Behind Steve Jobs' plans for Pixar

From Knowledge@Wharton
Special to CNET News.com
February 22, 2004, 6:00 AM PST

In a decisive move, Steve Jobs, CEO of Pixar Animation Studios, pulled the plug in late January on discussions about the company's marketing and distribution deal with Walt Disney.

Citing failure to strike a deal after 10 months of negotiations, Jobs said it was unlikely that the two partners would reconcile their differences and that it was time to move on.

Coming after a string of successful Pixar-Disney releases, the announcement set off in Hollywood and on Wall Street about Pixar's future and about potential replacement partners for the company. Many noted that the long-standing animosity between Jobs and Disney CEO Michael Eisner probably contributed to the break-off of the talks and wondered about the terms Pixar, given its extraordinary run so far, might demand of any new partner.

In an earnings conference call on Feb. 4, Pixar executives announced that the firm had almost quintupled its fourth-quarter earnings, compared with the same period the previous year. Much of that boost came from the runaway success of its most recent blockbuster film, "Finding Nemo." According to CNNmoney, the animation studio has augmented Disney's profits to the tune of $1 billion so far. Profits notwithstanding, making a deal on Jobs' terms may have proved too much for the equally strong-willed Michael Eisner. Jobs had been trying to negotiate a new agreement, whereby Pixar would receive a larger share of the take from both upcoming releases and as-yet unmade films.

Meanwhile, Eisner's own future seems to be uncertain. On Feb. 11, Comcast, the largest cable company in the United States, offered an unsolicited , sending the companies' shares up, as Wall Street considered the prospect of a bidding war. In response, Disney released quarterly earnings slightly earlier than expected, beating analysts' estimates. Two former Disney board members, Roy Disney and Stanley Gold, have called for Eisner to step down, and it is unlikely that Eisner would have a place in the new company, should Comcast succeed in its bid, some analysts say.

Hit parade
The uncertainty over Comcast's battle with Disney will complicate the entertainment industry's dynamics, as Pixar ponders the choice of a new distribution partner. Whether and to what extent a new partner will affect Pixar's prospects depends to some degree on how much pull its own brand now has. Pixar was created when Apple Computer CEO Jobs bought the computer graphics division of George Lucas' Lucasfilm in 1986. After a few years of and commercials, the company . Pixar would develop up to three movies, to be marketed and distributed by Disney.

Unlike Disney's traditional hand-drawn animation, Pixar's 1995 movie "Toy Story" was the first completely computer animated feature film.

Disney is already looking to fill the void the Pixar divorce created.

In the same year, ; the $140 million initial public offering beat out Netscape's to become the biggest of the year.

In 1997, Disney and Pixar renegotiated their deal, agreeing that they would make five original movies together in a "co-production" model. Both companies would share equally in the profits of each film and related merchandise and other products. The year 1998 saw "A Bug's Life"; " " was released in 1999 (though, as a sequel, and it did not count toward the five-picture deal). In 2001, the two companies released " " to wide acclaim. And last year's "Finding Nemo" took the cake, becoming the biggest-grossing animated film of all time. The final two movies to be made under the Pixar-Disney agreement, "The Incredibles" and "Cars," are slated to come out later this year and next year, respectively.

Brand matters
In the fourth-quarter earnings conference call, Jobs was critical of Disney's own record in animation, noting the flops of recent films like "Treasure Planet" and "Brother Bear." Jobs said that there was little creative input from Disney in the making of Pixar's films. The company would not suffer from the split, he said, as the quality of the film and the word-of-mouth buzz it generates is more important than the marketing.

Brand is certainly critical in the marketing of all films, says Ken August, a principal at Deloitte Touche Tohmatsu and the consulting firm's West Coast industry leader for media and entertainment. "There are two aspects to the "brand" of a movie--one is created by the movie itself, enhanced through the film's marketing and the brand of the distributor, if any; the other is the brand the material brings to the table as a consequence of prior exposure, such as literature.

Both the power of the movie itself and the quality of its marketing influence how it will fare in various markets--domestic, international and so forth. But it all begins with how good a movie is."

