19

Anatomy of a Deal

As the calendar turned to 1996, Pixar had organized itself for not one but two productions. A Bug’s Life was in full production, and work had begun on Toy Story 2, a sequel to Toy Story that was slated to bypass theatrical release and go directly to the home video market. Disney had enjoyed great success in recent years with direct-to-home-video releases like The Return of Jafar, a sequel to Aladdin. Because these sequels would not have the benefit of widespread theatrical distribution, they had to be made at far less cost than the original film in order to make financial sense.

I was on record as being skeptical about Pixar’s ability to reduce its film production costs enough to justify a direct-to-video release. We were running into similar challenges trying our hand at producing a Toy Story video game. The game was great, but the production costs were prohibitively high. Disney had honed ways to make less expensive sequels in traditional animation, but Pixar did not have a method to make lower-cost computer animation.

Another problem with Toy Story 2 was that it would extend the Disney contract because it would not count as one of the three original films we had to deliver under that contract. Here I had been looking for every angle to get out of that agreement, and this was going to make it last longer. There was a lot of momentum to make a sequel, however. Pixar’s creative and production teams thought they could find ways to make it quicker and at less cost than a theatrical release, and it would at least have the benefit of helping with the carrying cost issue—paying for production employees who would otherwise have no film to work on. On the theory that it would take much less time than a theatrical film, we decided to go for it.

At the same time, Steve and I were turning our sights toward another of our plan’s four pillars: increasing our share of film profits. This hinged on the terms of our film distribution agreement, presently with Disney but in the future potentially with any of the major studios: Disney, Universal, Fox, Paramount, Warner Brothers, or Columbia.

For two generations, these studios controlled the business of film distribution. Through their extensive networks, only they could deliver films into movie theaters in every corner of the world. In the United States alone a big movie would open in 2,500 to 3,000 theaters. For this kind of reach, Pixar would have to strike an agreement with one of the major studios, and that agreement would spell out Pixar’s share of the profits. It would also describe the terms for one of our other pillars: branding. If our films were to be distributed under the Pixar brand, whatever studio was distributing our films would have to agree.

Our choices were: either we rode out our existing contract with Disney and then entered a new contract with Disney or any of the other major studios, or we renegotiated our contract with Disney now. If we rode out the existing contract, we would have maximum flexibility at its conclusion, but that could take up to eight years. In short, it all came down to evaluating which option was better for Pixar: renegotiating now with Disney, if that was even an option, or entering a new agreement later with Disney or another studio. Much like the IPO, this topic began to occupy a lot of my time with Steve.

“If we’re going to make a move to renegotiate with Disney,” I suggested one night in early January 1996, “we should start thinking seriously about it right away, while Toy Story’s success is still fresh.”

“Or maybe we’re better off waiting,” Steve said, “until we’re free to negotiate with other studios and have more flexibility to pick our best distribution partner.”

Neither of us was sure whether or when to approach Disney to try to change our deal. We understood that if we did it now, we might get better terms even for our next two films, but if we waited, we might get even better terms later, when we were free of that agreement. We went back and forth, often switching sides in the discussion. Making the move now made sense only if we thought we could negotiate a deal that would be strong enough to justify giving up our options in the future. But how would we know?

There is no formula for easily making this type of assessment. In business relationships, or virtually in any relationships for that matter, there are two factors that determine one’s capacity to effect change: leverage and negotiation.

Leverage means bargaining power. It is the muscle you have to bring about change in your favor. The more leverage, the better your chances to get what you want. In poker, leverage would be the equivalent of the actual strength of your hand. Negotiation, in contrast, describes the tactics you employ to extract the best terms you can, given your leverage. It is about how you play the hand. Courage, fear, tenacity, trustworthiness, creativity, calm, the willingness to walk away, to behave irrationally—these all play into negotiation. Leverage is an assessment of bargaining strength; negotiation is how you put that bargaining strength to work for you. A good negotiator can make more out of the same leverage than a not-so-good one.

In Pixar’s first agreement with Disney, Pixar had fared poorly in terms of both leverage and negotiation. Pixar had not had much leverage because it had just closed down its hardware business, was struggling to remain afloat, and had never made a feature film. In terms of negotiation, I felt Steve had been caught in a rare weak moment. This was more than four years ago, though. Steve liked to cite the adage “Fool me once, shame on you; fool me twice, shame on me.” What had occurred four years earlier was not going to happen again.

