6

What’s an Entertainment Company?

“Steve,” I noted one night in early June 1995, “We don’t have precise data, but I’m looking at this home video market and it’s huge. Disney is making a fortune on it.”

“It’s because people love these family films,” Steve said. “They don’t want to see them just once in the movie theater. They want to see them over and over again. They love those characters. And parents would rather their children watch Aladdin or Beauty and the Beast than a lot of garbage.”

My own home was a great example of this. We owned all the recent Disney animated films, and Jason and Sarah had watched them many times. Aladdin was their favorite. They never seemed to tire of the Genie, masterfully voiced by Robin Williams. It was similar at Steve’s house, where he had a shelf lined with the same films.

“People are paying thirty or forty dollars a film to own them,” I continued. “Some are renting from Blockbuster, but with these animated feature films it looks like there’s a strong preference for actually owning them.”

“Do we know how much Disney makes on them?” Steve asked.

“Not precisely,” I said. “I’m trying to get the exact numbers, hopefully soon. But remember the calculation that said if Pixar had released Beauty and the Beast, we’d make about seventeen million dollars? I think that’s about ten percent of the actual profits. Even if I’m off by a lot, that means their profits on the film are enormous, maybe a hundred fifty million or more. I think much of that is coming from home video.”

Home video was turning animated feature films into big business, bigger than we had imagined. Beauty and the Beast, Aladdin, and The Lion King looked like they were among the most profitable films of all time. They had ushered in a new era of animated entertainment, and they were catapulting Disney’s animation division to new levels of commercial success.

“Investors will love this,” Steve said. “Pixar can be in a multibillion-dollar video market.”

“I agree, but let’s get the data first. Even then I’m not sure we can count on home video alone to take Pixar public.”

Steve winced at this. He didn’t like it when I made any suggestion that Pixar might not be ready to go public. He was itching to go public as soon as we could. I had one foot on the brake, though. Pixar was frantically trying to finish Toy Story for its launch in six months. I didn’t want potential investors to see how precarious the project was. Worse, we didn’t have a business plan to confidently share with them, and I knew from my talks with Sam Fischer that Pixar’s share of the home video revenues under the agreement with Disney was very small, even if the market for home videos was big.

It was one thing to learn that animated feature films had more financial opportunity than we thought, quite another to bet the entire company on it. In the first place, under the Disney agreement, our share of the profits from our films would remain small for a long time, potentially ten years. Second, there was no modern precedent for taking an independent animation company public. Disney had first sold shares to the public in 1940, and by the time it listed on the New York Stock Exchange in 1957, it had expanded beyond animation. My hope had been to do the same, to balance the risks of animation with more stable businesses like RenderMan software sales.

“You don’t believe any of Pixar’s other technologies can scale?” Steve continued.

“You’re right, I don’t,” I replied.

“That leaves animation,” Steve said.

“Yes,” I replied. “But getting Wall Street interested in a pure animation company that’s never released a film will be close to impossible. It would mean we’d be raising our flag entirely as an entertainment company, a business we know little about.”

Taking a company public meant selling its stock to investors through the public stock exchanges. It served the twin purposes of raising capital to finance a company’s business and enabling anyone, including the company’s founders, to freely sell their stock. In Silicon Valley this was an imprimatur of success like no other. From the time Steve and I had first met, Steve mused about taking Pixar public. It was one of the reasons he had hired me, and the idea was never far from his mind.

But taking a company public was a gargantuan task, exceedingly difficult to pull off. Most start-ups just ran out of money before they ever got to it. Steve’s willingness to fund Pixar for close to ten years went beyond all the norms for keeping a start-up alive. By Silicon Valley standards, Pixar should have closed its doors years earlier. Now Steve was envisioning an endpoint, and he couldn’t get there fast enough. Rushing wouldn’t help us, though. We needed a crystal-clear vision for what Pixar was. That vision was not just important to taking Pixar public; it was the strategic direction that would guide the company for years. But so far, we didn’t have one.

One of our challenges in developing that vision was that we were looking at a business Steve and I knew nothing about. We had no experience in the entertainment field. We had to learn it. On this front, Steve was all in. He may have been impatient about beginning the process of taking Pixar public, but he knew we had a lot to figure out first. We quickly threw ourselves into the challenge of learning the entertainment business, sharing what we learned, and piece by piece putting together a picture of what it was all about.