If there's a literary or newsworthy event, that in itself has created a brand, says August, part of the brand will draw from that previous activity. "'The Lord of the Rings' was brilliant, but there was already an audience waiting for it. The same is true for 'Superman' or the 'Harry Potter' movies."

While the distributor matters, he says, it isn't the whole story. "Certainly, the brand of the distributor and the quality of the marketing campaign are not irrelevant; the distributor can take a good film and accelerate its profitability. It can even take a film on the cusp and bring it to more people who might appreciate it. But it can't make a bad film good."

Of course, the economic impact of the theatrical release can be quite significant, given the expense of the production itself. "The most expensive part of the process is making the movie--the cost of making and marketing a movie for a major MPAA member studio is about $90 million or more," August says. "In that case, one might ask, 'Why don't studios go direct to video and subsequent ancillary markets with all movies?' The reason is that the movie release creates the desire and demand for the markets that follow. You might lose money or just break even at the box office, but you try not to skip that step, generally, because that's what drives the ancillary revenue later on.

"Interestingly, direct-to-video sequels, for which the brand is already established, can be successful. Other direct-to-video releases of theatrical features are usually smaller movies--or about cutting losses."

The crystal ball
Given the success of their now broken relationship, where do Disney and Pixar go from here after 2006? Wharton marketing professor Jehoshua Eliashberg believes that both companies will likely end up just fine. "Pixar will remain successful and thrive in the short run. They have an impressive track record in the computer graphics (CG) animation space, and in the entertainment industry, track record is critical."

What's more, Pixar's brand is established, August notes. "The Pixar brand is quite strong in the marketplace, so I think Pixar can be successful on its own. I imagine that Disney was probably more than just a distributor--the enhancing and accelerating aspect of the Disney brand had to have been helpful in promoting Pixar's movies. But now, Pixar has its own brand and can stand on its own feet."

But, Eliashberg warns, it can't coast along indefinitely without challengers. "In the long run, Pixar will face increased competition from other independent production firms as well as from the major studios themselves," Eliashberg says.

"Certainly, the brand of the distributor and the quality of the marketing campaign can take a film on the cusp and bring it to more people who might appreciate it. But it can't make a bad film good."

--Ken August

"Disney is in the process of developing an internal core competence in the CG space. At the same time, Disney has distribution deals with other CG production firms, Vanguard Films being one case in point."

Eliashberg believes that in the end, Disney won't be hurt. "While from a short-term perspective, Disney's situation does not look good, in the long run, given their outstanding marketing/distribution machinery as well as the general reputation they have in making and distributing family-type movies, they will do just fine."

Indeed, Disney is already looking to fill the void the Pixar divorce created. Vanguard Films, creator of the enormously popular "Shrek" for DreamWorks, has a deal to produce four computer-animated films for Disney, and Complete Pandemonium is also working on projects for the company.

While Jobs identified several potential in the last earnings call, just who will be chosen is the burning question. "I see Pixar fitting well with Warner Bros. and Sony," says Eliashberg, pointing to the as a plus for Pixar. "Warner Bros. has the largest distribution infrastructure in the global home video marketplace. The movie genre produced by Pixar is the type of movie that generates the highest revenue from DVD sell-through. Hence, this looks like a good match. Sony has competence and a culture that could blend well with Pixar and Steve Jobs' digital expertise and mind-set."

August agrees that there is a slew of likely suitors. "Any number of companies might distribute Pixar's movies. All the majors would be potential partners. Certainly, a company such as Warner Bros., which has a great track record of creating and distributing franchises, including children's fare--like 'Looney Tunes,' the ' ,' and ' ,' not to mention more adult-themed content, such as ' ' and ' '--might be on the list."

What will happen next, given the probability that Disney will be involved in some kind of merger in the near future? The answer is likely coming soon, to a theater near you.

To read more articles like this one, visit Knowledge@Wharton.

Interested in more research studies like these? If so, sign up for the Knowledge@Wharton Newsletter, a free service of the Wharton School of the University of Pennsylvania.