CASE 3B ESPN and ESPN+ in 2021: Challenges of growth

James Pitaro moved his chair away from the computer screen and took a deep, calming breath. He had just finished his second full year as President and Co-Chair at sports programing 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, the first outsider to be CEO since its 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 20 million subscribers since its peak of 99 million in 2011, and the app represented ESPNs first serious attempt to bring extensive content to mobile platforms. The app started strong and 2020 had been a banner year, with subscribers growing 243% and revenues over 300% (see Exhibit 1 for financial details of ESPN). As Pitaro prepared for his review with Disney CEO Bob Chapekwho had been in his role for just one yearhe wondered about how to navigate the growth of the ESPN+ app, both within the Disney+ streaming service and its relationship to the flagship ESPN set of networks (ESPN, ESPN2, ESPNnews, ESPNU, and the SEC network). He wondered what to recommend as the next steps to maintain ESPN's market dominance, given the current situation at ESPN and Disney. Two issues defined that situation: the "politicization" of ESPN, and ESPN+'s challenge to its fundamental business model. 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. Is ESPN Too "Political?" 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's critics claimed the CEO had "politicized" ESPN since taking control in 2012. On-air talent weighed in on 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 "ESPN is paying a really big price for its politics (and bad programming)." Hill responded by calling the President a "white supremacist."2 Many inside and outside the halls of ESPN, including former Disney CEO Bob Iger, felt the network needed to pull back on its reporting of social issues. 2020's focus on race relations in America, highlighted by the protests over the police killing of black Minneapolis resident George Floyd, put ESPN in a tough spot. Some subscribers felt the network should stick to sports reporting, while others saw sport as a vehicle to drive social change and wanted the network to become more involved. Prominent athletes such as NBA mega-star LeBron James often used the network as a platform to mix sports and politics. Was its commitment to social change a manifestation of Corporate Citizenship? How should the network balance advocating for social change without alienating a significant portion of its audience?

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 2014-2020. Affiliate Revenue (the fees paid by cable affiliates/individual subscribers for the network feed) constitutes five of six revenue dollars at ESPN through the period. Somewhere around half of these revenues came from "non-watchers," people who paid the $9+ monthly subscription fee but never watched the network. One analyst estimated the actual cost to those who watched the network at $34 a month.3 In 2019, ESPN contributed about 45%. ESPN in turn contributes about 54% of Disney's media and network affiliate revenue, and the $2.3 billion in advertising revenue represents 33% of the corporate total. ESPNs annual cable revenues are golden eggs, and both Disney and ESPN have been leery about any moves that would kill the goose. 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% between 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 consumers. 2019 and 2020 had seen fees slip from $9.67 per subscriber a month to an estimated $9.29, a loss of 4% (See Exhibit 1 for details). The goose might keep laying golden eggs, but it seemed as if its egg production would either stall or decline.

EXHIBIT 1 ESPN in 2020, Selected Financial Data 2021 Sources: Data on subscriber fees from Variety, https://variety.com/vip/pay-tv-true-cost-free-1234810682/. Data on 2019 ESPN+ subscribers from Disney 2019 10-K Data on 2019 ESPN Advertising from Motley Fool: https://www.fool.com/investing/2020/04/19/how-disneys-espn-makes-money-sportsbroadcasting.aspx#:~:text=In%20total%2C%20ESPN%20likely%20generated,of%20Disney's%20highest%2Dgrossing%20businesses. Data on ESPN 2020 Subscribers from https://nextlevel.finance/updated-espn-subscribers-and-espn-revenue-explained/ Data on ESPN+ 2020 Subscribers from Statista.

Cable Network Affiliate Revenue Advertising Revenue

Year ESPN Fee Other Chan Total Subscribers Monthly Revenue Annual Revenue Growth

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 $ 7.46 $ 1.54 $ 9.00 83,000,000 $ 747,000,000 $ 8,964,000,000 -10.18% $ 2,300,000,000

2020E $ 7.64 $ 1.65 $ 9.29 79,300,000 $ 736,697,000 $ 8,840,364,000 -1.38% $ 2,300,000,000

2019 ESPN + $ 5.00

3,000,000 $ 15,000,000 $ 150,000,000 N/A

2020E' ESPN+ $ 5.99

10,300,000 $ 61,697,000 $ 616,970,000 311.31%

Over the years, ESPN had continued to seek new content to satisfy sports fans. 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 2016.4 By 2018, programming costs, the contracts to carry sports programming, hit $4.7 billion a year, double what they were in 2013.5 Pitaro faced an equally dire prospect of programming cost increases. For example, under its current contract with the NFL, ESPN paid the league $1.9 billion to broadcast Monday Night Football and other games. The contract would expire at the end of 2021, and the renewal for the contract was expected to approach $3 billion annually, a 50% increase.6 The cost of existing and new content could easily outpace revenue growth at the network. The growth of the app had been impressive, but several questions remained. First, the rapid growth in the app coincided with the COVID-19 pandemic, and it was unclear how many of the new subscribers signed on because of boredom during the lockdowns and limited activity of the pandemic. Second, what was the split between people who used the app as a substitute for their cable subscription (the cord-cutters)? What percentage used the app to complement their existing cable subscription? Some users noted that the app was a great way to stay continuously connected, but not as sophisticated or rich as the cable version of ESPN.7 Finally, what percent of app subscribers were new to the entire ESPN experience? The implications of those customer groups would go a long way toward determining the future strategy of ESPN. That future strategy had to blend the explosive growth of the app with the similarly explosive rise in programming costs that ESPN. ESPN+ contributed over a half billion dollars in 2020 revenue; however, ESPN would need 5 times that many subscribers just to pay the expected costs of the NFL contract. Prices had risen 20% in the first year, but a price ceiling for a sports app was hard to determine. Revenue for ESPN+ would also depend on the blend of subscribers who bought ESPN+ as a part of the Disney+ app. As 2020 drew to a close, ESPN+ was $5.99, Disney+ cost $6.99, and Disney's Hulu joint venture cost $5.99. Consumers could purchase Disney+, ESPN+, and Hulu for $12.99 per month. If the majority of future ESPN+ subscribers came through the bundled package, the network would experience significant pressure on both revenues and profits.

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 and social edge drive people away or attract more subscribers? What should the cable business look like going forward? Would the network be forever dependent on cable? Finally, and perhaps more importantly, what role should the app play in the long-term strategy of ESPN and Disney?

1. What is ESPN good at doing to create value for customers? What key resources and capabilities enable ESPN to perform its value-creating activities? Feel free to use Table 1 below as a template to categorize ESPN's resources and capabilities. There are likely multiple assets in each category, please list all that you can identify. Your focus should be on ESPN at the time of the case, as opposed to the company's earlier years.
2. What are ESPN's physical assets? Financial assets? Human Resources? Intangible assets? Operational capabilities? Dynamic capabilities?