4

Starving Artist

My previous experiences had prepared me for understanding the aspects of Pixar’s business that I had examined so far. Nothing I had done, however, prepared me for understanding Toy Story’s business potential. Getting my head around that was no small task. Pixar had never released a computer-animated feature film. No one had. There was no way to predict the market for it. No way to gauge the public’s taste for ninety minutes of computer animation. It didn’t help that I knew nothing about the film business.

The obvious place to start was Pixar’s original production agreement with Disney, signed almost four years earlier on September 6, 1991. The agreement would at least tell me what Pixar might earn on Toy Story, and the terms that would apply to future films that would fall under the same agreement.

The agreement itself was surprisingly short: only twelve and a half pages. I’d seen seventy-page agreements covering less complicated matters. Though brief, however, it was impenetrable, written in indecipherable Hollywood jargon. One clause said, “AGR shall be defined, computed, accounted for and paid in accordance with WDC’s Exhibits GRP and NP and the Riders attached thereto.” What did any of that mean?

To decipher the agreement, I contacted Sam Fischer, Pixar’s lawyer for negotiating that agreement. Sam was the newest partner in one of Hollywood’s elite entertainment law firms, Ziffren, Brittenham, Branca & Fischer. I visited Sam at his firm’s spacious and tasteful offices in an upscale Los Angeles business district not too far from Beverly Hills. Sam was sharply dressed, with a short beard and glasses. He was immediately warm, welcoming, and eager to help. He listened attentively and made me feel like what I said mattered. He came across as very natural and at ease in the arcane world of Hollywood and entertainment law.

Sam spent a couple of hours walking me through the details of the terms, exhibits, and riders of Pixar’s contract with Disney. We started with the agreement’s term. It was a three-picture agreement that would end six months after the release of the last of the three pictures. That sounded simple enough, but how long would it be exactly?

The first picture, Toy Story, was targeted for release in November 1995, just over four years after the agreement was signed. The second picture, as yet unnamed, had barely been started. It was ostensibly a story about bugs trying to save an ant colony. Everything I had learned so far about Pixar told me it would take at least the same amount of time to produce the second picture as it did to produce Toy Story. That meant the release of the second picture would be four years later, around 1999. The third picture would then take another four years after that because Pixar had the resources to work on only one film at a time. That would be November 2003. This meant that on our present track, the overall production agreement would end six months later, in May 2004. It was now May 1995. In sum, Pixar would potentially be living under the terms of this agreement for nine more years, a very, very long time in the world of start-ups. I started to grow nervous.

Another provision relating to the term of the agreement had also caught my eye. Tacked onto the end of a paragraph, it said that until the end of the agreement, Pixar would not submit to any other company any new film ideas it had presented to Disney, even if Disney had rejected these ideas.

“This can’t be right,” I suggested to Sam. “If Disney rejects Pixar’s film ideas in 1995 and doesn’t even have the slightest interest in those ideas, Pixar can’t even talk to another studio about them for ten years. But we have to share film ideas with potential distribution partners years before films based on those ideas are released. This means film ideas we might love are completely off the table just because Disney doesn’t like them.”

“That is exactly what it means,” Sam confirmed. “Disney wants Pixar focused on films for Disney, not other studios. That’s why it’s willing to put so much money into funding Pixar’s films.”

All right, I thought. The clause that prohibits Pixar from sharing ideas with other studios applied only to ideas Pixar presented to Disney and Disney rejected. But perhaps there was a loophole?

“That leaves us free to develop ideas that we don’t present to Disney, right? In that case the clause would not apply and Pixar would be free to discuss those ideas with another distribution partner whenever it wanted.”

“No, Pixar can’t do that either,” explained Sam.

He pointed to another paragraph called the “Exclusivity” clause. It said that the services of Pixar’s animation division, including Pixar’s key creative talent, would be exclusive to Disney during the term of the agreement.

I was aghast.

“This means John Lasseter and Pixar’s entire team of animation and story artists can work only for Disney for the next ten years. We can’t develop any film ideas, not one, for distribution by other studios.”

“That’s true,” Sam replied. “This kind of clause is standard for unproven talent.”