I began with reading all I could about the Disney company. Some of the parallels between Disney and Pixar were striking.

Walt Disney had long had an interest in newspaper cartoons. After returning from service as an ambulance driver in France in World War I, he encountered animated cartoons for the first time and quickly fell in love with the field. Ironically, he feared that he had entered the field too late, that there was no growth opportunity left in it. He ended up creating that opportunity by pushing the field into new territory, both creatively and technologically, just as Pixar was doing now.

In 1928 Disney released a short black-and-white cartoon that changed the course of animation. Called Steamboat Willie, it ushered in breakthroughs on two fronts. It introduced the world to the most fully formed cartoon personality audiences had ever seen: Mickey Mouse. It was also the first cartoon to use synchronized sound, meaning that the sounds were timed to the action, making the overall audience experience far more immersive than ever before.

After the success of Mickey Mouse, Disney set his sights on the first animated feature film. It took him until 1937 to release Snow White and the Seven Dwarfs, a virtuoso accomplishment that ushered in many more breakthroughs in story, character, color, sound, and the way animation displayed depth. The film also introduced the world to the Seven Dwarfs and quickly sealed their place as icons of American culture.

Other parallels between Disney and Pixar were less inspiring. Like Pixar, Disney had struggled financially for years. Walt Disney had bet it all on Snow White and the Seven Dwarfs, including mortgaging his house and a risky bank loan. The success of the film paid off financially, but it wasn’t long before Disney was struggling once again. Animation was proving to be a very fickle business, and soon Disney was diversifying.

In 1953, he started a film distribution company, Buena Vista Distribution; in 1954, he went into television, with the acclaimed Disneyland television show that first appeared on ABC; in 1955, he opened Disneyland, a daring adventure to re-envision the theme park experience; he also went into live-action films, culminating with the breakthrough Mary Poppins in 1964. The enormous degree to which Disney had diversified made the idea of a pure animation company seem even more doubtful. If the undisputed king of the animation world hadn’t pulled it off, what was the likelihood that anyone else could?

Maybe the answer was for Pixar to diversify as well, just in the way Disney had. But two of Disney’s businesses seemed out of the question for Pixar right off the bat. It would cost billions to open a theme park, and Disney had the rights to use Pixar’s characters in its parks, so we wouldn’t even be able to use our own characters. A film distribution business was also out of the question. Film distribution had been locked up by the major studios for decades, and we didn’t even have the rights to distribute our own films. But what about live-action film? That might be worth exploring. Which is what led Steve and me to a meeting in the offices of Joe Roth one day.

Joe Roth was an A-list Hollywood executive and film producer. He had been chairman of 20th Century Fox and a year earlier had become chairman of Walt Disney Studios. All of Disney’s live-action film business went through him. Steve and I felt fortunate to arrange a meeting with him. Our goal was to understand the business of live-action film so we could determine if Pixar should go into it.

Arriving at Joe Roth’s office felt like we were entering the inner sanctum of Temple Hollywood. It was located at the Team Disney corporate headquarters in Burbank, California, built just a few years earlier, an imposing building on Disney’s Hollywood lot. Towering above us on the building’s facade were giant statues of the Seven Dwarfs. We stopped and ogled them on our way into the building, like kids going to Disneyland.

Beyond the giant dwarfs, the building emanated a quiet somberness. Few people were around; security guards kept a close watch. We were directed to Joe’s office, in the executive suite. His office was large, plush, and imposing, a beautiful wooden desk on one end, by the window, with a couch at the opposite end where he invited us to sit.

Joe was immediately warm and friendly. He was a few years our senior, soft-spoken, casually but well dressed, with a warm and gracious smile and graying hair. We began by describing what we were up to at Pixar. After a few minutes, a phone rang in the corner of the room behind Joe’s desk.

“Excuse me,” Joe said, “I’m terribly sorry. I need to take that call, but it won’t take long. Please stay and be comfortable here.”

Joe spent a few minutes on the phone by the window at the other end of his office. Then he returned to us.

“So sorry to have to take that call,” he said. “It was Robert Redford. He’s not easy to reach. There won’t be any more interruptions.”

As soon as we left the building, Steve and I tried to keep our cool, but we both had one thing on our minds.

