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Essay: Discover How Disney Has Grown Internationally and Examined the Impacts of Their Internationalised Environment

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Disney is a diversified worldwide entertainment company. The company consists of four business segments: Media Networks, Parks and Resorts, Studio Entertainment plus Consumer product and Interactive media. This assignment analyses how Disney has grown internationally and examines the impacts of operating in an internationalised environment.

II. Impacts of Internationalisation

Operating in an international environment has provided Disney with many opportunities and advantages.

Advantages

The global market gives Disney access to wider audiences. In the vision of “The World Is Flat”, Friedman (2005), the company’s products are readily available for consumption of internationalised audiences as distribution methods enable it increasing access to consumers in new parts of the world. “Born global”, Disney has international appeal. The content production of the company has very high operating leverage; once a film is produced the only variable costs are the distribution of the content which are falling as distribution methods improve. This means the more internationalised the environment, the more profitable the product.  This global presence facilitates coordinated advertising and cross promotion (Schmid, 2007).

Disney’s internationally adored characters and the standardized engineering blueprints for theme parks have given the company great international scale-up potential (Sylt, 2018). Disney has benefited from increasing disposable income in emerging market regions and the resultant revenue growth. In its merchandising, it operates a decentralised, subcontracted business model to outsource human capital where possible, taking advantage of lower wages in comparatively cheaper regions internationally. While empowering Disney to focus on intellectual property creation (Robbins & Polite, 2014).

Challenges

A global presence reduces the company’s control over brand equity which threatens the continuity of Disney’s brand image. Greater internationalisation of a single brand creates greater liability that a subsidiary or partner will damage the brand equity. Research carried out by Van Maanen (1992), found that Disneyland employees are strictly managed and trained in mitigating this risk. A second challenge emerges in catering for audiences of different cultures. Disneyland Paris required compromise on both sides, French cast members had to shave, while Disney gave in on the issue of alcohol in the park, making wine available in its restaurants (Rukstad, et al., 2001). This issue also pertains to the crafting of content for international distribution. The company must carefully structure its content. Upon the release of Aladdin, Arab-Americans interpreted the characters’ portrayal to be of a racially stereotypical disposition. The international expansion of content is also met with language barriers, for example High School Musical, with 290 million viewers in 100 countries, has been translated into 30 languages (Giovanni, 2017). Lastly, Disney’s Hong Kong theme park had been delayed for two years, due a Disney movie, Kundun (1997) about the Dalai Lama that the Chinese government found objectionable.

III. How International is Disney?

The Disney brand is internationally recognized and adored. The company generates revenue from countries all around the world while holding assets in many foreign countries and owning subsidiaries on three different continents. Disney has theme parks in Tokyo, Paris, Hong Kong and Shanghai as well as two US parks in California and Florida.

Breadth & Depth

The breadth and depth of Disney’s geographic spread of market engagement is analysed in Table A. (Appendix) and represents what Aggarwal et al. would classify as a SG-IT3 firm. The breadth of a company is defined as the extent of its geographic spread across six regions, which roughly represent each continent (Aggarwal, et al., 2011). Depth of market engagement is measured according to a company’s contractual agreements, licensing and investments in subsidiaries. Using two depth dimensions – Trading (sales) (S) and investment in subsidiaries (I), Disney can be classified as a company with global sales with revenue from all six continents but with only transregional (T3) subsidiaries as subsidiaries are only in 3 regions (Appendix). Therefore, Disney is a SG-IT3 firm . If we interpret (Aggarwal, et al., 2011) definition of depth to include all assets and arrangements, Disney could be described as SG-T(5)I (Global Sales, Trans-Regional Investments), with globally reaching sales but investments in only 5 regions. The greater the width and depth of the firm, the better hedge it has against currency and operational risk. Depth, breadth and the resultant effects on financial market risk are further explored in Section V.

Although Disney has a large international presence, international revenue accounts for a mere 24% of total revenue (The Walt Disney Company, 2017) (figure 1). The company’s international share of revenue has only increased from 17% to 24% in the 17 years from 2000 to 2017. Portfolio Theory maintains that international diversification reduces a company’s risk, Therefore Disney should try and increase their international share of revenue. However, when analysed in isolation, it’s clear that international revenue has risen dramatically by 209% from 2000 to 2017. This growth is primarily due to European expansion from 2000 to 2010 and has been driven by the Asia Pacific since the turn of the decade as European revenue fell during the 2008 financial crisis and then stagnated (figure 2). Investors may be concerned that international revenue is growing at a slower rate falling from 128% (2000-2010) to 35% (2010-2017). This may indicate that international growth is stagnating.

