Fluent Essays

provide an 750 to 1,500 word narrative analysis in APA format that discusses the following: Describe the difference between value extraction and value innovation, and the role they played in Marvels history. Under what circumstances would you implement these strategies? Where they successful at Marvel? Describe the concept of ERRC and how it was implemented at Marvel? Was it successful? How would you modify its implementation? What role does culture play in a company like Marvel? What should the strategic road map look like for the future? IN1182 The Marvel Way: Restoring a Blue Ocean 08/2016-6205 This case was written by Michael Olenick, Institute Executive Fellow at the INSEAD Blue Ocean Strategy Institute, under the supervision of W. Chan Kim and Renée Mauborgne, Professors at INSEAD. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Additional material about INSEAD case studies (e.g., videos, spreadsheets, links) can be accessed at cases.insead.edu. Copyright © 2016 INSEAD COPIES MAY NOT BE MADE WITHOUT PERMISSION. NO PART OF THIS PUBLICATION MAY BE COPIED, STORED, TRANSMITTED, REPRODUCED OR DISTRIBUTED IN ANY FORM OR MEDIUM WHATSOEVER WITHOUT THE PERMISSION OF THE COPYRIGHT OWNER. D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 1 After Iron Man smashes his way to victory the credits roll. For those who linger the movie unexpectedly starts again and Tony Stark arrives home to find a stranger wearing a leather jacket and an eye patch in his living room. “You think you’re the only superhero in the world?” asks the man. “Mr. Stark, you’ve become part of a bigger universe. You just don’t know it yet.” “Who the hell are you?” asks Iron Man Stark. “Nick Fury,” answers the man. “Director of S.H.I.E.L.D.” “Huh?” shrugs Stark. “I’m here to talk to you about the Avenger initiative.” This roundabout announcement – that Marvel intended to recreate their epic Avengers storyline in a future series of Marvel-produced movies – was arguably more exciting to Marvel fans and investors than the blockbuster movie itself. “Seeing Sam Jackson with the eye patch telling [Iron Man actor Robert Downey Jr.] about the Avengers initiative made the hairs on my arms rise,” wrote a Marvel fan on Reddit. Marvel investors should have been equally intrigued by the roundabout announcement of a major strategic pivot. Marvel, which struggled to make payroll just a decade earlier, went on to unlock a blue ocean of moviemaking that has yielded more revenue and profit than any film franchise in history. Marvel’s Early Years Founded in 1939 by Martin Goodman, Marvel1 has seen a cast of heroes, villains, and events that rival anything found in their comic books. Goodman produced pulp fiction, magazines, and comic books and his strategy was straightforward: create many titles then, “If you get a title that catches on … add a few more; you’re in for a nice profit.”2 Goodman’s motive was purely financial, but over the next few decades, his company would go on to create over 8,000 characters in what became arguably an American version of Homer’s The Odyssey and The Iliad. During the 1940s, the comic book industry thrived, filling the entertainment space now saturated by children’s television programming, games, websites, smartphones, and all other manner of media. Besides the iconic Captain America – created for WWII – most Marvel titles of this era were thin knockoffs of the more popular DC Comics, home to Superman, Batman, and Wonder Woman. Except for a short time after the war,3 business boomed until, in 1954, squirrel-faced psychiatrist Dr Frederic Wertham testified to the Senate Subcommittee on Juvenile 1 In the early years the business that would come to be named Marvel had many names and corporate shells. For clarity we refer to these collectively as Marvel. 2 Howe, Sean (2013-10-01). Marvel Comics: The Untold Story (p. 10). HarperCollins. Kindle Edition. 