“Robert Redford!” Steve exclaimed. “Butch Cassidy! The Sting! I wouldn’t have kept him waiting either. Wow!”

“I know,” I said. “That’s about all I could think about the rest of the meeting!”

“Me too,” said Steve.

We were starstruck! It would be a few years yet before Steve had access to every celebrity in the world, but in this moment, we were more like teenagers glimpsing stars on the red carpet.

In that meeting we had also received our first lesson on live-action filmmaking.

“Think of it as a portfolio business,” Joe had explained. “Each year a studio earmarks funds for a slate of films: low budget, medium budget, and big budget. Then we do the same with marketing, allocating amounts to market each film. We release the slate, hoping that we create enough hits to make up for the ones that don’t perform.”

“How many films are in the slate?” Steve asked.

“It depends,” Joe said. “There’s no magic number. It could be as few as a half a dozen, as many as fifteen or twenty. It depends on the year, the size of the studio, the sources of financing, and other factors.”

“How do you know which might be the big films?” Steve asked.

“We don’t know,” Joe confessed. “We like to think we do but we really don’t. It’s hard to predict the films that will break out. Sometimes you know a big star will assure a big opening, but even that doesn’t tell you how the film will ultimately perform.”

“So it’s as much a financing strategy as a creative strategy?” I asked.

“That’s right,” Joe said. “Of course, we try to make the best films we can creatively, but it’s all about assembling the right slate.”

This was all new to us. Disney and the other studios were spreading money across a slate of films, hoping that some would break out and become hits, to make up for the ones that didn’t.

“Filmmaking is not a great business,” Joe went on. “It’s hard to succeed by releasing new films. The value often comes in the library.”

“How does that work?” Steve asked.

“Once a film has enjoyed its theatrical run, both here and abroad, it becomes part of a studio’s film library. If it’s a good film, it stands to be watched again and again over the years. New technologies like home video make that even more likely. The major studios have built up enormous film libraries that continue to provide value to their film businesses.”

Another revelation for us. I wanted to know how studios valued those libraries.

“It’s not an exact science,” Joe explained, “but look at the value of the major Hollywood studios and you’ll see their library of films is really significant.”

Steve and I continued the discussion on the way home. Steve had rented a private plane to fly us to Los Angeles and back. It was a small jet that could seat around six people in comfortable leather seats. We had flown commercial before but Steve didn’t like the airport hassle. We sat across from each other, my first time in a private jet. Joe had been immensely open and helpful, so much so that our meeting turned out to be the start of a relationship that would culminate a few years later with him joining Pixar’s board of directors.

“The big studios are really about providing capital and distribution,” Steve said. “They don’t focus on making one single great product. It’s a different business model completely.”

“In that model,” I added, “even if a film does just okay in its theatrical release, it may have value for years in a film library. That’s the opposite of tech products that become obsolete quickly.

“It means that if we go into live-action film,” I went on, “we can’t do it a little. We’d have to make a slate of films every year, hope for some hits, and build a library.”

“But animation is different,” Steve added. “Even Disney makes only one or two animated films a year. Why couldn’t we apply the same model to animation? If Pixar pours itself into making one animated film a hit, couldn’t we do the same for a live-action film?”

The discussion continued as we contemplated how Pixar might enter the live-action film business, whether it would be able to attract the right talent for filmmaking, need an office in Hollywood, and other details. As we considered it, I couldn’t help but think that there I was on a private jet, talking with Steve Jobs about whether Pixar ought to go into the live-action film business. For a brief moment, I felt like a Hollywood mogul. We were not studio executives yet, but we were having fun learning about it.

A few days later, we took the topic up with Ed. We sat in his office and discussed whether we could make live-action films the same way we made animated films.

“It’s about the way the films are made,” Ed said. “In animation there is much more control. We iterate on the story over and over again, through storyboards, character modeling, animation tests, and other processes. If the story or a character isn’t working, we can change it. Live action doesn’t offer that flexibility. Once the film has been shot, you’re locked into using the footage you have.

“This is why so many films don’t quite hit the mark,” Ed went on. “It’s not that the filmmakers want to make films that fall short; it’s that they have to make the film from the footage they shot, and sometimes it’s not what they need.”

“Wouldn’t Pixar’s approach to storyboarding help with making a live-action film?” Steve asked.