To conclude, Disney’s international revenue growth in the last 17 years appears lacklustre when compared to the rise in domestic revenue (figure 3). Therefore, while internationalization has improved, there is a long road ahead for full diversification. This may be due to differences in customer demographic or that Disney’s international expansion strategies fail to maximize potential revenue.

IV. Disney’s International Expansion Strategy

Disney’s international expansion strategy has been one of forward integration and licensing agreements. Disney has integrated both organically and through acquisitions (section VI); e.g. acquiring Fox Family Worldwide expanded Disney into European and Latin American markets (The Walt Disney Company, 2007) Disney owns its distribution networks which then show content directly to international countries or indirectly through licensing agreements allowing international broadcasters and networks to show their content. Disney’s media networks include 100 Disney branded television channels, which are broadcast to 162 territories reaching 645 million subscribers outside of the U.S alone. These include major cable channels in India, Russia, Africa and allow global online access. The company owns and operates the Latin American version of Disney Channel, with headquarters across the continent (The Walt Disney Company, 2017).

In 1987 Disney vertically integrated downstream into retailing and launched Disney stores which sold consumer products direct to customers globally (The Walt Disney Company, 1987). Disney has licensing agreements with manufacturers who pay royalties to produce their products. Disney owns and operates 221 stores in North America, 87 stores in Europe, 55 stores in Japan and two stores in China (The Walt Disney Company, 2017). The Company licenses characters from its film, television and other properties for use on third-party products and earns royalties across the globe.

International Expansion of Theme Parks

Disney’s theme park expansion strategy is characterized by the trade-off between risk and profit potential. Disney’s first international theme park, Tokyo Disneyland, opened on 15th April 1983. Disney believed there was a huge risk in building an American theme park in a country with a different culture. To minimize risk, Disney entered a licensing agreement with the Oriental Land Company Limited (OLCL) (Hernandez, 2011). This exposed OLCL to all the risk in return for the use of Disney’s trademarks and intellectual property. OLCL would own Tokyo Disneyland while Disney would receive 10% on admission revenues and 5% on food, beverage and souvenir sales while also providing continual technical assistance (Rukstad, et al., 2001). OLCL, a Japanese company, ensured the park adhered to local customs and regulations and the park was a great success becoming the only Disney park to attract over 15 million visitors a year by the late 1980s. Despite Disney receiving royalties of $573 million in 1989 (Hernandez, 2011) the company would have earned a lot more if their appetite for risk was higher when choosing their expansion strategy.

After seeing the success in Tokyo, Disney decided to bear more risk to receive greater profits in their next project, the opening of Disneyland Paris, by opening a majority owned subsidiary. The park opened in 1992 but the project experienced great problems (Rukstad, et al., 2001). The construction was over budget and attendance was sluggish, blamed on a “cultural Chernobyl” of a mismatch (Hernandez, 2011). In 1994, a Saudi Arabian billionaire purchased a 24% stake to help the highly leveraged Euro Disney.

The large discrepancies between the two cultures made a wholly owned subsidiary the wrong strategy. However, the strategy minimized transaction costs, prevented knowledge leakages and the locational advantages justified investment in the country. Disney would have limited these risks while keeping considerable control and gaining local expertise if they operated via joint venture with a French company.

Disney learned from their mistakes of failing to maximize profit in Tokyo and adapting to a new culture in Paris and decided to open Disneyland parks in both Hong Kong (in 2005) and Shanghai (in 2016) via joint venture with companies from those respective countries. Disney owns 43% and 47% of the parks in Shanghai and Hong Kong, respectively (The Walt Disney Company, 2017) Therefore, Disney obtains considerable profits and ensures the Disney experience is authentic while sharing risk and addressing cultural differences.

V. Financial Market Risk Exposure & Hedging Strategies

Disney boasts international recognition and is considered one of the world’s corporate branding giants (Hatch & Schultz, 2001). Despite this, in FY17, approximately 76% of its revenue was from domestic sources. Comparatively, this is quite high when contrasted with S&P Global’s (2018) approximation of an overall rate of 56% for S&P 500 domestic revenue. Hence, Disney’s currency exchange rate risk is not as prevalent as it is for other firms. Disney has established policies and procedures to manage the Company’s exposure to interest rates, foreign currencies and commodities using various financial instruments (The Walt Disney Company, 2017). The company uses derivative securities for hedging rather than speculation.

Foreign Exchange Exposure

Exchange rate risk is a financial risk posed by Disney’s foreign subsidiaries’ financial statements being denominated in a currency other than the currency of the consolidated entity. The risk arises from adverse movements in the exchange rate of the denomination currency vis-á-vis the base currency  (Levi, 2005) (Moffet, et al., 2009).

