Competitive Intelligence

Pixar vs. Disney: Clash of CEOs and the New Competitive Challenges Both Will Face

Late last week, 10-month-old talks to renew the pact between Disney and Pixar that produced $2.5 billion in box office over the past few years, broke down as the companies failed to arrive at an agreement to move forward together - instead, they'll move forward as competitors.

Pixar's chief executive, Steve Jobs, who also runs Apple Computer, abruptly ended negotiations with Disney after no progress was made in what Disney and its financial analysts believed was just asking too much, including sole ownership of the films the two had made together under the existing agreement - including hits like "Finding Nemo", "Toy Story" and "Monsters Inc."

"What Pixar has that we don't have is John Lasseter," Eisner said during an investment conference last year. "It's like Walt in a way. He has that quirky sense of humor and understanding. John is unique." This gives Disney two years to nurture or hire its own version of Lasseter - himself a former Disney animator - to compete against future Pixar films.

Eisner faced criticism for having mismanaged one of the most profitable tie-ups in the history of Hollywood and letting Pixar go its own way. "He made them feel like second-class citizens when they were producing the best product in the country," said Stanley Gold, a former board member allied with ex-director Roy Disney who is campaigning for Eisner's ouster. "It was no way to manage talent," added Gold, who is campaigning for shareholders to vote against Eisner and three other board members up for reelection at the March 3rd shareholder meeting in a symbolic protest.

But short-term, analysts said, Disney would benefit, since it was not going to give away any of its profit from the two films left in the current Pixar deal, which had been part of the renegotiation. "Eisner had no other choice in my opinion," said Schwab SoundView analyst Jordan Rohan who estimates Disney would have forgone up to $1 billion in pretax profit over four years. "If my financial projections are correct... then Eisner will be vindicated, the company will be back and Roy Disney will find it hard to effect any change," he said.

Then, yesterday, in an conference call announcing a quadrupling of earnings on the strength of "Finding Nemo" DVD sales, Jobs ended any hope that the companies might continue their partnership by blasting Disney's own animation efforts and blaming the company for refusing to reach a compromise. Jobs said Pixar is now the "most powerful and trusted brand in animation" and is free to work with new partners.

"The truth is that there has been little creative collaboration with Disney for years," Jobs said. "You can compare the creative quality of Pixar's last three films, for example, with the creative quality of Disney's last three animated films and gauge each company's creative abilities for yourself."

"We will truly miss working with Dick Cook and his terrific distribution and marketing teams," Jobs said, referring to the chairman of Walt Disney Studios. "And you would be hard pressed to find anyone who loves the original spirit of Disney more than John Lasseter, Ed Catmull or myself. But after almost a year, it's time to move on." Lasseter, a former Disney animator, is the chief creative force at Pixar. Catmull is Pixar's president.

"Not even Disney's marketing and brand could turn Disney's last two animated films, ‘Treasure Planet’ and ‘Brother Bear’ into successes. Both bombed at the box office," Jobs said. "No amount of marketing will turn a dud into a hit," Jobs said. While Disney must now face Pixar as a competitor, it retains the rights to make video and theatrical sequels and TV shows to the movies covered by the current deal. However, despite retaining the right to make sequels to Pixar films, Disney does not own the underlying technology and must recreate the millions of lines of computer code for each character. "We feel sick about Disney doing sequels because if you look at the quality of their sequels, like ‘The Lion King 1-1/2,’ ‘Peter Pan’ sequels and stuff, it is pretty embarrassing," Jobs added.

Pixar still has two movies to deliver under its current deal, including "The Incredibles," due in theaters in November, and "Cars," which will be released next year.

Disney's studio division contributed 19 percent of the company's overall operating income in 2003 and during the past five years, Pixar contributed more than 50 percent of Disney's studio profits, but if Disney had agreed to Pixar's terms, it would have forfeited hundreds of millions of dollars in profits it is entitled to under the current deal.