“It would help,” said Ed, “but it wouldn’t be a guarantee. In animation we still have the chance to iterate on a story even when we’re into production of a film. That’s a lot harder in live action when all the sets have been dismantled and the cast and crew have moved on.”

On our way home, in Steve’s car, we continued the discussion.

“I’m not sure if going into live-action film gives us any advantages,” I said. “In animation we put all our eggs in one basket, and we watch it very closely. In live action we spread out the eggs over many baskets, hoping a few of them will hatch. Both businesses are risky. I’m not sure one balances or helps the other.”

“It might even be the opposite,” Steve said. “If we have to release a slate of live-action films, what’s to stop the ones that flop from damaging our reputation in animation?”

“That’s true,” I agreed. “Walt Disney only went into live-action film after he was established in animation.”

“I hate the idea of Pixar releasing products that might not be great,” Steve added emphatically.

I felt the same way. Silicon Valley was built around changing the world with breakthrough products. It wasn’t that releasing a slate of live-action films was a bad strategy; it just was not the way we thought about things. And besides, it looked like both animated films and live-action films were very risky businesses. One would not offset the risk of the other.

From that point on, it felt like we were talking ourselves out of going into live-action film rather than evaluating it as a serious option. There was no part of Steve that bought into the idea of making products that might not all have a shot at greatness. Live-action film was quickly losing lift as the risk-reducing strategy we had hoped it would be.

More and more, committing Pixar to animated entertainment alone was looming as Pixar’s only option. I’d been fighting it ever since I’d come to Pixar because every stone I had turned over revealed just how hard that path would be. I’d thought it when I’d learned how onerous the Disney agreement was, and then again when I learned the risks of releasing blockbuster films, and then again when I learned there had pretty much never been an independent, animated feature film company without other businesses to diversify the risks.

I had never had the notion that I was being hired to build a pure entertainment company. But it was becoming clearer that I needed to understand what that meant. Steve was keeping up the pressure on taking Pixar public, and I didn’t have the numbers to support it. That would take more than a few meetings in Hollywood. If this were to be a serious strategy, I would have to understand the economics of the business in detail. Where should I begin?

I started at the library.

At the Mitchell Park Library in Palo Alto, I discovered a book on the entertainment industry, Hal Vogel’s Entertainment Industry Economics. First published in 1986, this book had become somewhat of an industry reference, cataloging in detail all the financial and economic principles driving the entertainment business. It was a dry read, populated with charts, formulas, and dense economic analysis. I read it cover to cover, and many sections I read repeatedly.

The book’s section on filmed entertainment began with this ominous assessment:

 

Many people imagine that nothing could be more fun and potentially more lucrative than making movies. After all, in its first four years, Star Wars returned profits of over $150 million on an initial investment of $11 million. Nonetheless, ego gratification rather than money may often be the only return on an investment in film. As in other endeavors, what you see is not always what you get. In fact, of any ten major theatrical films produced, on the average, six or seven may be broadly characterized as unprofitable and one might break even.¹

 

Ouch! Ego gratification the only return on investment? Two out of ten films profitable? This was worse than baseball batting averages. Vogel’s analysis made it clear that the likelihood of a hit was small, the likelihood of a blockbuster tiny.

It got worse.

Later, in the book’s discussion of filmed entertainment, Vogel became even more foreboding:

 

As historical experience has shown, common stock–based offerings do not, on the average, stand out as a particularly easy method of raising production money for movies. Unless speculative fervor in the stock market is running high, movie-company start-ups usually encounter a long, torturous, and expensive obstacle course. . . .

Strictly from the stock market investor’s viewpoint, experience has shown that most of the small initial common-stock movie offerings have provided at least as many investment nightmares as tangible returns.²

 

Vogel was talking about taking a film company public, exactly what we were hoping to accomplish. A “long, torturous, and expensive obstacle course” and “investment nightmares” were not the ideal scenario, to put it mildly. Steve was pressing for a public offering, and here Vogel was holding up a big, bright, neon warning sign. Now I worried even more if this was the right direction for Pixar, especially when we were struggling to finish our first film. I understood that a public offering was the path, and probably the only one, to raise the funds we would need to build Pixar. But a failed public offering would be a gigantic, possibly even fatal, blow for the company. I was caught between Steve’s drive to go public and business realities that looked awful.