3 In 1949, during the post-WWII recession, economics forced Marvel editor Stan Lee to layoff virtually the entire comic book staff. Many were rehired when the business rebounded. D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 2 Delinquency that comic books were linked to teenage pregnancy and homosexuality. “I think Hitler was a beginner compared to the comic-book industry!” testified Wertham to the US Senate during a two-day hearing.4 Comic book sales plummeted5 and the industry created a self-censorship organization, the Comics Code Authority. Marvel’s First Blue Ocean Before Wertham there were five major comic book publishers. By the time comic book hysteria subsided only two were left, Marvel and DC Comics.6 Vying to compete by controlling retail shelf space, DC purchased Marvel’s distribution arm and limited the number of books that Marvel could distribute each month. Marketing low-cost me-too knockoffs targeted towards children would not sustain the business in this environment: Marvel needed to attract noncustomers. Marvel’s as-is strategy – delivering little original work and me-too knockoffs – no longer worked. Faced with red ocean competition that threatened to shutter the comic book division Marvel adopted a new strategy: original content aimed at an older demographic, college students. From 1961 to 1965 Marvel Editor-in-Chief Stan Lee, along with comic book legends Jack Kirby, and Steve Ditko, delivered a multi-year burst of creativity creating a new blue ocean.7 Rather than copying DC’s traditional macho crime fighters many Marvel characters start as ordinary people and are transformed, oftentimes by accident, into reluctant superheroes. In 1961 Marvel introduced four ordinary people mutated by cosmic rays into superheroes, the Fantastic Four. After the Fantastic Four came The Incredible Hulk, a quiet scientist who morphs into a ferocious green monster when angered. Thor, a God who visits earth as a superhero, was introduced soon after. Ant-Man, the reformed thief who changes size, came next. In June 1962, Steve Ditko introduced the world to a teenager, bitten by an irradiated spider, who develops spider-like abilities, Spider Man. Next came an alcoholic womanizing military contractor with a bad heart who builds a high-tech metal suit to fight bad guys, Iron Man. Not long after this burst of creative output Lee and his team decided to bundle their superheroes into a group called The Avengers. At the same time they created another group of entirely different characters, ordinary people endowed with extraordinary powers and distrusted by the unenhanced they lived amongst, The X-Men.8 4 Wertham released his book, Seduction of the Innocent – which argued comic books were tied to juvenile delinquency – days before the Senate hearing. 5 In 1956 Lee again had to fire his entire staff. 6 EC Comics produced, depending upon one’s vantage point, either the edgiest or most inappropriate comics and refused to submit their work to the censor. EC closed as a comic book publisher but went on to reinvent the business, publishing Mad Magazine, since magazines were not subject to censorship. 7 Lee served as editor-in-chief and lead storywriter. 8 Countless other characters would be introduced during this period, including The Human Torch, Dr Strange, Thor enemy/brother Loki: Lee’s prolific team created literally thousands of different personalities. Eventually they would re-introduce the only 1930s Marvel superhero into the modern fold, Captain D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 3 “We were trying to reach a slightly older, more sophisticated group,” Lee wrote.9 Stan Lee also created a new writing method, The Marvel Method, where he outlined stories, sent them for drawing, then filled in the story bubbles later. Lee’s focus on noncustomer college students opened a blue ocean where Marvel thrived. “Marvel Comics are the first comic books in history in which a post-adolescent escapist can get involved, for Marvel Comics are the first comic books to evoke, even metaphorically, the Real World,” wrote the Village Voice in April, 1965.10 By the end of 1965 Marvel circulated 35 million comic books per year and inspired 500 fan letters per day.11 By 1967 Marvel sold six million comic books per month, just behind DC’s seven million despite that Marvel’s distribution channel, which was owned by DC, restricted the number of issues they could offer. Into the Red In a typical comic book plot all goes well until it doesn’t, then mayhem erupts. In June 1968, Goodman sold Marvel to conglomerate Cadence Industries12 for $15 million ($102.1 million, inflation adjusted to 2015). Cadence owned a print distribution arm but knew nothing about publishing.13 Not long after the acquisition, Cadence hired Sheldon Feinberg, the former CFO of Revlon, as CEO, the first of many awful managers. “Pit your executives against each other, make them fight each other, and then, somehow they should do better. And try to humiliate your subordinates,” is how a Feinberg associate described his management style.14 Legendary cartoonist Jack Kirby soon quit, signing a three-year contract with DC Comics. The X-Men and Silver Surfer series were cancelled.15 Blue Ocean Strategy