“But Pixar is not like a music group or TV actor; it’s an entire company,” I protested. “We could hire a thousand new people for our animation division and under this agreement they would have to spend all their time working for Disney. How can an entire company be tied up like that?”

“I hear where you’re coming from,” Sam said, “but look at it from Disney’s side. When they entered this agreement, Pixar had never made a film. This was a risky bet on a totally unproven type of animation and an unproven director. They wanted to make sure Pixar was strictly focused on the films Disney was funding.”

Sam felt Pixar had been fortunate to get a deal that funded all its production costs when Pixar had no track record, and that these exclusivity provisions were the price Pixar had to pay for Disney to take that risk.

But regardless of the reasons for these provisions, their combined effect was devastating. They meant that for the term of the agreement, which was likely to last from 1991 to 2004, Pixar could do film, TV, or video projects only for Disney and could not even discuss, think about, or work on projects with someone else. And since a film’s development time averaged four years, that meant Pixar wouldn’t be able to complete a fourth film under new terms until 2008, thirteen years in the future. I was stupefied at how long Pixar’s hands were shackled.

Okay, I thought to myself, perhaps these severe limitations might, just might, be palatable if Pixar stood to make a great financial return on its films.

The terms by which Disney compensated Pixar took me the longest to understand. They were steeped in the peculiar world of Hollywood accounting. They began by saying that Disney would pay the production costs of each film, up to certain limits. Pixar would then receive a percentage of the film’s revenues. Seven tiers of compensation were defined.

Sam slowly walked me through the provisions by which revenues from our films made their way to Pixar. As he did so, the nervousness I had felt before escalated into pure dread. Pixar did indeed have a share of the profits on its films, but by the time all the calculations were made, and Disney’s costs and fees taken off the top, Pixar’s ultimate share would be tiny, under 10 percent.

To help me understand the reality of these provisions, I decided to see how Pixar would have fared if we had produced one of Disney’s most recent film successes, the acclaimed Beauty and the Beast, released in 1991. Beauty and the Beast was the third-highest-grossing animated film of all time, behind two more recent Disney releases, Aladdin and The Lion King. The film had earned $146 million in the domestic box office, and $200 million in the foreign box office. This was at least three or four times the revenues of an average animated film.

Under Pixar’s agreement with Disney, I estimated that if we had made Beauty and the Beast for Disney, our share of the profits would have been around $17 million. Because it takes four years to make a film, this would amount to a little over $4 million of profits per year. I also guessed Disney would likely have made ten times that much. These were just educated guesses, because I didn’t have access to the details of Beauty and the Beast’s financial performance, but even if I was off by 50 percent, it wouldn’t change the impact on Pixar very much.

Four million dollars of profits per year may sound like a lot, but it really isn’t close to enough to build a growing company, especially when those profits require success at the almost impossibly high levels of Beauty and the Beast. If Pixar’s films earned $100 million in the domestic box office, a level still considered a smash hit but far less than Beauty and the Beast, Pixar’s share of the profits under the agreement would be all but nonexistent.

The impact of all these contractual provisions was crushing: until Pixar could release a film outside of the Disney contract, the most we could expect to earn from our first three films would be a few million dollars a year—and even then, only if those films ranked with Disney’s most profitable films ever. No one would invest in a company that had to perform at those levels in order to eke out a small profit.

“Sam, did no one at Pixar understand these calculations?”

“I’m quite sure Steve did,” Sam told me. “We walked him through all the terms and what they meant.”

I couldn’t wrap my head around it. If Steve understood what Sam was telling me, why didn’t he have someone run the numbers to see what it meant for Pixar as a company? Moreover, even if these profit provisions were standard for live-action film, Pixar was an animated filmmaker. It takes a year or two to make a live-action film, four or five to make an animated film. This meant that profits per year for an animated filmmaker would be much less. These numbers didn’t make sense for animation. I just didn’t understand why these differences were not taken into account.

As the reality of these provisions sank in, I began to feel a hopelessness I don’t think I’d felt anytime in my career. And even worse, I still didn’t fully understand the Disney contract. There were important provisions in the agreement covering sequels that I needed to dissect.