For Disney, currency exchange rate risk is prevalent in the following forms:

Transaction Exposure is cash flow risk. It deals with the extent to which any given exchange rate will have an effect on the value of foreign currency denominated transactions which have already been entered into (Menon & Viswanathan, 2005).

Translation exposure, is a form of balance sheet risk. It relates to “exchange rate moves to the valuation of a foreign subsidiary and, in turn, to the consolidation of a foreign subsidiary to the parent company’s balance sheet” (Papaioannou, 2006) .Notably, in FY16 favourable segment operating results were “partially offset by the impact of foreign currency translation due to movement of the USD against major currencies” (The Walt Disney Company, 2016)

Economic (operating) exposure risk associated with long-term exchange rate movements (one to five years) on DIS’s expected future cash flows. This form of exchange rate risk is more difficult to quantify as the cash flows linked to risk are not certain to materialise (Dhanani, 2000)

The company uses options and forwards to manage foreign exchange risk for both assets and anticipated revenues. The same instruments are used to secure not firmly committed purchasing and sale transactions. Also, options and forwards are exercised to hedge foreign currency assets and liabilities (The Walt Disney Company, 2017). Disney

 mainly hedges against euro, British pound, Japanese yen and Canadian dollar currencies.

Interest Rate Exposure

 Interest rate risk arises for Disney through its debt structure and holdings of interest-sensitive securities. Disney’s current financing mix is 14% debt and 86% equity (J.P. Morgan, 2018). To reduce its exposure to the interest rate market volatility Disney uses pay-floating and pay-fixed interest rate swaps to secure the position of its portfolio borrowings. Primarily pay-fixed interest rate swaps are used as cash flow hedges on floating rate borrowings. They effectively convert floating-rate borrowings to fixed-rate borrowings which enables the company to retain a fixed rate throughout the period of its obligation repayment. In 2016 to facilitate interest rate risk management strategies, the company sold an option to enter into a future pay-floating interest rate swap indexed to Libor for $0.5 billion for future borrowings (The Walt Disney Company, 2017).

VI. Risk Management

According to Moody’s creditworthiness rating the Disney has an A2 rating which means that its hedging costs are much lower than of companies with lower credit rating (Moody's, 2018). This enables the company to hedge more of its positions at a lower cost which should suggest a lower transaction exposure. Additionally, Disney company employs over-the-counter cross-currency swaps to convert foreign currency denominated borrowings to U.S dollar denominated borrowings. The company adjusts hedge coverage based on the percentage of its forecasted foreign exchange exposure generally for periods not exceeding four years (The Walt Disney Company, 2017).

To estimate the possible risk of one-day loss on investments, Disney employs the Value at Risk model at 95% confidence level. In computing the model, the company accounts for the interrelationship of movements between interest rates, foreign currency, commodities and market changes over the preceding quarter. The chart below illustrates the VaR model for the last five years.

The chart portrays a declining trend of risk associated with the investments of Walt Disney. However, is it important to realise that the VaR model is only reliable in normal market conditions and does not consider any anomalies which questions its reliability  (Brown, 2004).

The table below shows the estimated maximum of potential one-day loss according to the VaR model. As we can notice the interest rate financial instruments portray the largest risk of loss. However, the combined VaR has decreased from $113 million in 2016 to $92 million in 2017 which implies that the company is effectively improving its risk management strategies (The Walt Disney Company, 2017).

In international finance, the issue pertaining to appropriate hedging strategies for the different forms of exchange rate risk is yet to be conclusively settled (Jacques, 1996). However, as is the case for Disney, corporate treasurers utilize various risk management strategies subject to, ceteris paribus, the prevalence of different forms of financial risk, the size of the firm, and the degree to which it operates internationally (Allen, 2003).

VII. Mergers & Acquisitions

In the last twenty-two years Disney has completed roughly twenty-five M&A transactions. The company places a strong emphasis on synergies in its strategy; highlighted at one point by the existence of a synergy group which reported directly to the CEO (Fabrikant, 1995). A case study of the Lucasfilm acquisition shows a recent example of the firm’s synergy focus in acquisitions.

Disney-Lucasfilm: Deal Rationale

Disney has historically been weak in targeting masculine markets but strong targeting feminine ones, such as through its Disney Princesses franchises which had accrued an estimated $3b in global sales (NG, 2013). Star Wars helps bridge that gap, giving potential for revenue synergies – attractions for both boys and girls in families increases the likelihood a family will make a trip to its Parks (Russel, 2012).