requires the alignment of value, profit, and people. Marvel’s comic books from this era were generally considered high quality but, internally, the lack of fair process damaged and demotivated the people, which led to potential profits being left unrealized. Untapped profits and poor management are like blood in the water, attracting sharks, and Marvel was soon swimming face to face with some of the bloodiest predators in the business world. In November 1986, Cadence sold Marvel to New World Entertainment, an entertainment conglomerate whose executives did not know the difference between Superman, owned by DC Comics, and Marvel’s Spider-Man. New World’s fortunes quickly foundered – Marvel America, and also recreate Daredevil, the blind lawyer whose heightened other senses give him superpower-like abilities. 9 Howe, Sean (2013-10-01). Marvel Comics: The Untold Story (p. 38). HarperCollins. Kindle Edition. 10 Kempton, Sally. “Marvel Comics Are the First.” Village Voice 1 Apr. 1965. 11 Howe, Sean (2013-10-01). Marvel Comics: The Untold Story (p. 63). HarperCollins. Kindle Edition. 12 Cadence was then called Perfect Film & Chemical Corporation but changed the name later. For clarity we use the name Cadence throughout. 13 Cadence also owned a vitamin division, which is where Spider-Man vitamins were developed, an early crossover product. 14 Howe, Sean (2013-10-01). Marvel Comics: The Untold Story (p. 104). HarperCollins. Kindle Edition. 15 Both were later revived and went on to perform well.D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 4 was their only profitable business – and they turned to Wall Street for help. Their investment bankers decided to sell Marvel. “Trouble with the comic business,” said then Marvel Editor-in-Chief Jim Shooter, “is that it seems that every time things look like they’re going to look good, then the owners of the company end up selling it. And it falls into the hands of the philistines and you’ve got to start all over again.”16 In November, 198817 investment bank Drexel Burnham Lambert auctioned Marvel to corporate raider, and long-time Drexel client, Ronald O. Perelman for $82.5 million ($165.3 million adjusted for inflation to 2015).18 Perelman, a multi-billionaire, used $10 million of his own money to finance the acquisition and borrowed the rest.19 Like most Drexel-connected raiders Perelman believed strongly in value extraction rather than value innovation. Raiders typically purchase companies using high-priced “junk” debt, build the businesses through high-yield20 debt-fueled acquisitions, and finally flip the business, oftentimes carved up into pieces. Perelman immediately and repeatedly raised comic book prices. During this time collectors were bidding the price of sports trading cards into a frothy bubble, where single sports cards could sell for hundreds of thousands of dollars. These collectors also fueled sales of new trading cards, as they sought to purchase the cards when released, betting they would increase in value over time. Perelman decided to copy the trading card strategy and build his own bubble in comic books. To fuel speculation Marvel introduced many versions of every comic book – each with a different cover – encouraging collectors to purchase more volumes. Perelman’s bubble strategy initially worked to raise revenues, and he sold 40 percent of Marvel to the public in July 1991, raising $70 million. Buoyed by strong sales – value extraction managers oftentimes produce short-term returns at long-term expense – the stock soared. Perelman used $30 million from the IPO to buy down a portion of the debt he used to acquire the business and paid another $40 million to himself as a “special dividend.” Perelman then borrowed approximately $600 million to spend on acquisitions and sold another $700 million in junk bonds, eventually pocketing a total of about $300 million from the bond sales personally.21 Besides raising prices and encouraging speculators, Perelman also consolidated all distribution from twelve distributors to one, Hero’s World Distribution, which Marvel owned. Perelman’s goal was to effectively sell comic books directly to retailers, capturing revenue paid to distributors. This single-source distribution system wreaked havoc on comic bookstores, their primary retailer, and the number of comic bookstores quickly fell from 9,400 16 Thomas, Michael. “Jim Shooter Interview: Part I.” Comic Book Resources. CBR News, Oct. 6, 2000. 17 The sale closed January, 1989. 