The Chinese Entertainment Industry: Overcoming Barriers to Entry

This article has been published with the permission of Attentional - www.attentional.com

November 2011

 

Executive Summary

 

  • The question of China’s openness in the global entertainment industry has often stirred debate and frustration within the media’s executive community. Formats had been copied seemingly without consent, exporting movies had harsh limits on volume and censorship, while setting up any entertainment venture inside China for foreigners appeared fraught with headaches. However, in early 2010 China adopted an important WTO ruling, which means that much of these prior limitations are likely to change. We decided to investigate this further with the help of Chien-Han Huang, an expert in China’s media legislation. As the primary author of this piece, Huang has used his considerable knowledge of the discussions currently going on internally in China to assess what kind of impact the WTO’s ruling might have on the domestic Chinese market.
  • One of the key differences in China, compared to say, the U.S., is that watching a movie is an entertainment luxury because the ticket prices are expensive. In 2010, the average ticket price went up to 40.4 RMB (around $6.3), which is close to the standard ($7.8) in the U.S. In fact, the ticket prices in some big cities, such as Beijing and Shanghai, are higher than the average U.S. ticket price. Buying a ticket, however, can be a hard task, because of the limited number of screens. This means a market structure where demand easily outstrips supply – a rarity in western film markets.
  • One of the main drivers of cinema-viewing in China is the audio and video qualities found in movie theaters. The alternatives such as TV or monitor screens (where poor-quality pirated content can be consumed) cannot compete in this regard, and the result is a revenue-distribution split that is incredibly uneven.

  • For foreign content-owners to really impact this market, they have to deal with the current regulations. In terms of foreign movies in China, these are limited by 4 areas: Production, where filmmakers are required to apply for government licenses; Importing Films, which is a state monopoly business that is exclusively managed by the China Film Group (CFG), the largest and state-owned studio, and are subject to government censorship as well as a quota system (20 movies through box office split deals, and roughly 50 foreign movies areimported through buying outright rights); Distribution, which is exclusively operated by CFG and Huaxia Film Distribution Company; and Exhibition, where the annual screening time of foreign movies at theaters cannot exceed one-third of the total screening time.
  • As a result, the industry is operating in a linear way between the production and theatrical exhibition sectors. To put it another way, the purpose of making movies in China is to supply theatrical markets. This implies that ancillary distribution windows and movie- related products have not been effectively developed. This is, however, set to change. Any relaxing of the regulations will encourage a competitive environment in domestic distribution, which will likely lead to a drastic rise in the number of theater screens – exacerbated by digital projectors that will undoubtedly lower P&A costs.
  • With the deregulation in foreign films and the evolution of the market environment, aside from blockbusters, middle-budget and independent movies, as well as made for TV-movies and mini-series could have the chance to be circulated in the Chinese theatrical market. For instance, consider the six-part British comedy series, The Trip, which aired on BBC2 in the UK. A cut-down 90 minute version of this was later edited for cinemas and released theatrically in the US, Australia, Belgium, France, Netherlands, New Zealand, Sweden and many other markets. There are clearly certain types of TV shows that can be re-purposed for the cinema in China. International distributors willing to employ a more creative strategy could find this a lucrative market in future.
  • Chinese media institutions have started to treat intellectual property rights seriously. This transformation was embodied in online video websites competitively bidding for the copyright of television drama series. In addition, more Chinese television stations have been willing to acquire and localize foreign TV formats. For example, broadcasted by Shanghai Dragon Television, China’s Got Talent, the most popular program on Sundays in 2010, was adapted from Britain’s Got Talent. These trends reveal that China’s entertainment industries are slowly becoming more intellectual property friendly.
  • It is worth paying close attention to the development of online distribution in China because the Internet is one of the major video consumption platforms for younger generations. Many video sites such as tv.sohu.com establish Hulu-like business models, incorporating paid and advertising-supported platforms. These websites circulate Chinese and foreign copyrighted TV drama series and movies. They may well represent a way in future to circumvent domestic TV broadcasters, who are subject to extremely strict government regulations. More and more international TV series may end up being available legally to the Chinese market via these video streaming sites.

