Disney's Dilemma: Viacom Unit Nicks Walt's Audience

Viacom's Nickelodeon division plays pied piper for kids 2 to 11.
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Mickey Mouse is still Mickey Mouse, but Disney is no longer the company it once was. The icon of American culture, which in its heyday regularly steamrolled Wall Street's expectations as it churned out top-notch entertainment, is struggling to redefine itself as an evolving society threatens to make its core business less relevant. This five-part series, which concludes today, takes a look at the challenges facing Disney as it tries to reverse its recently flagging fortunes.

One entertainment company has found the right formula to appeal to this generation of children. It's edgy but not offensive, educational but not preachy.

Unfortunately for

Disney

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shareholders, that company is

Nickelodeon

, a division of

Viacom

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. Since its creation two decades ago, Nickelodeon has become the dominant children's television network, largely by offering shows that kids can relate to.

"Nickelodeon is probably the best

at understanding that these kids under the age of 12 are very sophisticated," says Ed Winter, chief marketing officer for

Digital Entertainment Network

, a new company headed by a former Disney executive that plans to deliver interactive television over the Internet to teens and young adults. "What

Nickelodeon did is they sent a signal from day one to kids that this is of, by and for you."

Indeed, Nickelodeon is practically obsessed with researching its target audience, kids aged 2 to 11. The company conducts hundreds of focus groups each year; each episode of

Blue's Clues

, a show about the adventures of a computer-animated dog that's a hit among the preschool set, gets tested on four sets of shorties as it's written and produced.

"We started with one very simple idea, 20 years ago, which was that we were going to look at the world from a kid's point of view," says Cyma Zarghami, Nick's executive vice president and general manager.

So where Disney's signature character is a talking, neutered mouse, Nickelodeon's biggest hit is

Rugrats

, a show about the adventures of a group of babies and their well-meaning but sometimes ineffectual parents. Another popular Nick show,

The Journey of Allen Strange

, features a brother and sister raised by a single father, a nod to the many kids who live in one-parent homes.

"The Disney characters come out of storybooks, out of history, out of mythology, and the Nickelodeon characters reflect real kids and real kids' stories," Zarghami says.

Nick's stuff isn't always tasteful. One of the most popular shows in the early days of the network,

Ren & Stimpy

, once featured the characters playing a game called "Don't Whiz on the Electric Fence." But for the most part, it wins high marks for avoiding explicit sex or violence and giving kids characters with whom they can identify.

"I really respect a lot of the things that Nickelodeon has done and tries to do," says David Walsh of the

National Institute on Media and the Family

, which rates television shows and movies based on their violent and sexual content. "They're trying to create a media environment that can be commercially successful and we can all get behind."

Nick has certainly been commercially successful. The network attracted more than half of the $1 billion that marketers spent on children's television in 1999. Nick's total cash flow last year topped $500 million on revenue of almost $1 billion, an astonishing operating margin of more than 50%. Meanwhile, the

Disney Channel

, an ad-free network designed mainly for preschoolers, has hardly registered on kids' radar screens.

So far, Nickelodeon has concentrated its brand-building efforts on television, leaving Disney's lucrative theme park and animated film businesses largely unchallenged. But in November, Nick rolled out its first animated movie, based on the

Rugrats

characters. The film, which Viacom says cost just $25 million, less than one-third the cost of Disney's

Mulan

, became the first non-Disney animated movie to gross more than $100 million at the U.S. box office.

Now, Viacom expects to ramp up its production of animated movies, eventually equaling Disney's output of one full-length animated film every year. Given the importance of animation to Disney's profitability, that threat alone makes Nickelodeon a serious issue for the Mouse. (Other companies have also tried to enter the animation business, generally by aping Disney's lush, expensive features. Those efforts have been largely unsuccessful. Nickelodeon's success stems from the fact it's found a new formula for kids' animation, attacking Disney from the side rather than trying to replicate what the Mouse does best.)