18 Perelman had a byzantine array of holding companies the most well-known being MacAndrews & Forbes. For clarity these businesses are collectively referred to as Perelman himself. 19 Inflation adjusted to 2015 Marvel was sold for $165.3 million with Perelman’s investment amount to $20 million. 20 High-yield low-rated or unrated corporate debt is informally referred to as “junk bonds.” 21 Perelman retained the proceeds from the bond sales. Judge Roderick McKelvie, presiding judge in Marvel’s bankruptcy case, would eventually rule this was legal because it was disclosed.D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 5 to 4,500.22 Perelman’s Marvel also decided to branch into trading cards and purchased three companies, sports card makers Fleer and SkyBox, as well as Italian sticker company Panini.23 Finally, Marvel acquired 46 percent of toymaker Toy Biz in exchange for an exclusive royalty-free license to produce and sell Marvel characters. High prices, fewer distributors, lower quality, underperforming acquisitions, and a predictable burst in the comic book collecting bubble destroyed sales. In January, 1996, Marvel fired 275 people then followed-up in November by firing another 115, one third of its workforce. On December 27, 1996 Marvel filed for bankruptcy: Marvel’s red ocean strategy had run its course. For nineteen months, various groups fought for the business. Perelman, legendary corporate raider Carl Icahn24, Marvel’s banks, Marvel bondholders25, Marvel subsidiary Toy Biz, and a few other parties wanted Marvel. Perelman offered creditors $365 million, leaving Perelman owning about 80 percent of Marvel, with the public, bondholders, and bankers owning the other 20 percent.26 Icahn, who briefly took control of the business27, offered creditors similar terms with a different management team. Toy Biz majority owners Isaac Perlmutter and Avi Arad offered $231.8 million cash, 40 percent of restructured Marvel, the Italian sticker company, and a strategy to return the company to profitability. Creditors voted to accept the Toy Biz offer even though the cash was $100 million less, due to Perlmutter and Arad’s strategy and vision.28 Even when battling billionaires a solid strategic vision can prevail over cash.29 Perlmutter and Arad – low on cash but high on chutzpah with their strategic vision – prevailed over the battling billionaires. Perelman told the New York Times if he had to rank his 22 Comic book stores receive discounts from distributors based on the total number of books they order from any publisher. Forcing comic book stores to split their orders between Hero’s World and their regular distributors, lowered their volume, subsequently lowering their discount and their already slim profits. 23 Perelman’s Marvel acquired trading card maker Fleer for $286 million in July 1992, Hero’s World Distribution for $7 million in 1994, trading card maker SkyBox International for $150 million in March 1995 and later, also in 1995, Italian sticker company Panini for $158 million. 24 Icahn and Perelman are arguably the two most well-known corporate raiders of their time. They were both prominent attendees at Drexel’s Predators Ball, an annual conference of junk bond luminaries. 25 Icahn purchased distressed Marvel bonds so fought for control both on his own and as the lead bondholder. 26 All parties also offered creditors the Italian stocker company Panini, which was performing reasonably well internationally. 27 Perelman pledged Marvel’s stock as collateral for the bonds and, once he defaulted on bond payments, bondholders successfully acquired the stock and control of Marvel. However, in December, 1997 – one year into bankruptcy – the bankruptcy court ousted Icahn in favor of a court-appointed receiver. 28 Creditors were owed about $700 million. They were paid $230 million in cash, given the sticker company which sold for another $120 million, and received 40 percent of the new Marvel. 29 Perlmutter and Arad’s vision was reinforced by a well-timed stroke of luck. On July 2, 1997, in the midst of the bankruptcy battle, Sony released The Men in Black, a movie based on a Marvel comic book that had been in production for years. Two prior Marvel character movies, Howard the Duck and The Punisher, both bombed. The Men in Black earned $589.4 million ($869.6 million adjusting for inflation to 2015), the second highest grossing film in 1997, suggesting the economic viability of movies based on Marvel’s characters.D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 6 successes Marvel would not be included. Icahn said “I have framed articles of every deal I’ve ever