 

Introduction

 

On February 18, 2010, China adopted an important World Trade Organization’s (WTO) resolution. It said that the Chinese monopoly system in the importation and distribution of foreign films breached China’s trading rights commitments. As a result, China must amend related regulations in accordance with the WTO’s rulings. This result was considered “a significant victory” for the U.S. entertainment industry.1

With China at the forefront of many strategic decisions regarding media and entertainment, we decided to assess the current situation in the market regarding this restrictive legislative framework. This paper also addresses potential changes in law and how that might impact foreign content owners and distributors seeking to capitalize on this enormous media market.

Although the gaming sector and animation/comics are a large component of the media industry’s revenues, we will concentrate primarily on Film (20%) and TV (7%), as any potential legal changes are likeliest to impact those sectors.

 
It is worth noting that while the global economy fell into recession, the Chinese film market continued to boom (Table 1). Collecting from major cities, China’s annual box office revenue hit its peak of $ 1.60 billion in 2010, increasing 10-times the amount of 2000. Millard Ochs, President of Warner Bros. International Cinemas, predicts that the Chinese market will exceed the U.S. within 10 years, becoming the world’s biggest theatrical market. In addition, the marketization of theatrical sectors and the potential deregulation of film policies will undoubtedly encourage Western media institutions to enter China.
 
 
However, before monetizing China’s market, Hollywood studios and international content owners have to confront Chinese trade barriers and film protective policies. The Chinese government has carried out a licensing policy in production, importation, distribution, and exhibition because movies are considered an entertainment product and an ideological machine. The government imposes severe restrictions on foreign movies and capital.
 
 

Existing Legislation

 
According to the Film Regulation and the Film Enterprise Rule,4 the existing regulations on foreign movies in China are outlined as follows.
 
  • Production: Filmmakers are required to apply for government licenses, and co- production with Chinese partners is encouraged.
  • Importation: Importing films is a state monopoly business which is exclusively managed by China Film Group (Hereafter CFG), the largest and state-owned studio. In addition, before being imported, foreign movies are subject to the government censorship system and import quota system. The quota system annually allows around 20 movies through the box office split deals. In addition, about 50 foreign movies are imported through buying outright rights.
  • Distribution: The distribution of foreign films is exclusively operated by CFG and Huaxia Film Distribution Company.
  • Exhibition: The annual screening time of foreign movies at theaters cannot exceed one-third of the total screening time. Foreign capital, apart from specific cities, is not allowed to have a major theatrical ownership. The regulation on theatrical ownership means foreign investors cannot control screening titles and schedules.
In summary, subject to the censorship, import quota system, licensing system, and screen quota system, the market access and profitability of foreign films is restricted. In fact, in the case of the box office split deals, the U.S. studios can only receive 13% of box office receipts, which is the least revenue share the studios can get in the global entertainment market.5 However, foreign movies have still maintained over 40% of the market share in the last six years,6 showing considerable market potential if it is to gradually open up.
 
 