One factor in Disney's favor may be that Disney's studio division has found increasing success with live-action films, such as "Pirates of the Caribbean: The Curse of the Black Pearl." Strong box office returns in that area could reduce the company's reliance on Pixar profits and Disney's theme parks, which contribute the bulk of the company's revenues, also have been recovering from several years of lower attendance.

Disney has said it will release its first-ever computer-animated film, "Chicken Little," in 2005 and has several other computer and hand-drawn animated films in the works. But the big challenge for Disney will be to fill the creative vacuum left by the loss of Pixar writers and animators such as Lasseter, Andrew Stanton, the director of "Finding Nemo," and Lee Unkrich, co-director of "Monsters Inc." and several other Pixar films.

Disney has cut back its own feature animation department having earlier this month announced it would close its Orlando animation studio and shed more than 250 jobs. Computer-generated characters will largely replace hand-drawn ones in Disney's restructured animation department.

In a recent interview with The Associated Press, Disney studio chairman Dick Cook said attracting and nurturing creative animation talent is a priority. "There is a group of kids graduating today from CalArts or from UCLA or USC that are bigger, better, faster, smarter than the current group," Cook said. "They have the ability to know what the masters have done before them, and they're better than they are. Attracting that kind of talent, for us, is one of the great priorities."

"Finding Nemo," Pixar's latest film, has earned more than $800 million at the international box office to date, surpassing the record previously held by Disney's 1994 film, "The Lion King." Jobs said every major studio has expressed interest in working with Pixar and negotiations with at least four of them will begin in March and Pixar hopes to have a new deal in place by the fall.

In an e-mail, David Stainton, picked by Eisner last year as Disney's new chief of animation, tried making lemonade: "Given Pixar's demands, this is good news for the company. It is also a great vote of confidence for feature animation - confidence in our talent, our slate, and our future. You all are awesome and ready for your close-up!"

Barron's said Pixar has probably capped its earnings power for the next three years because its next two movies, "The Incredibles" and "Cars," will be released under the existing deal, which effectively gives Disney more than 60 percent of any profits, and the same report cited a Morgan Stanley analyst who said the possibility of negotiating more favorable terms on those two movies is now off the table. And, as Pixar faces Disney as a rival in the increasingly competitive animated film business, Pixar's new partner is unlikely to be as strong as Disney in family entertainment. In the future, starting with its as-yet unnamed 2006 movie, Pixar will probably bear all the production and marketing costs, Barron's said.

So, can Eisner carry on? His instincts appear to be failing him… Several months before last summer's release of "Finding Nemo," Eisner, told his board not to expect a blockbuster and suggested that such a fate might not be all that bad. Eisner said that although Pixar was excited about its film, he was not impressed by early cuts he'd seen, according to people familiar with the matter. Should the movie falter, Eisner said, Disney could gain negotiating leverage in contentious talks to extend its partnership with the highflying animation company. Pixar, Eisner concluded, may be headed for "a reality check." The computer-animated film would, in fact, prove to be a reality check for Eisner, as the critically acclaimed "Finding Nemo" would soon make more money than any animated film in history. Advantage: Pixar.

I think in the end, the real source of competition was probably in the inflated egos of the two firms' CEOs, Eisner and Jobs, both famously strong-willed and who let their personal differences cloud their objectivity in a partnership in which the spoils were evenly split. Jobs felt so slighted that he put an offer on the table designed to make Eisner so angry talks would break down and each company could go their separate ways. Here’s a great backgrounder excerpt from the LA Times, comparing the two leaders:

Eisner has been at the helm of Disney for 20 years. He has weathered a number of storms, including poor performance of its stock, deteriorating ratings of its ABC television network, weak sales at its retail stores, and the defection of high-level executives who have found success elsewhere. The Disney chairman is widely known as someone who will not give an inch in his business dealings, whether it's litigating over merchandising royalties for Winnie the Pooh or forcing cable operators to pay escalating fees to air Disney's ESPN network.