And while Viacom has no plans to open a Nick theme park, Disney's hegemony in that business is also under attack.

Seagram

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and Britain's

Rank Group

have spent $1 billion to expand their

Universal Studios

theme park in Orlando with a new gate,

Islands of Adventure, opening this spring. Universal promises that the new park, which has already won raves from analysts and reporters for its action-packed rides, will be "edgier" and cooler than Walt Disney World.

None of this changes Disney's strengths. The Mouse is still the world's most profitable entertainment company. For parents, it remains the gold standard of family entertainment, representing safety, quality and community. (Disney's planned community of Celebration, built near Walt Disney World, has proven extraordinarily popular, despite above-market prices for its homes. Would anyone pay a premium for a house from

Time Warner

(TWX)

?) Disney's management still is the most forward-looking in the entertainment industry; it was the first major old media company to see the potential of the Internet, and while the rest of Hollywood just whines about the poor returns on live-action film, Disney has actually taken steps to cut its costs.

Nor will age compression destroy Disney's appeal to really young children. At age 5, kids aren't likely to be smoking in the boys' room, getting the jokes on

Friends

or worrying about whether Mickey Mouse is cool, no matter how much television they watch or Web sites they surf.

"Age compression can still go a little further, but I would venture to say 6 is the absolute end. There will always be a core childhood," says Johann Waachs of advertising agency

Saatchi & Saatchi

.

Even in the short term, Disney investors have reason for hope. At this point, expectations for fiscal 1999 are so low that it won't take much for the company to beat them. Maybe

Tarzan

, coming out this summer, will be a

Lion King

-esque hit for Disney, and the growth of digital video disks will provide a multiyear boost to the value of the company's film library, and the burst in millennium-related ad spending will turn ABC into a cash cow. Or maybe daytraders will just start pretending Disney is an Internet stock.

But in the entertainment industry, where performers, not companies, are usually what counts, Disney's brand has given the company a unique advantage. Exploiting the love Americans have for the Disney brand -- on Broadway, in animation, in ever-expanding theme parks -- has enabled the company to grow from a $2 billion piece of takeover bait in 1984 to a $65 billion global giant today. Now that sword has turned double-edged.

Disney is too well-run a company to ignore the threat age compression represents to its future. Many of the company's recent initiatives, from its aggressive push into educational Internet toys to

DisneyQuest

, its indoor amusement park loaded with virtual reality rides, are clearly designed to broaden the company's allure to older children and teens.

Even so, the Mouse isn't particularly interested in discussing its efforts. It declined to make R&D head Bran Ferren or any of its most senior executives available for this story. After considerable prodding, Disney did make Hilary Meserole, its senior vice president of corporate brand management, available for a short interview. Meserole declined to discuss specific initiatives Disney will unveil or any research the company has done on the way kids perceive them. But she acknowledged that Disney sees age compression as an issue.

"You have hit at the heart of something that's very important to us," Meserole says. "It is absolutely true that kids in developed countries are growing up faster. ...

But we're not going to compromise the trust of parents and the value that the Disney brand stands for. We see our target as being families."

Does that leave the company doomed to choose between shelving Mickey Mouse or appealing to an ever-younger group of kids? No, Meserole says. Instead, the company will update the image of its brand in subtle ways.

"Our next big animated movie is

Tarzan

. Whereas X number of years ago you might have had a more traditional telling of

Tarzan

, our Tarzan basically surfs" rather than swings, Meserole says. "The animator who created Tarzan has a son who surfs and skateboards. ... Nothing about the movie is purposefully edgy. It's more subtle than that. ... We are just striving to be more relevant to the way kids watch things."

That won't be easy, says Richard Chase, the Johns Hopkins psychiatry professor. "A safe and entertaining world is what Disney has created," Chase says. That model "is one that will make sense in any time and place. But it made more sense in the time behind than in the time going forward."

As originally published, this story contained an error. Please see

Corrections and Clarifications.