Potential for Change

 
Chinese protective measures and trade barriers were opposed by the United States government because China, as a member of the WTO, did not follow its entry commitment: to gradually open up the domestic market to foreign movies. Among these protective policies, the monopoly system of foreign film importation and distribution was accused by the U.S. in the WTO’s Dispute Settlement Body. After investigation, the WTO panel determined that the Chinese monopoly system violated other members’ trading rights. As a result, the panel required China to amend its policies by no later than March 19, 2011.7 However, until November 2011, the Chinese authorities had not introduced new regulations regarding the management of foreign movies.
Some industrial professionals estimate that China will break the monopoly system of film importation, which has lasted for three decades, and open this field to domestic private enterprises and major Hollywood studios.8 Additionally, Film Promotion Law, entering a stage of final revision, might further relax the market access to the production, distribution, and exhibition sectors. It may also lift the restrictions that are currently being applied to private Chinese capital.9 This suggests that private Chinese companies, or foreign capital, might be allowed to establish sole proprietorship or joint venture distribution companies in the future. Moreover, the restriction of theatrical ownership on foreign capital might be relaxed. By this way, international content owners can compete with local Chinese companies on more equal ground.
Although the WTO’s rules are forcing the Chinese government to relax film regulations, this does not apply to the television sector. With the strong impact on domestic cultures and national security, the television industry is not yet open to foreign capital. According to the Radio and Television Regulation (1997),10 television stations and their distribution platforms are exclusively established by the Chinese government, and foreign companies are prohibited from operating television stations. In addition, foreign TV shows are subject to tough regulation, in terms of the importation and censorship rules.
 
 

The Market is Blockbuster Driven

 
In China, watching a movie is an entertainment luxury because the ticket prices are expensive. In 2010, the average ticket price went up to 40.4 RMB (around $6.3),11 which is close to the standard ($7.8) in the U.S.12 In fact, the ticket prices in some big cities, such as Beijing and Shanghai, are higher than the average ticket price. However, when a blockbuster, such as Avatar, is released in these cities, buying a ticket is a hard task. This reveals one of the main drivers of cinema-viewing in China: the audio and video qualities found in movie theaters.
This is something difficult to experience with television or monitor screens, and it implies that the majority of audiences in China prefer to watch movies with big-budgets and high- level audio and visual effects.
This preference echoes the dominant position of Hollywood blockbusters in China. A series of blockbusters from Titanic and 2012 to Transformers and Avatar, have broken China’s box office records. The trend of making blockbusters also applies in Chinese films. For example, Aftershock, a disaster film that utilized 3D effects, became the highest-grossing Chinese movie in 2010. If the market is to open up, American and European independent films may still find it a challenging market to exploit.
 
 

Distribution: Prints & Advertising Costs are High

 
Releasing a movie in China is relatively difficult. The majority of Chinese movies do not have a chance to be screened in theaters. During 2009, the unreleased rate of Chinese movies was about four-times higher than the rate of American movies in the United States.13 The high unreleased rate is mainly due to a lack of theaters.14 In terms of screen density, 10 million moviegoers share 7.3 screens in China, while the same amount of viewers share 129.8 screens in the U.S.15 The insufficient theaters result in the severe competition for securing theatrical screening. Small productions have to compete with blockbusters, thereby jeopardizing the distribution of small movies.
Another issue related to film distribution is the high prints and advertising (P&A) costs.
Because theaters are scattered across China, the cost of print transportation is enormous. In addition, if a movie wants to reach national audiences, the marketers have to spend a huge advertising budget on regional, provincial, and national media platforms. Such a considerable advertising cost becomes a burden not only for middle and small productions, but also for blockbuster projects.16 In fact, for some independent movies, the P&A costs are greater than the production costs. With limited promotion and marketing efforts, middle and small productions find it hard to gain high attendances, causing a vicious circle in market performances when the box office is the largest revenue source for films.
With new built theaters having digital projectors, the cost of P&A will reduce significantly, benefiting the distribution of small productions and encouraging foreign movies to break into the market.
However, any movie has to pass the censorship system before being released in the theatrical market. Potentially, independent films with social criticism can be quite subversive, so would usually be banned by the government. The censorship system can also cause the delay of movie distribution. To go through the censorship process, it sometimes takes up to six months, making the screening schedule in China behind the debuts in other countries. As a result, the delay not only indirectly drives audiences to consume pirated movies, costing Hollywood $2.5 billion per year, 17 but also undermines the ideal operation of film distribution.
 