We needed to understand how much leverage we had in order to negotiate a good deal with Disney now. If we approached Disney and didn’t have the muscle to back us up, we would be politely, or maybe not so politely, dismissed out of hand.

One Friday in late January 1996, when Steve was at Pixar, we stepped into the small, windowless conference room near my office to discuss where we thought Pixar stood in relation to Disney. As we often did, we wrote down the main points of discussion on a whiteboard. There was one in the front of the room, with a wooden casing around it. We had discussed all of these points before, but it was helpful to see them in one place. Steve took a whiteboard pen and made two columns: Disney and Pixar. Under the Disney column, he would write the points that gave Disney leverage. Under the Pixar column, he would write the points that favored Pixar.

Point one for Disney: NO OBLIGATION TO CHANGE CONTRACT

“We know there’s nothing that can force Disney to negotiate with us,” Steve said. “They have a three-picture deal and they can stick to that contract simply because they want to.”

“They have us tied up for two more films,” I added. “They keep most of the profits, and we can’t talk to any other studios until we’re done. It’s a great deal for them. Why would they change it?”

Steve added a second point in the Disney column: CAN INVEST IN COMPUTER ANIMATION THEMSELVES

The impact of Toy Story had made Disney examine its own potential in computer animation. They might easily assume that they could hire the best talent they could find and build up their own capability.

“If Disney makes a substantial investment in computer animation,” Steve said, “they may have no interest in extending their agreement with us.”

“Disney has plenty of resources to do it,” I added. “Plus they also have time on their side. Their deal with us could buoy them for a few years while they build up their own capacity in computer animation. We’re basically giving them the lead time they need.”

This was a potentially perfect strategy for Disney. They could use Pixar to tide them over until they no longer needed us, reaping most of the profits along the way. Then they’d have their own computer animation capability ready to go and could easily jettison Pixar.

“Another point for the Disney column,” I added, “is that Disney will undoubtedly think it offers Pixar more than any other studio can offer, given its expertise in animated films.”

Steve wrote in the Disney column: OTHER PIXAR OPTIONS INFERIOR

Disney was clearly better at distributing animated feature films than anyone else. It had extraordinary merchandising capability for churning out toys, clothes, and other branded items; it had the very best theme parks for showcasing the films and their characters; and the imprint of the Disney brand on an animated film gave it a cachet that no other studio could provide. Where else could Pixar find that kind of distribution clout? Disney might well conclude that Pixar needed Disney far more than Disney needed Pixar, and they might be right. It would certainly diminish our leverage with them.

Next Steve added to the Disney column: PIXAR ONLY ONE HIT

“We’ve had only one hit,” Steve said. “Before we prove we can repeat it, Disney might be reluctant to change our deal.”

This was the one-hit-wonder problem. One hit did not make for a track record.

“Anything else in Disney’s favor?” Steve asked.

“We’ve talked about this,” I said, “but maybe Eisner’s interest in animation is waning. He just bet big by buying ABC, which includes ESPN. Animation could be on its way to becoming a sideshow for him.”

Michael Eisner was Disney’s CEO. He had a reputation for being mercurial and hard to read. The notion that he might not care all that much about animation seemed a bit far-fetched, but it was possible he was more interested in television and other media outlets than animation. He had just spent $19 billion to buy ABC. Maybe it spelled a new direction for Disney.

Steve wrote in the Disney column: ANIMATION MIGHT BE LOSING PRIORITY

The Disney column now read:

 

DISNEY

• NO OBLIGATION TO CHANGE CONTRACT

• CAN INVEST IN COMPUTER ANIMATION THEMSELVES

• OTHER PIXAR OPTIONS INFERIOR

• PIXAR ONLY ONE HIT

• ANIMATION MIGHT BE LOSING PRIORITY

Any one of these factors wouldn’t bode all that well for Pixar. Collectively, they added up to a bleak outlook for Pixar’s leverage. Some might say Disney had all the bargaining power, that Pixar was just a fly on the side of the elephant. Disney could let us hang around for as long as we were useful, then swat us away in an instant.

There was another column, though.

The first thing Steve wrote in the Pixar column was: IPO $ TO PAY FOR PRODUCTIONS

“We can now pay for our own productions,” Steve said. “Disney doesn’t have to pay for all the costs.”

