,000
Sources: Case Writer Estimates, various sources; secondary channels from https://www.businessinsider.com/cable-satellite
-tv-sub-fees-espn-networks-2017-3; TV ad rates basically flat in 2017–2018: https://www.adweek.com/tv-video/national-tv
-ad-revenue-was-flat-during-the-2017-18-season-but-ad-loads-jumped-4/.

Bamtech designed and powered the ESPN+ sports app and would likely prove instrumental in any corporate streaming service.
In December 2018, the US Department of Justice gave final approval for Disney’s $71.3 billion purchase of several 21st Century Fox assets. The deal would add Fox’s film and TV catalog to the Disney offering, as well as give Disney another brand name studio for producing feature films. Iger and Disney seemed to believe that if they had enough enticing content on their own service, potential subscribers would add Disney’s streaming offering to their current palette, or they might abandon Amazon and Netflix entirely.
The Fox acquisition entailed one more wrinkle that complicated Disney’s plans. As a part of the Department of Justice approval process, Disney had to divest 22 regional sports networks it acquired in the Fox deal.8 Selling 22 stations as a group proved harder than Disney originally planned, and delays in divesting these assets could delay the rollout of the Disney streaming service, without ESPN.

Pitaro’s Dilemma
Pitaro exhaled again. As he turned over the issue in his mind, several questions arose. First, should he make any efforts to “de-politicize” ESPN over the next years? Would sports reporting with a political edge drive away, or attract, more subscribers? Had ESPN’s fee increases been short-run smart but long-run foolish? How much higher could subscription fees climb before cable partners or their customers rebelled? Had the network become fatally dependent on cable? Finally, and perhaps more importantly, what role should ESPN play in a Disney streaming app? Could Disney charge enough for the app to offset potential losses if substantially more subscribers cut the cable cord and abandoned ESPN?

References
1“James Pitaro,” https://www.thewaltdisneycompany.com/leaders
/james-pitaro/, accessed February 26, 2019.
2M. Prada, “NBA to Announce 9-Year, $24 Billion TV Deal with ESPN, Turner,” SB Nation, October 5, 2014, https://www.sbnation
.com/2014/10/5/6916597/nba-new-tv-deal-espn-turner-24-billion, accessed February 26, 2019.
3S. Ramachandran, “How a Weakened ESPN Became Consumed by Politics,” Wall Street Journal, May 24, 2018, https://www.wsj.com
/articles/how-a-weakened-espn-became-consumed-by-politics
-1527176425, accessed February 26, 2019.
4See C. Rosen, “Donald Trump Lashes Out at ESPN, Jemele Hill on Twitter,” Entertainment Weekly, September 13, 2017, https://ew.com/ tv/2017/09/15/donald-trump-twitter-jemele-hill/, accessed February 27, 2019.
5M. Castillo, “Disney’s New Netflix Rival Will Be Called Disney+ and Launch Late 2019,” CNBC, November 8, 2018, https://www.cnbc
.com/2018/11/08/disneys-new-netflix-rival-will-be-called-disney-plus
-and-launch-late-2019.html, accessed February 26, 2019.

6For CBS, see L. Feiner, “CBS Reaches Its 8 Million Streaming Subscribers Goal Two Years Early,” CNBC, February 14, 2019, https://www.cnbc
.com/2019/02/14/cbs-reaches-its-8-million-streaming-subscribers
-goal-two-years-early.html, accessed February 27, 2019. For Netflix, see
S. Fiegerman, “Netflix Adds 9 Million Paying Subscribers, but Stock Falls,”
CNN Business, January 17, 2019, https://www.cnn.com/2019/01/17
/media/netflix-earnings-q4/index.html, accessed February 27, 2019.
7S. Perez, “Bamtech Valued at $3.75 Billion Following Disney Deal,”
Tech Crunch, 2017, https://techcrunch.com/2017/08/08/bamtech
-valued-at-3-75-billion-following-disney-deal/, accessed February 26, 2019.
8A. Ellingson, “Disney Looking to Sell Fox Regional Sports Networks Piecemeal,” LA Biz, December 11, 2018, https://www.bizjournals
.com/losangeles/news/2018/12/11/disney-looking-to-sell-fox-regional
-sports.html, accessed February 26, 2019.