The Iger Sanction
The Disney CEO's embrace of digital technologies means big change--and a search for a new business model.
By Marc Gunther

(FORTUNE Magazine) - JUST 12 DAYS AFTER BOB IGER BECAME CEO of Walt Disney Co., he made a splash by agreeing to let Apple sell ABC's television shows over the Internet. So before flying to Los Angeles to see Iger, I paid $1.99 to load the latest episode of Desperate Housewives onto my video iPod. With a broadband connection, it took 21 minutes to download the 43-minute program (no commercials!) from Apple's iTunes store onto my laptop, and another four minutes to transfer it to the iPod. On the plane the picture looked fabulous, even on the 2½-inch screen. But engine noise drowned out a lot of the dialogue, and I gave up midway through the program.

"This is such a big deal?" I asked Iger a few hours later. Yes, it is, he assured me, because TV on an iPod is just the start. New channels of distribution, including broadband Internet, wireless phone networks, and video-on-demand are all growing rapidly. New electronic devices, including the TV-enabled cellphone, videogame players, digital video recorders, and the iPod, are proliferating even faster. "The changes I'm talking about will affect the entire media landscape,whether you are in television, radio, music, movies--the whole thing," said Iger, 54, who has moved, along with his Hewlett-Packard xw8200 computer and 30-inch Apple Cinema monitor, into the conrner office he inherited from Michael Eisner when he took over as CEO Sept. 30. "It's not down the road. It's here. It's real. It's long-lasting."

Iger intends to be an early adopter as he guides the $31-billion-a-year Disney into the digital world. "Bob has Disney in the lead right now," says Lowell Singer, an analyst with S.G. Cowen & Co. "He's doing the most out-of-the-box thinking in the media sector." Disney's rivals have quickly followed--NBC has put Law & Order and Late Night With Conan O'Brien on iTunes, CBS has licensed Survivor to Comcast for video-on-demand, and Sprint Nextel has formed a joint venture with four big cable operators that will deliver streaming cable channels to your cellphone. Hollywood is once again abuzz about broadband entertainment, multiplatform plays, the "third screen" (meaning the cellphone), and that old standby, convergence.

"Technology is in the process of completely rearranging the way people consume video," says Nicholas Donatiello, CEO of Odyssey, a market research company in San Francisco. "The most important thing for big media companies to understand is that they need to be on this train or under it."

All this has created a climate of uncertainty--something that Wall Street hates. Disney generated $2.5 billion in net income in fiscal 2005, which ended Oct. 1, and it projects double-digit earnings growth in fiscal 2006. Even so, its shares have fallen 13% in the past year, slightly more than those of Viacom and Time Warner (FORTUNE's parent); all the media giants lagged behind the S&P 500.

Does Iger's embrace of digital distribution amount to a new business model? Not yet, but he can't afford to sit still. His challenge will be to manage the inevitable decline of older but still lucrative distribution channels while placing the right bets on new ones--and hoping they one day become as profitable as the old ones were. It is far too soon to tell, of course, what the revenue streams from digital distribution will look like. Right now they are incremental: In the first two months they were available, episodes of Disney shows were downloaded about 800,000 times at $1.99 each. Disney isn't saying how much of that $1.6 million total it keeps, but by way of comparison, a single recent episode of Desperate Housewives generated $9.9 million in ad revenue, according to Nielsen Monitor-Plus.

Iger has to decide whether Disney wants to invest in its ten TV stations and 64 radio stations or get out of those businesses. They are cash cows today, but they will decline in value as consumers take charge. Iger says Disney's TV stations will be fine, but others who own TV stations that distribute ABC are watching nervously as more of its programming becomes available over the Internet or via cable's video-on-demand platform. "I can't blame Disney for trying new things, but we don't want to lose our prime-time audience," says Deb McDermott, president of Young Broadcasting, which owns five ABC affiliates.

Then there's the DVD, which has been a boon to Disney. A seven-disk boxed set of the first season of Lost has sold about 1.2 million units, with a list price of $59.99. If people can easily download and store TV shows and movies, will they buy as many DVDs? Wal-Mart, which sells more DVDs than anyone, has let Iger know that it is unhappy.

Truth be told, Iger does not worry much about protecting traditional distribution channels. That train has left the station. If you doubt it, Google this: "desperate housewives torrent." What you will find are file-sharing websites where movies, TV shows, and videogames are available--illegally, to be sure, but a few clicks away. Download a TV show or movie using so-called bit torrent software, connect a late-model laptop to a new digital TV with an S-video cable, and you will see why Iger has no time to waste.