The equally tough-minded Jobs has survived his own share of setbacks. In 1985, the legendary Silicon Valley entrepreneur left Apple Computer, the company he co-founded in his father's garage, amid a power struggle over its direction. Like Eisner, he is guarded and intensely protective of his company's brand name. Jobs recently demonstrated his maverick vision and shrewd negotiating skills in persuading executives at Universal Music Group and other labels to sell songs online with few restrictions through Apple's iTunes Music Store. Associates say he wins some battles sheerly on the force of personality. "He is the best salesman in the technology industry, bar none," one Silicon Valley analyst said of Jobs.

The pairing of two men with such combustible personalities may have been destined for a blowup.

The companies first joined in 1991. Back then, Pixar was not an equal partner. The upstart animation company was paid a fee to create digitally animated movies that Disney would market and release.

But after the surprise success of "Toy Story" in 1995, Jobs insisted on changing the financial balance of the relationship. He demanded that Pixar be paid half the profits on the films it wholly created for Disney. When Eisner balked, Jobs nearly walked.

Still, according to sources who know both men, Eisner continued to treat Jobs - known to have a disdain for authority - in a paternalistic fashion. "Steve viewed it as a partnership and he thought Eisner treated him like a hired hand," one source said.

Many say the turning point in the unraveling of their relationship came when Jobs and Eisner collided over the fate of "Toy Story 3" and how sequels figured into their new five-picture deal.

Under the terms of the agreement, sequels would not be counted as part of the five. At the time, Disney was trying to save money and time by making direct-to-video animated sequels. That's how "Toy Story 2" was initially envisioned. But as production proceeded, Jobs could see the financial and creative potential of turning it into a major movie that would be released in theaters.

Although Eisner resisted, Jobs would not give up, according to sources familiar with the dispute. In the end, Jobs' persistence paid off for Pixar and Disney. "Toy Story 2" made more money than the original, raking in a stunning $245 million domestically in 1999.

But because the movie was a sequel, it was not counted under the multipicture deal — a fact that Jobs accepted without making a ruckus. He was not so amenable when it came to plans to make "Toy Story 3."

This time, Jobs was adamant that the sequel be counted as one of the films Pixar owed under the Disney contract. Jobs' view was that "Toy Story 2" was a giant "freebie" for Disney and that Pixar should not be forced to provide another one.

Despite a collaboration that unexpectedly enriched Disney, Eisner insisted on sticking to the letter of the contract. He refused to compromise and publicly bragged about the leverage he had over Pixar.

Jobs was livid, according to a source close to the executive.

Even Walt's nephew Roy Disney couldn't mend the rift after Jobs sought his counsel, following Eisner's 2002 congressional testimony that directly mocking Apple's "Rip. Mix. Burn." slogan exemplifying digital piracy of entertainment content. But Eisner strictly forbid Disney from visiting Pixar to screen his pet short film project "Destino" saying Disney personnel would not mingle with Pixar's during tough contract re-negotiations.

Still, those analysts who'd speculated last week's announcement by Jobs was just a negotiating ploy are left to remember words from last November, while discussing Pixar's third-quarter earnings with analysts: "If we cannot strike a deal with Disney, then we can talk with the rest of these companies and they will know that we're not just talking to them to get a better deal with Disney, because we'll be finished with Disney."

The competitive dynamics get pretty interesting to think about for other players in Hollywood, namely DreamWorks with its upcoming "Shrek II" sequel, following up on the success of "Shrek" – the first film to win Best Animated Feature at the Academy Awards. Other studios will be vying to build out an animation franchise as well, as they spot a weakened competitor in Disney – possibly with Pixar – although they’d need to tolerate the relationship.

In the end, I think Disney thought DreamWorks took the right road by building their own animation machine and this represents largely a revision of history to redeem what was originally an unexpectedly entangling decision to buy rather than build. That said, "Toy Story", the film that started it all, might not have happened without both Disney and Pixar behind the wheel.

- Arik

Posted by Arik Johnson at February 5, 2004 01:04 PM | TrackBack