This was why we had done the IPO. If money talked, we now had quite a bit of it. We anticipated that production costs for Pixar’s next film might approach $50 million, and production costs for future films more still. If we offered to put up half of it, this would surely get Disney’s attention.

Then I added a second point: TOY STORY SUCCESS

Steve wrote it in the Pixar column.

“No one expected Toy Story to be so successful,” I said. “Least of all Disney.”

Toy Story was still playing in theaters and had surpassed $170 million in the domestic box office, vastly exceeding Disney’s expectations. Much to their surprise, the quaint experiment in computer animation had gone mainstream. The world might not know that Pixar made the entire film, but Disney knew, and it would make it harder for them to brush off Pixar and computer animation as a sideshow.

“By itself it doesn’t compel Disney to renegotiate,” I added, “but it would make them more inclined to keep Pixar happy.”

Skip Brittenham, the Hollywood super-lawyer now on Pixar’s board of directors, had told us how success talks in Hollywood. If that was true, Pixar’s star was shining a lot brighter these days. That would surely give us some leverage.

“There’s also the DreamWorks factor,” I added.

DreamWorks was founded in 1994 after Jeffrey Katzenberg’s well-publicized resignation from the Walt Disney Company over CEO Michael Eisner’s decision not to promote him to president of the company. As chairman of the Walt Disney Studios division, Katzenberg had overseen the revival of its animation business. Together with its two other founders, Steven Spielberg and David Geffen, DreamWorks’s vision was to produce live-action films and a brand-new animation studio that would compete directly with Disney.

The implications of DreamWorks for Pixar were twofold. First, DreamWorks Animation was a potential competitor to Pixar. Second, and more important to this discussion, DreamWorks’s competitive threat to Disney might make Disney less willing to alienate Pixar. Better for Disney to keep Pixar in its camp than risk not one but two serious competitors in animation when, for the preceding sixty years, it had none.

“Katzenberg would like nothing more than to trump Disney in animation,” Steve said. “He’s a thorn in Disney’s side. If Eisner loses Pixar to another studio, and DreamWorks succeeds in animation, Eisner could go down as the Disney CEO who lost animation.”

Steve wrote in the Pixar column: DREAMWORKS THREAT TO DISNEY

Then Steve made another entry in the Pixar column: BETTER DEAL IF WAIT

“If we don’t do a deal with Disney now,” Steve said, “we’ll get a better deal later when this contract is over. We’ll then have multiple studios bidding for Pixar’s business. We might even be able to keep eighty or even ninety percent of the profits, much more than we’re likely to get from Disney now.”

“We can’t count on that,” I countered. “If our next films underperform, maybe we get worse terms later. This point can cut for or against us. Also, if we renegotiate with Disney now, we might get better terms right now, even for A Bug’s Life.”

“But I think there’s a premium we have to pay for a partnership with Disney,” Steve added, “because of their experience in animation compared to the other major studios. If we go with another studio later, we can get even better terms.”

I agreed that Pixar would pay a premium to be in business with Disney, probably in the form of Disney keeping more of the profits than we might have to relinquish to another studio. I also felt that any deal with another studio would depend on our track record then. There was no need to press the point now, though.

The chart now looked like this:

 

DISNEY	PIXAR
NO OBLIGATION TO CHANGE CONTRACT	IPO $ TO PAY FOR PRODUCTIONS
CAN INVEST IN COMPUTER ANIMATION THEMSELVES	TOY STORY SUCCESS
OTHER PIXAR OPTIONS INFERIOR	DREAMWORKS THREAT TO DISNEY
PIXAR ONLY ONE HIT	BETTER DEAL IF WAIT
ANIMATION MIGHT BE LOSING PRIORITY

 

It was difficult to assess how this would shake out. Both of us had leverage. But did Pixar have enough to force a negotiation now, and on favorable terms? I felt we had enough to find out. Just one of our points might be sufficient to bring Disney to the negotiation table. And we were not afraid to wait if it didn’t materialize now.

“I think we should go for it,” I said to Steve.

“It would be better if Disney approached us,” Steve replied. “We just had this huge hit. Wouldn’t Eisner want to keep us happy?”

Steve was right. It would be much better if Disney made the first move. We didn’t want to appear weak, or needy. I was nervous about Pixar making the first move too.