The good news is this: By making TV shows and movies available conveniently and at a fair price in digital form, the entertainment giants should be able to curb piracy and wring more value out of their content. Eric Garland, CEO of Big Champagne, a research firm that tracks file sharing, says, "There is really no reason for online piracy to savage Hollywood the way it has the music industry." There's so little cost to putting video libraries onto the Net that all the companies will do it. Time Warner (parent of FORTUNE's publisher) and its AOL unit, for instance, this year plan to launch an ad-supported online service offering shows from the Warner Bros. library. And not a moment too soon for fans of F-Troop.

Ultimately, Iger is betting that new digital platforms and devices will enhance the value of content, especially branded, high-quality movies and TV shows. "This transition is creating an even more voracious appetite for content," he said. His own media consumption habits prove it. Iger has stored his music on Internet servers since the mid-1990s, his car is equipped with 120 channels of Sirius Satellite Radio (Spa 73, a soothing jazz and blues channel, is a favorite), and he travels with two iPods, the 40-gigabyte videoplayer as well as the Nano, which goes into his pocket during workouts at the gym. "And I listen to more music than ever," Iger says.

Iger joined ABC in 1974. That predated cable, VCRs, DVDs, videogames, and the Internet, so he has seen the networks withstand technology shocks. As ABC's top prime-time programmer, he put Twin Peaks and America's Funniest Home Videos on the air and managed Roseanne, so he knows what it takes to make hits. No matter what lies ahead, he says, network TV won't wither away. "People are still going to look to aggregators, editors, and intermediaries," he says. And as a manager, Iger has two attributes that bode well for Disney: He is willing to share power, and he plays well with others.

One of Iger's first moves, after being chosen to succeed Eisner as CEO, was to shrink Disney's centralized strategic planning unit, giving the business units more authority. The company's metabolism picked up a bit. Anne Sweeney, co-chair of Disney's Media Networks, which includes ABC and the Disney Channel, negotiated the iPod deal in three days. "There was no bureaucracy," Iger said. "Zero." It did not escape notice that Steve Jobs, Apple's CEO and no fan of Eisner's, has gone out of his way to praise Iger. This bodes well for future relations between Jobs' other company, Pixar Animation Studios, and Disney, which distributes its movies. They are renegotiating that arrangement now, and some Wall Street analysts have speculated that Disney may acquire Pixar.

Such an acquisition would fit nicely with Iger's strategy. He plans to invest heavily in programming, especially animation. "Animation is and will remain the heart and soul of Disney," he says. Because Disney's businesses--movies, television, theme parks, and consumer products--are closely integrated, an animation hit can generate revenue for all the divisions and all around the world.

Disney is also investing more in television production. That is because a hit TV show, too, can generate revenue from multiple sources: the sale of advertising when it airs on the broadcast network, DVD sales, Internet distribution, syndication, and global licensing. Desperate Housewives is or has been the top-rated show in Australia, Britain, New Zealand, Italy, Singapore, South Africa, and Germany, and it was sold in China last month.

ABC, as a result, becomes less of a standalone business and more like a platform for creating intellectual property. Think, for example, of slicing and dicing TV shows for delivery to cellphones. Says Anne Sweeney: "You could have a very compelling two-minute episode of Lost."

Disney's ESPN unit is also making big investments. In 2005 it spent $8.8 billion for the rights to Monday Night Football, $2.4 billion for baseball, and $2.1 billion for NASCAR, all for eight years. In each deal ESPN acquired Internet and mobile-phone distribution rights. All over Disney, people are experimenting with new technology. A Disney-branded cellphone network for families will be introduced later this year. ABC News Now, a 24-hour Internet news channel, is being distributed by AOL, Comcast, and SBC Yahoo. Toontown Online, a multiplayer game, has attracted tens of thousands of users, who pay $9.95 a month to play inside its fantasy world.

None of that will matter if Disney can't keep making content that people really want to consume. One consequence of the digital world is that viewers will reject second-tier content--you know, like that TV show hammocked between two hits that people watched because nothing else was on. Now there will always be something else on. "That might be a good thing," muses Iger. "We'd weed out some of the chaff." Ask him what he worries about, and he does not talk about broadband take-up rates or piracy or cannibalization. He worries about creating hits. Tech, shmeck. Some things never change.

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