Striking a balance: My analysis of Disney+'s price increase

Posted by Q McCallum on 2023-08-11
Description: photo of two hands, counting out twenty-dollar bills. Photo by Igal Ness on Unsplash.

(Photo by Igal Ness on Unsplash )

You may have seen that Disney is raising the price of its Disney+ streaming subscriptions by twenty percent. I can see how this could be frustrating for customers. But what might it mean from a business perspective?

I have no insider knowledge, so I can’t say for sure. But I’ll note that the company has only announced rate hikes on its ad-free, full-fare subscriptions. And to me, that means this is more than just your typical cash-grab operation. It’s more likely that Disney’s trying to balance its subscription plans.

I expect this lesson generalizes to other companies that mix ad-free subscriptions with ad-supported. Read on:

The background: Disney+ offers two monthly subscriptions. One is ad-free while the other is a lower-cost, ad-supported arrangement.

Disney+ started with the ad-free and introduced the ad-free one last year.

What does this mean for revenue calculations? It’s easy for Disney to see how much money the ad-free plan brings in: multiply the number of subscribers by the monthly fee. The catch? The only ways to make more money with that arrangement are to raise prices or increase the number of subscribers.

Raising prices is tricky, because you lose your price-sensitive customers. Growing the subscriber base isn’t any easier. At some point Disney+ will reach everyone who is interested (its total addressable market, orTAM); or the cost of customer acquisition will get too high (so they’ll pass on “overpriced” people who are interested); or there will be some other reason for subscription growth to flatten. Revenue will follow suit.

The ad-supported tier tells a different story, though, because revenue-per-subscriber has two parts:

  • the fixed-price component – this is the reduced monthly fee, paid by the subscriber
  • the variable-priced component – this is the money advertisers pay to Disney, which is likely based on the number of people who view their ads

(If you’ve worked in finance, you probably see where this is going. Don’t worry; I’ll get to that in a moment.)

How much money does Disney make on the ad-supported model, then? If ad revenue is absolutely terrible one month, then they’ll make just the reduced monthly fee collected from the subscriber. But advertising can also have a great month, in which case the subscriber fee will be dwarfed by the ad revenue. The benefit of the ad-supported model is that Disney+’s revenue is capped on the minimum but unbounded on the maximum.

Disney can increase revenues on the ad-supported side by raising the prices they charge to advertisers. Disney holds the cards here because they hold exclusive rights to much of the content: if advertisers want to reach, say, fans of Andor or The Mandalorian, they’re going to have to pay whatever toll Disney chooses.

How does all of this tie into the recent rate increases? What could all of this mean for the Disney+ revenue model? I reason that any company that mixes ad-supported and ad-free plans would want the two to generate similar levels of revenue, either on a per-customer basis or per type of plan. That tells me:

  • Advertising has proven profitable: Disney+ is already seeing (or expects to see) very healthy advertising revenue. So much so, that the ad-supported side of the house is generating significantly more money than the current ad-free side. The price bump on the ad-free plans will bring the two groups in line.
  • They still need a hedge: The ad-free customers represent a steady amount of revenue every month, so they serve as a hedge against a weak run in advertising.

These points are flip-sides of the same coin: when advertisers are eager, they pay Disney+ a lot of money. When advertisers pull back, those fixed-fee, ad-free customers keep the ship afloat.

Earlier you said something about “people who had worked in finance.” What was that about? The financial realm – everything from trading to credit/lending – is all about hedging bets. It’s how they handle the harsh reality of not being able to control the future. Finance professionals want to cap their downside loss while remaining exposed to upside gain.

One approach in the trading world is to mix low-risk and high-risk assets. Say that you weight one side of the portfolio with stocks from industry bellwethers, or bonds, or the like – the kinds of things that won’t generate a ton of profit, but you can rely on them to not tumble. The other side of the portfolio contains assets that can vary wildly in price, like a high-tech company or an emerging-markets play. Maybe you make a ton of money on the risky stuff, or maybe it goes bust and you live off the revenue from the stable side. One flavor of this arrangement is called a barbell strategy.

An ad-supported plan is one form of a barbell: the subscriber fee represents the steady, fixed-income side while the ad revenue represents the risky side.

And when a company runs ad-free and ad-supported plans side-by-side, then they get a second level of a barbell: the ad-free side is steady, while revenue on the ad-supported side can vary.

So to my earlier point, about bringing the two subscription plans in line, I think the Disney+ price hike is mostly a matter of rebalancing the barbell. There’s still room for general profit-seeking, sure, but that’s not the whole story.

What are some other reasons they could be raising prices? You have to be careful falling in love with an analysis. When you run out of ideas on where your genius plans may break down, you can always call a friend who will play Devil’s Advocate.

One friend raised two scenarios that chip away at my Disney+ analysis. What if …

  • … the company had underpriced the offering as a way to build market share? (You know, the way so many gig-economy startup investors subsidized customers…) Now they’re raising prices to match the real costs of providing the service.
  • … the company is anticipating increased costs and/or lost future revenue? The Hollywood strikes are top of mind for anyone in the entertainment business right now. They’re capturing revenue now to cushion that blow.

Both of these are entirely plausible, so let’s keep that in mind as I wrap up this post.

What does this mean for other subscription companies? I’ve used Disney+ as an example here, but I expect this analysis holds for most companies that mix ad-free and ad-supported subscriptions. Even if they aren’t using financial terms like “fixed-fee,” “variable-price,” and “barbell,” I bet they still consider general concepts as they develop pricing models.

(For more of my thoughts on the Disney+ ad-supported tier, check out my O’Reilly Radar piece from last year: “Ad Networks and Content Marketing – The Potential to Do More With Less.”)