done. In all honesty, this is one frame I’m considering taking down.”30 On October 1, 1998, with approval of the court and creditors, Toy Biz, Inc. used $250 million in high-yield debt (junk bonds) to acquire the assets of the former Marvel and renamed itself Marvel Enterprises.31 Perlmutter’s Marvel now faced the daunting task of resuscitating the struggling business and executing their strategy. Evaluating Post-Bankruptcy Marvel After bankruptcy, in late 1998, Marvel had five high-level businesses: 1. Comic books. Marvel’s flagship comic book business produced direct revenue and vast intangible assets: intellectual property, decades of characters, storylines, brand, customer goodwill, and an institutional knowledge about how to weave their IP into great stories. Marvel estimated the intangibles of their comic book business to be worth $127.7 million. 2. Trading Cards. Marvel had two trading card companies, SkyBox and Fleer, which had been combined under Perelman. A third business, Panini – an Italian company that made trading-card like stickers – was ceded to Marvel’s bankers to end the bankruptcy. Trading cards required guaranteed steep royalties to sports leagues, lacked company-owned intellectual property, and sales were driven by collectors who tended to buy based more on speculation than any real interest in the cards. Marvel did not break out revenue or profitability for the trading card business separately from the toy business in 1998. 3. Toys. Toys were a low-margin business but Marvel did well; most 1990s-era Marvel revenue came from the toy group. Movies based on Marvel characters brought incremental toy revenue that was expected to increase as Marvel inked more movie deals. Marvel leveraged their unique character’s intellectual property to build high quality toys. 4. Character Licensing. Marvel always licensed characters. Licensing deals were optimal: with an investment of little more than drafting a contract Marvel need do nothing but open envelopes and cash checks for high margin revenue. In 1998 Marvel received $4.9 million in licensing fees for $4.5 million in gross profit but estimated the licensing business to be worth $401.1 million. 5. Marvel Studios. Marvel had a handful of people in Hollywood licensing Marvel characters to motion picture studios for films. This team, referred to as Marvel Studios, was not a real movie studio: they did not independently make movies and had no intention of doing so. Their goal was to drive sales of licensed goods by increasing demand for Marvel characters through films. 30 Bryant, Adam. “Pow! The Punches That Left Marvel Reeling.” The New York Times 24 May 1998. 31 The bonds carried interest of 12 percent and required monthly payments so the capital costs Marvel $30 million annually in interest alone.D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 7 Management Stabilizes the Business The post-bankruptcy late 1990s was a dire time for Marvel. Comic book sales were slipping 20 percent year-over-year and licensing deals dried up because licensees were concerned about long-term contracts with a company that might cease to exist. Cash became so tight that Marvel almost failed to make payroll. One Spider-Man comic from this era describes a “criminal businessman” who advises the publisher of Spider-Man’s employer, The Bugle newspaper, to take the paper public. “I’d never take the Bugle public ... because I know that its long-term integrity would suffer under corporate connivers like you, who dream up ridiculous little schemes which only produce short-term goals!” Spider-Man’s alter ego, Peter Parker, along with 100 other comic book characters, are then laid off.32 Marvel was starved for cash and saddled with $30 million in annual junk-bond interest payments. In this context Perlmutter and his board of directors hired turnaround specialist Peter Cuneo, who had worked with Perlmutter turning around Remington, as CEO. Cuneo focused on Marvel’s core businesses, selling comic books and toys, and licensed the exclusive movie rights to several of Marvel’s most popular characters.33 Cuneo and the board reasoned that successful movies would spur sales of licensed goods, driving toy revenue. Additionally, the early movie deals provided much-needed capital and helped prove the economic viability of Marvel-based comic book movies. Sony purchased the rights to Spider-Man for $10 million plus 5 percent first-dollar royalties.34 Twentieth Century Fox acquired the rights to X- Men, the Fantastic Four, and several lesser-known characters on less expensive