Another dimension for synergies comes from Disney’s expertise with renewing old intellectual property. This goes all the way back to the rerelease of Snow White in 1944 (Rukstad, et al., 2001) Leading up to the Lucasfilm deal, it acquired Marvel in 2009 for $4.2b and released the Avengers film using Marvel characters which, at the time, became the third-highest-grossing film ever taking in over $1.5b worldwide (IMBD Database, 2018).

Furthermore, Disney’s platforms for new merchandise forms, such as its parks, could drive revenue synergies by attracting new visitors via Star Wars rides or even parks. The Star Wars franchise was already remarkably popular in merchandise markets, with 76% of the franchise’s $42b of revenue coming from sale of goods such as toys and books (Baidawin, 2016).

On Lucasfilm’s side, the production studio revolved around its eponymous owner, George Lucas. In his 70s, Lucas was mindful of his age “To do another would be 10 years… I don’t know whether I’ll be here when I’m 80”.

Lucas also had a close relationship with Disney CEO Bob Iger. The pair met often and had discussed the potential selling of the franchise as late as 2011 (Jones, 2016)

Market Reaction:

The general consensus was that this was a fair deal for both sides. Wall Street pencilled the deal as a negative weight on near-term expectations but earnings accretive by 2015. Perhaps reflecting the size of Disney, shares were down on the day in spite of the deal overall being perceived as good (Boorstin, 2012).

Post-Merger Integration:

Integration hampered many of the acquisitions the firm did in the online gaming space in the mid 00’s (see appendix). However, Disney appears to have learned to give its acquisitions the space and autonomy they need to remain happy and productive, like keeping Lucas on as a consultant to the studio (PON Harvard Law School, 2018) .The success of integration is also measurable in the success of the productions since the acquisitions, with Disney’s instalments of Star Wars each generating billion-dollar revenues (Rodriguez, 2018)

Cultural fit between the organisations seems strong also, with Kathleen Kennedy, Lucasfilm president, seen as a potential successor to Iger.

VIII. Corporate Governance

Corporate governance mechanisms provide shareholders some assurance that managers will strive to achieve outcomes that are in the shareholders’ interest (Shleifer & Vishny, 2012). These mechanisms are of increasing importance as a result of the growing power vested in top level management and the impact of agency theory, as put forth by Jensen & Meckling (1976) identifying manager’s self-interest.

Disney today places corporate governance and the protection of shareholders investment at the core of its operations and hold that “good board governance is integral to achieving long-term shareholder value” (The Walt Disney Company, 2018). The combination of increased competitive pressures (Johnson & Greening, 1999)  and increased shareholder demand for strong corporate governance (Pound, 1988) were conducive to the change in Disney’s corporate governance structure in the 1990’s under the reign of Michael Eisner. The company came under serious scrutiny due to the composition of its board due to the existence of personal relationships between many of its directors. Disney’s board was graded F and ranked amongst the ten worst out of 1800 American public companies by the Corporate library which rates boards on behalf of institutional investors (Gunther, 2003).The composition of the board and the $140M severance package paid to a former president Michael Ovitz where catalyst in the transformation process.  

Disney is now “committed to government policies and practices that assure shareholder interests are represented in a thoughtful and independent manner (The Walt Disney Company, 2018). Disney operates on a policy in which the substantial majority of directors on the board are independent of the company and of the company’s management, and who are a “balanced blend of global leaders”.  This is consistent with the benefits of the resource dependency theory as outlined by Daily, Dalton and Cannella (2003) as it allows the board to enhance organizational functioning, firm performance and survival via independent board directors and their knowledge and skills. Directors must now “hold shares of common stock which have a market value of at least five times the annual board retainer” (The Walt Disney Company, 2018). This helps combat the agency problem as “shareholders with significant ownership positions have both the incentive to monitor executives and the influence to bring changes they feel will be  beneficial” (Bethel & Liebeskind, 1993). Events of Disney’s past lead to the development of a strong corporate governance culture today and Disney’s trend towards outside directors helps further reduce the agency problem as it “safeguards the shareholders’ investment in a firm, in the face of potential managerial opportunism or incompetence” (Baysinger & Hoskisson, 1990).

IX. Conclusion

Exploring Disney from the perspective of international finance, we examined the extent to which the company has internationalised and the associated advantages and challenges. This internationalisation has manifested in M&A activity, risk management and corporate governance development. Observable in Disney’s international disposition is an internationally recognised brand equity, yet, monetising this global reach has not been exploited to the full extent of it potential (HBR). This concept, coupled with Disney’s lack of investments by way of capital employed abroad, is indicative that they still owe significant thought to fully establishing themselves as an international firm.

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