The agreement said that Pixar would have an option to make sequels of its own films only under limited conditions that included making the original film, on which the sequel would be based, within its agreed-upon budget, and agreeing on terms for the sequel that fit within Disney’s standard parameters. If these conditions were unmet, Disney was free to make sequels of Pixar’s films without any involvement by Pixar. Disney could literally take Woody and Buzz, characters lovingly crafted over years at Pixar, and make its own film with them. Once again, I asked Sam about these provisions.

“Sam,” I asserted, “the only reason Disney would want to make a sequel is if the original film is a hit. These provisions say that unless Pixar meets all the conditions specified, Disney could do whatever it wants with Pixar’s characters.”

“Yes, but that’s not unusual,” Sam explained. “Disney is investing tens of millions of dollars to create these characters. They want to make sure that investment will yield returns, including making sequels. I’m sure they would prefer Pixar to make the sequels, but they need to be able to move forward if Pixar cannot.”

“So we’d have to go to John Lasseter, Toy Story’s director, for whom Woody and Buzz are like children, and tell him, ‘Thanks for the work; Disney will take over from here.’ ”

“I hope it wouldn’t come to that,” Sam replied. “Presumably Disney would prefer that John and his team make the sequels.”

Which might be fine, except for one other issue: sequels wouldn’t count as one of the three original films Pixar owed Disney under the agreement. If we made a sequel, it would be tacked onto the existing agreement, potentially extending it several more years.

“We lose either way,” I told Sam. “Either Disney makes the sequel and Pixar loses control over its creations, or Pixar makes the sequel and the terms of this agreement continue.”

I was left feeling very frustrated. I couldn’t blame Sam; he was simply educating me in the ways of Hollywood deal making. In that world, he felt Pixar had fared quite well in this negotiation, especially for a company with no track record. He told me it was rare for Disney to give any profit share at all in an animated film, and that it had done so only because Pixar had invested so much in technology. Nevertheless, the size of that profit share was small, too small for building a robust company, and Sam acknowledged that Steve had yielded on how that profit share was calculated in ways that favored Disney. All told, the overall impact on turning Pixar into a substantial business, which was my focus, was devastating.

I read and reread the provisions of the Disney agreement, looking, trying to find some gap, some loophole, something missing. There was nothing. Fifty years of Hollywood lawyering had made it all crystal clear: Pixar could work only for Disney. Disney had to approve the films Pixar made. It chose whether to make sequels of those films. It had creative control over the films. It prohibited Pixar from working with anyone else. It kept the lion’s share of the profits.

By tying up the company so completely in exchange for funding up to three films, it was as if Disney owned Pixar without ever buying it. And all this turned out to be just the standard way that Hollywood deals with new talent. Sam told me it was no different in music or other parts of the entertainment industry.

One evening at home, after the children had gone to sleep, I shared my frustration with Hillary.

“I’m not sure how to say this,” I said. “I don’t think I knew what I was getting myself into. I think I blew this one.”

“What do you mean?”

“I’ve turned over every stone at Pixar. There’s nowhere to take it. Disney has closed every door. The best we can hope for is a tiny profit, and that’s only if our films are among the most popular animated films ever made.”

“Pixar has to be as successful as Disney is at animation?” Hillary asked.

“More successful! Disney keeps the lion’s share of the profits on its own films. That means the hits can make up for the flops. But Pixar has such a small share of the profits that it wouldn’t even have this luxury. They all have to be hits. I don’t know what Steve was thinking when Pixar signed that contract.”

“So what are you thinking about doing?” Hillary asked.

I didn’t know.

“If I had known what I know now,” I said, “I can’t imagine I would have taken this job. Taking this company public seems like a crazy notion. No investor I know would come near this. Fifty million in losses, no profits, no growth, Disney holding all the cards. I’m not sure Pixar even needs a CFO.”

“I think you have to understand where Steve’s at with all this,” said Hillary.

But as frustrated as I felt, I waited. I needed to be in a better frame of mind for a discussion I didn’t expect would be easy. If I called out Steve on entering what I thought was an insane agreement with Disney, I expected he would dig in and defend it. It must have seemed like a good idea to him at the time.