terms. Universal purchased the rights to make standalone Hulk movies. Marvel does not release actual figures but industry analysts estimate Sony paid Marvel no more than $62 million in royalties for Spider-Man, Spider-Man 2, and Spider-Man 3, which collectively grossed about $2.5 billion. Fox is estimated to have paid Marvel $26 million total for X-Man royalties; the films have collectively grossed approximately $2.3 billion. Blade, a deal struck during the Perelman years, grossed $131 million; Marvel was paid $25,000. Although the deals may not appear favorable in hindsight they served a strategic and tactical purpose. Tactically they brought much-needed capital to Marvel in the form of up-front payments and increased licensing royalties giving the company a breathing space to eventually move in a more strategic direction. “The big kicker for us was the licensing around the movies. That was more important to us than the actual amount of money we got from the films. When we started Marvel Studios, with our own financing, we were then able to capture all the profits that came from the movies ourselves and that was a gigantic change,” Cuneo said. Strategically the deals proved the popularity of Marvel characters at the box office and taught Marvel how to make movies so that, someday, Marvel could produce their own films. “Sony did a great job on Spider-Man and Fox with the X-Men did a great job,” said Cuneo. “Those are big and they make a lot of money from those franchises.” 32 Howe, Sean (2013-10-01). Marvel Comics: The Untold Story (p. 382). HarperCollins. Kindle Edition. 33 Some of these licenses have since reverted back to Marvel and some others, notably The Incredible Hulk, are licensed back in exchange for film distribution rights. 34 Under a system informally called “Hollywood Accounting” movies never earn a profit so the provision for royalties based on gross revenue to the studio is a victory.D o N ot C op y or P os t This document is authorized for educator review use only by TOM COUGHLAN, Mercy College until Apr 2020. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860 Copyright © INSEAD 8 In February, 1999, Marvel divested trading card businesses Skybox and Fleer for a combined total of $26 million, a $410 million (94 percent) loss that would offset future earnings from taxation. The toy business accounted for the bulk of Marvel’s revenues but these were relatively low- margin high risk revenues. In March 1999, Marvel exited the toy production and sales business, selling exclusive rights to market Marvel characters, for five years, to their toy manufacturer for a $5 million per year fee35, a 15 percent royalty, plus an additional 24.5 percent fee for Marvel to continue designing the toys.36 “When I came to the company we had a full toy business doing everything: designing toys, finding a manufacturer, taking working capital risk, selling to mass retailers, and so on,” said Cuneo. “That’s what I inherited. After two years I felt we shouldn’t be in any business where we were taking capital risks: we had a lot of cash flow problems. The industry in 2001 had a terrible year because Hasbro oversold Star Wars toys into mass retailers around the world. Marvel lost $30 million that year on the toy business and we couldn’t afford to lose anything. So the board agreed to license out the business to one of our primary vendors. We transferred the risk of working capital to this guy and we were just responsible for the selling. We were also able to sell off about $25 million in inventory so we got an influx of cash from that.” Besides stabilizing the business financially Cuneo moved to quickly heal the corporate culture, building an environment where creativity could thrive. “If you as an organization can’t handle a culture which rewards people with crazy ideas, of people who are difficult to deal with, then you’re not going to be successful in a creative business,” said Cuneo. “You want to create an atmosphere where those people feel good about where they’re at, and prosper, and you’re able to cope with some of the idiosyncrasies that they might exhibit. But, in the end, that’s where all the revenue growth is coming from. In a character-based business you can’t discount the value of having great creative people work with you on a positive basis. Instill the proper atmosphere, the proper rewards system, let them know that you appreciate what they do.” Marvel Steers Towards a Blue Ocean Once management stabilized the business there was a sense that a major strategic initiative was needed to boost the …