Vogel’s book gave me a tremendous overview of the industry. I still needed something more granular, however, something that would show me the blow-by-blow detail of where every dollar went that was associated with Pixar’s films. We were still missing a detailed financial projection of how our films would make money. Without that information, we could not make headway in understanding and plotting the real business possibilities. It was like looking for buried treasure without a map.

By now it was June of 1995; Toy Story was coming out in November, Steve was antsy to start thinking about a public offering, and I still didn’t have the basic information I needed to develop the numbers.

By this time, I had hired a new controller for Pixar, Sarah Staff. It was Sarah who so kindly picked me up on her way back and forth to Pixar while my leg was healing. She was my right-hand person in all the accounting and financial planning aspects of Pixar’s business. Sarah was smart, thoughtful, and endearingly humble. She was polished and poised, tall, with straight blond hair, and consummately professional. Her office was in a corner of Pixar reserved for finance and administration. I was over there often.

“Sarah,” I asked her one morning, “have you had any luck finding a film model we can use to build our projections?”

“No luck,” Sarah replied. “I’ve talked to my old accounting firm, who checked in with their offices in LA, but they don’t have one.”

Another dead end. All we needed was a chart of numbers that all the studios had, and we couldn’t get it.

“I have one more idea,” I said. “How about calling Sam Fischer, our Hollywood lawyer? Ask if he knows where we can get this.”

A couple of hours later, Sarah came over to my office.

“Good news, and not so good,” she said. “I talked to Sam. Believe it or not, they have a film model. Only they don’t give it out. They use it only internally, to advise their clients. He said they’d be happy to run the numbers for us but can’t give us the model itself.”

“Wow!” I thought to myself. “These financial models must be etched in gold plate. Why are they so secret?”

“That’s not going to do it,” I said. “We need our own model. Let me give Sam a try.”

Sam explained that his firm’s film projection model was confidential because it helped them counsel their clients and they didn’t want others to have access to it. He also said that his model was only for live-action film and that animation would be different.

“I totally understand why you don’t give out your model,” I said, almost pleading, “but I’m really hitting a wall on this one. Every place I turn all I hear is that these film models are confidential, but Pixar has to have its own in order to move forward.”

“I’m sympathetic,” said Sam, “but we’ve never shared the information in our model.”

But the truth was, I didn’t want that particular information for live-action films. I wanted to build a model for animation, which would be different. I just needed a start.

I had an idea.

“Sam, you mentioned your model is only for live action. How about if Pixar agrees to use it only for animation? We’ll evolve it. We won’t need to use your original data because we’ll tailor it to animation. Then we’ll share the results with you and in the end, you’ll have an animation model if you need it.”

“Where will you get the data for animation?” Sam asked.

“Disney said they would help us; they just can’t give us their model. With your model and their help, I think we can do it.”

Sam thought for a moment.

“You know, I can go along with that,” he said.

I felt like jumping through the phone and giving him a hug. I never thought I would be so thrilled over a spreadsheet. Sam’s reticence to share the model was well founded. He had stretched himself to help us out. I felt truly grateful.

Sam’s firm sent up the numbers. It was our first glimpse at the way films made money. At last, we could see how much studios kept from the box office revenues; what were reasonable assumptions for film marketing costs; when films were released in video, TV, and other markets; how much they made; the impact on profits of film production budgets and profit-sharing arrangements; as well as other details without which we’d never fully understand the business. To tailor the model to animation, we took up Disney’s offer to answer our questions about how the business of animated feature films worked.

Before long we cobbled together our first model of how an animated feature film performed financially. It was rough and crude, at best. But it was ours. Over time we would learn how to perfect it. Right now, it was good enough to give us a start. Sarah and I were elated. It was one of those small, quiet victories that gave us far more satisfaction than one might expect. It may have seemed trivial to others, but it made us feel we could finally start talking the talk of the film business. There was a chance that one day we might even seem like we knew what we were doing.

As the numbers crystallized, however, I began to see why Hal Vogel had characterized raising capital through the stock markets as a torturous obstacle course for a film company. It was virtually impossible to make the numbers work in a way that generated the kind of smooth, even profit growth that investors liked. Worse, the numbers had tremendous risk in them. Just a small change in box office performance could wipe out the entire profitability of a film. There was also another issue that was unique to animation, a pesky detail that went under the title of “carrying costs.”