 

The Distribution Windows

 
Repurposing content in multiple distribution windows, such as home video, television, and the Internet, is the cornerstone of the film business. In the U.S, home video products often provide the highest revenue stream for most movies18 and represented almost the half of studios’ revenues in 2007 (Figure 2).19 In China, however, the highest revenue source was box office receipts consisting of 65% of the industrial income in 2010 (Figure 3).20 In other words, the revenues derived from other auxiliary windows were relatively small. Chan Ho- Sun, a distinguished director and producer, argues that a Chinese blockbuster with a 200 million RMB box office record can only generate three million RMB in home video products.21 From Chan’s observation, the revenue of home videos for a Chinese film comprises less than one percent of the box office receipts. Without robust multiple distribution windows, it is hard for a movie to reduce the risks and expand revenues. Under such circumstances, the theater is the most vital distribution window in China, determining if a movie is commercially successful or not.
 
 
 
However, relying on theater ticket sales as the major revenue source cannot promote the industry towards healthier developments. China’s government plans to fully implement the policy of integrating the three networks: radio and television, the Internet, and telecommunication from 2013 to 2015. The Internet will serve as a backbone infrastructure integrating the services that the other networks provide.24 This policy is likely to establish a foundation for online distribution.
By integrating these networks, the Internet can deliver movies to all kinds of devices from cell phones, televisions, to personal computers. Therefore, as the business model of online distribution matures, it will facilitate the establishment of other circulation windows and the expansion of the market. In other words, because distribution is currently so regulated, the Internet’s potential to revolutionize the Chinese entertainment is enormous.
 
 

Intellectual Property

Film piracy in China not only deeply affects the market interests of Hollywood studios, but also harms the healthy development of China’s film industry. Furthermore, film piracy destroys the traditional window system, making theaters the most important window for generating revenues (over 50% of total per title revenue). Therefore, making and enforcing the regulation on intellectual property rights protection become a vital issue for the government.

 

Recently, Chinese media institutions have started to treat intellectual property rights seriously. This transformation was embodied in online video websites competitively bidding for the copyright of television drama series, setting the new high price.25
In addition, more Chinese television stations have been willing to acquire and localize foreign TV formats. For example, broadcasted by Shanghai Dragon Television, China’s Got Talent, the most popular program on Sundays in 2010, was adapted from Britain’s Got Talent.26 These trends reveal that China’s entertainment industries are slowly becoming more intellectual property friendly.
 
 

Narrow Supply Chains

 
The Chinese film market is close to a seller’s market condition. In other words, the demand is greater than the supply. First of all, although increasing significantly in the recent years (refer to Figure 3), the number of theater screens is still insufficient, making the ticket prices fairly expensive. Additionally, the audiences who pay for the expensive tickets have limited movie choices because only a small portion of movies which can afford high P&A costs are released in theaters. As a result, what audiences can watch at theaters are movies with big budgets and intensive marketing efforts.
 
 
 
Under the industrial environment where the window system has not been fully established, controlling theatrical outlets is the pre-requisite of making a profit due to the box office being the largest revenue source. However, since most theaters are profit-oriented, a movie’s screening times and schedules are based on its market performance. So in order to succeed in the box office, a movie has to maintain high production quality, as well as execute strong advertising and marketing campaigns.
 
While the Chinese film market is growing tremendously and the market demand is greater than the supply, these trends do not mean that making movies is a low risk business. On the contrary, lacking the distribution window system and intellectual property protection infrastructure, producing movies in China is more risky than Hollywood. Lee Tain-Dow, Founder of the Research Center of Media Technology and Creative Industries, points out that the industry is operating in a linear way between the production and theatrical exhibition sectors. To put it another way, the purpose of making movies in China is to supply theatrical markets. This implies that ancillary distribution windows and movie- related products have not been effectively developed.
This kind of industrial operation is like pre-1950s Hollywood where televisions had not been introduced to the mass market, so the revenue totally relied on box office receipts.28
 
Additionally, the creative environment is restricted due to the censorship system, and market competition is limited because of government intervention. These measures can harm the innovative ability of content development, which in turn decreases the competitiveness of Chinese movies.
 