“It would be better,” I agreed. “But everything we’ve learned suggests that’s not how Eisner works. He keeps things close to the vest. Even if Disney did want to sweeten the deal for Pixar, there’s nothing compelling them to do it now. Maybe we make the move while the glow of Toy Story still shines brightly.”

“But if they say no,” Steve added, “it might poison the relationship, making the next two films harder to make.”

“I hope it wouldn’t affect the film productions,” I said. “We have to keep the business and creative relationships separate.”

“Let’s look at what we want if we do approach them,” Steve continued.

This was another topic Steve and I discussed a lot. If we approached Disney to renegotiate our deal, we had to be crystal-clear about what we wanted. This was about our negotiating strategy.

The natural tendency in negotiations is to engage in positional bargaining. This means taking a position knowing that it is not a final position, and holding in reserve a backup position. The danger of positional bargaining is that it forces you to think about backup positions, which weakens your conviction in your original position. It’s like negotiating against yourself. Plan A may be your optimal outcome, but inwardly you have already convinced yourself to settle on Plan B.

Both Steve and I had a strong distaste for approaching negotiation this way. We preferred to develop our positions without thinking through a backup. Once Steve decided what he wanted in a negotiation, he developed something akin to a religious conviction about it. In his mind, if he didn’t get what he wanted, nothing else would take its place, so he’d walk away. This made Steve an incredibly strong negotiator. He would dig into his positions with a fierce, almost unbreakable grip. The risk, however, was in so overreaching that we would end up with nothing. If we were not going to have a backup plan, we had to be very careful about knowing what we wanted.

Steve changed the whiteboard pen for a new color, and in a different part of the board he wrote: NEW DEAL

Below that he wrote: 1. CREATIVE CONTROL

“We need control over our creative destiny,” Steve asserted. “We’ve proven we can make a great film. We can’t go on indefinitely beholden to Disney to approve our creative choices.”

Unless you were Steven Spielberg, Ron Howard, or another celebrity director, it was almost unheard of for an independent production company whose films were being funded by someone else to have creative control. That usually belonged to whoever was putting up the money. We had already decided that John and his team would have creative control within Pixar. Now we wanted to diminish any outside influence over them.

“It will help that we are willing to fund our films,” I added, “but Disney will be nervous about this so long as they’re putting up even some of the money.”

Nevertheless, we both agreed that creative control was essential to Pixar’s future.

“Another must-have is favorable release windows,” I said.

It mattered a lot when films were released, especially big-budget family films. There were two optimal dates: early summer and Thanksgiving, which runs into Christmas. No other time periods came close in terms of box office opportunity. Any contract we entered, with Disney or anyone else, would have to guarantee that Pixar films enjoyed optimal film release windows. Steve wrote on the whiteboard: 2. FAVORABLE RELEASE WINDOWS

“Disney has to treat Pixar film releases like its own,” Steve added to emphasize that point.

Then he wrote: 3. TRUE 50/50 PROFIT SHARE

This was a big one. All of our financial projections told us that we had to keep at least 50 percent of the profits from our films.

“A true fifty-fifty,” Steve said. “Calculated fairly.”

“Not using ancient Hollywood accounting terms that favor the studios,” I added.

“That leaves the branding issue,” I went on. “Pixar’s films under Pixar’s name.”

We had discussed this endlessly. Steve wrote: 4. PIXAR BRAND

“We made the films,” Steve said. “The world needs to know that.”

That was the fourth pillar of Pixar’s business plan.

“Anything else?” Steve asked.

“Of the big issues, no,” I said. “These are the ones we stick to, no matter what.”

Now the whiteboard had a column that said:

 

NEW DEAL

1. CREATIVE CONTROL

2. FAVORABLE RELEASE WINDOWS

3. TRUE 50/50 PROFIT SHARE

4. PIXAR BRAND

We understood there would be many other issues in any renegotiation, but on these four matters our plan was to hold firm. If we gave up on any of these, Pixar’s future would be jeopardized too much. These were our deal breakers.

“I think we’re ready,” I said.

“I’ll call Eisner,” Steve replied. “I’ll tell him what we have in mind.”

I felt sure this was the right move. It was a little scary, though. If Eisner shut the door on us because he thought we were overreaching, our chances of improving our financial situation in the near or even the medium term would evaporate. But we had thought this through every which way. It was time to set in motion a renegotiation with Disney. We could not predict what would happen next, but one thing was clear: when Steve picked up the phone to call Eisner, there was a lot at stake for Pixar.