Carrying costs are the costs of paying employees when they are not working on films. When animation finished on Toy Story, for example, Pixar still had to pay its animators even if it had nothing for them to do. I was learning that carrying costs could drain a little company like Pixar of all profitability. It was a problem that had dated all the way back to the time of Walt Disney, and one of the reasons it was so difficult to go into animation. This problem did not exist in live-action film because the crew making the film, from the producer and director to the film’s stars, to the cameramen, extras, and everyone else, comes together for the sole purpose of making the film. They are paid only during the time they are involved. As soon as that ends, they all disperse and there is no further obligation to pay them.

Animation studios don’t work this way. The artists and filmmakers are studio employees. They remain at the studio often for their entire careers. They are paid whether they are making a film or not. The cost of continuing to pay studio employees when the studio is not in the heat of producing a film could grow enormous. If Pixar didn’t have well-planned solutions to keeping its people productive between films, even a hit film could be drained of its profits by the overall carrying costs.

“Steve,” I said one night when we were on the phone, “I am worried about this carrying cost issue. The more we grow Pixar, the higher the carrying cost if we’re not working on a film. We could literally have dozens of people sitting around with nothing to do and we’d still have to pay them.”

“It’s a pipeline issue,” Steve said. “We have to have enough work in the pipeline to keep people busy.”

“That isn’t easy,” I said. “It depends on story development, which is notoriously unpredictable. It would be better if we had more options than just a story pipeline.”

We took it up with Ed.

“It’s a big concern, I agree,” Ed said. “But I think there are things we can do. We always have technical challenges to work on, problems like animated skin, water, wind, hair, human beings. We can move small teams of people to work on these. We also want to continue to make short films, as a way to develop talent, especially directors.”

“So when film production is quiet, we basically do more research and development so that our future films are better?” said Steve.

“Yes,” Ed said. “We obviously have to try to time our film production pipeline so that our employees remain busy. That’s the main goal. But we have other options if that doesn’t work.”

“But that’ll mess up our business plan,” I said. “We still have to pay everyone. We’re shifting the cost from filmmaking to research and development, but we’re still incurring the cost. It would be much better if we could put people to work on products that could generate revenues.”

“Pam’s been thinking about video games,” Ed said. “We have some people here interested in making games based on our films. We might be able to shift some people to that.”

There were, at least, some options, but this carrying cost issue had the potential to be the Achilles heel that, even if our films did well, could eat away at Pixar’s business viability.

It was now approaching the end of June 1995. The release of Toy Story was a few months off. I finally understood the business possibilities in animation. But even if I could make a case that an independent animated feature film company could work in theory, in Pixar’s case we would remain for years under the vise grip of the Disney agreement, which gave Disney most of the profits. We also had to deal with the carrying cost issue.

My instincts said that animation as a stand-alone business, without anything to diversify its risks, was going to be very, very difficult to make stick with investors. Many would see it as a fool’s errand. How could an upstart company with no experience in Hollywood credibly claim it would build an animated feature film studio that would rival Disney’s? No studio had pulled it off in two generations, and Disney had long ago diversified.

Yet the pressure on me from Steve continued to intensify. He wanted to know when we’d take Pixar public. It felt like he thought going public was the endgame, that all would be magically okay if only we could do it. I didn’t see it that way. The pressures that Pixar would feel once we went public would be monumental. The whole world would be watching for every single slip-up. Every misstep would be magnified. It could just as easily backfire as it could launch Pixar into a better future.

Moreover, if Pixar raised its flag as an entertainment company, we would take steps that would be hard to reverse. Things like: stop selling RenderMan software; shut down the commercials group; announce to the world, and particularly to Wall Street, that we were an entertainment company; assign more and more resources to filmmaking. Once we stepped into that world, there would be no turning back. No second chance. Pixar had to be ready for it, financially, strategically, psychologically. With the pressures of trying to finish Toy Story, I was not sure we were.

But I had examined this from every angle I could imagine. Fully committing Pixar to becoming an entertainment company focused on animated feature films was our only shot. Steve, Ed, and I were all on board with it. This was our mountain to climb, no matter how steep or far away the summit. With much weighing on my mind, it was time to begin the ascent.