One Saturday afternoon about a week later, I headed over to Steve’s house. We took a seat on the back porch, and I went through what I had learned.

“Steve,” I concluded, “this contract ties our hands for the better part of a decade. We can’t talk to other studios. We can’t make much money. And it doesn’t even make sense to make sequels.”

“Do we even want to make sequels?” Steve asked.

“We might. Disney’s having a lot of success with direct-to-video sequels. We might want to make those.”

“Can’t we get through the contract faster if we speed up how long it takes us to make our films?” Steve asked.

“I’ve discussed this with Ed,” I said. “He’s very skeptical about making films quicker. He’s open to looking at it, but he’s doubtful.”

“Well”—Steve shrugged—“if Toy Story and the other two films are hits, we’ll make some money. Then we’ll be free to do whatever we want.”

That was certainly a true statement, but it wasn’t the answer I was looking for. Of course we’d be free after the three films, but that was still years away. I wanted to ask Steve why he let Pixar enter such a one-sided contract, why he didn’t tell me it was so constraining, and why he seemed so nonchalant about it.

But I didn’t. As we sat there talking, I realized Steve had no interest in looking back. He didn’t defend the contract. He didn’t justify it. He listened carefully to everything I had to say about it, taking it all in. That was pretty much it.

Instead of pressing Steve, I was left to draw my own conclusions. I pieced together a scenario that made sense of what had happened, at least to me. I never verified it with Steve; it was simply my own way of understanding things.

I reasoned that around 1991, Steve was ready to let go of Pixar. He had never set out to build an animation company. In 1986, when he took control of Pixar, Steve dreamed of building a technology company, a graphics powerhouse that would stun the world with machines that could do computer imagery like no other. Storytelling was an afterthought, a way to demonstrate the technology. The hopes of that graphics company had rested in part on the Pixar Image Computer, which had failed. By 1991, that division of Pixar had been shut down completely.

At that moment, I concluded, Steve was ready to give up on Pixar. He must have wanted out. The burden was simply too great, and the dream dashed. He was in a very tough spot, however. It was five years since his departure from Apple, and he had not had a hit since. If he couldn’t chalk Pixar up as a win, he badly wanted to avoid another highly public loss. That was the instant when the Disney opportunity came along. To Steve, the deal with Disney was a way to stop the financial bleeding. Steve’s guard was down, and in that negotiation with Disney he had been bested by Jeffrey Katzenberg, chairman of Walt Disney Studios, who handled the deal on behalf of Disney. Steve had signed up for terms the implications of which he either didn’t fully understand, or to which he had simply yielded in order to get the deal done.

None of this changed our current situation, however. We had no long-range hope in RenderMan software. No hope in animated commercials. No hope in short films. No hope in animated feature films. One of the world’s richest and most powerful companies controlled our future and our fortunes. And on top of everything else, a terribly strained relationship between Pixar and its owner, Steve. That was the hand we were dealt.

Early in my career I had learned the wisdom of not griping over the hand I was dealt. I had a mentor who taught me lessons about business and life that served me for many years. He looked at business the way a grand master might look at a chessboard.

“There’s nothing you can do about where the pieces are,” he’d say. “It’s only your next move that matters.”

I had worked at training myself in this way of thinking. It was a lot more productive than getting emotional about things that were out of my control. Business can be harsh, but the stakes are rarely a matter of life and death. It was not going to help me to fret over the reasons why Pixar may or may not have entered a one-sided contract a few years earlier. I simply had to remain focused on the task at hand: find a way for Pixar to flourish.

I also found one silver lining to keep me going. Somewhere out of the fog of those first two months, one more important conclusion struck me. Hillary and I discussed it as we were sitting in the living room after dinner one night.

“You know,” I said, “in all my conversations with Steve these past two months, I’ve never found him defensive. I’ve critiqued and dismantled every aspect of Pixar’s business and he had every reason to justify and defend it. But he didn’t. Not once. It’s as if he’s taking this journey with me, learning it at the same time I am.”

“He hasn’t given you a reason to distrust him,” Hillary said. “You two are in this together. You have to work it out together.”

That’s how it felt. Whatever mess we were in, we were in it together. What mattered was our next move.