Having just watched 'Toy Story 3', I must admit I missed Emperor Zurg. Then again, I was glad the film didn't constantly 'nod' to the previous films - showing Sid as an older guy, showing Wayne Knights crappy toy store, etc.
I have no idea how Zurg would have fitted into the story without being a shameless 'remember this guy' moment, but one idea might have been to use Zurg as an example of a Toy that gets destroyed by the toddlers. Imagine the horror!
Fact is, the start of Toy Story 2 was incredible and, I remember how - on DVD - I thought it looked incredible. Ultimately, it still does look amazing.
On a side note, I can't seem to write comments on certain bloggers posts and, interestingly, The Kid in The front Row had a dilemma about watching previous Toy Story films prior to the third one. I was fully intending to watch the 2nd one prior to watching the third (having watched Toy Story in 3D on its rerelease) but, alas, some friend had borrowed it and didn't get it back to me. Upon watching the third one, I realised that the music themes were still very similar and I reckon, if I did watch all the films over a week - i would have got a little disillusioned and bored by the same-y music and same-y jokes and characters. To cut a long story short, if you have watched the first two loads in the past, you don't need to rewatch them before watching 3 ... until you have a shiney new boxset whereby it is, almost, a ritual.