 

How can Content Owners Take Advantage of any Legislation Change?

 

It is certain that the WTO’s ruling will accelerate the deregulation on the film importation and distribution system in China, which has been exclusively controlled by government- owned studios. An ideal prospect for foreign companies is that they can set up joint venture distribution organizations with private Chinese institutions, though foreign capital cannot have a majority share.
 
Another situation is that aside from government-owned institutions, private Chinese companies are allowed to serve as foreign film distributors. Either way provides considerable business opportunities for foreign investors. However, we will not have a clear understanding until the latest version of the film regulation is published.
 
The transformation in the film sector does not apply to the television industry which is potentially more lucrative than the film industry. Deregulation in the Chinese TV industry is a long way behind the film sector, though online distribution windows may accelerate that deregulation faster than the authorities may perceive. The trade in TV formats is starting to boom, providing an emerging business model for foreign content owners.
 
 

Co-Productions

 
By far, the most common means of breaking into China is through co-productions which the Chinese state encourages.
Co-productions create a win-win situation for Chinese and Hollywood studios. In fact, it improves the competitiveness of Chinese movies by educating them with Hollywood’s storytelling expertise and management experiences. As for Hollywood studios, co- production movies are regarded as home-grown products, therefore bypassing the usual Chinese trade barriers and enjoy the same treatment as domestic films.
As for monetizing the Chinese market, when releasing a movie, the first consideration is the high P&A cost. However, as the penetration of digital projectors increases, the P&A cost will go down, possibly paving a way for middle and small productions.
Additionally, the number of theater screens will continue to grow, especially in the second tier cities, province capitals and regional cities which currently do not have modern theaters. The growth in screens is important because it means that the expanding market will support diverse film genres and themes. With the deregulation in foreign films and the evolution of the market environment, aside from blockbusters, middle-budget and independent movies, as well as made for TV-movies and mini-series could have the chance to be circulated in the Chinese theatrical market.
For instance, consider the six-part British comedy series, The Trip, which aired on BBC2 in the UK. A cut-down 90 minute version of this was later edited for cinemas and released theatrically in the US, Australia, Belgium, France, Netherlands, New Zealand, Sweden and many other markets. There are clearly certain types of TV shows that can be re-purposed for the cinema in China. International distributors willing to employ a more creative strategy could find this a lucrative market in future.
 
 

Online Distribution

 
It is worth paying close attention to the development of online distribution in China because the Internet is one of the major video consumption platforms for younger generations. Many video websites such as tv.sohu.com and letv.com establish Hulu-like business models, incorporating paid and advertising-supported platforms. These websites circulate Chinese and foreign copyrighted TV drama series and movies.
Based on China’s market environment, these websites employ distinct operational practices. For example, tv sohu.com offered Wu Xia, a blockbuster, for free streaming after it was theatrical released for two months. The period between theatrical and online releases being much shorter than the U.S. standard might be due to rampant video piracy.
 
The booming film industry in China remains at a fledgling stage, and the operation and business models are immature. Moreover, government regulations play a significant and powerful role in shaping the market environment. These factors raise the risk levels of the film business. However, the huge market potential and the new industrial landscape brought by digital technologies mean that China will offer plenty of opportunities to international producers and content owners – but not necessarily in traditional ways.
 
Currently, an obvious entry strategy for content owners is to take advantage of the growing theatrical market by co-producing and distributing blockbusters. Another potential entry strategy is utilizing the Internet to distribute movies. The Internet has the advantage of low costs and the ability to directly communicate with audiences, providing an alternative outlet for small productions which cannot afford the high P&A costs.
Undoubtedly, the practices of online distribution must follow the government’s regulations, although they have not been fully established. Regardless of the openness in the import and distribution system, the Chinese government still retains the right to censor content, which remains the ultimate barrier for all content owners.
 
---
 
 

Contributors

 

Chien-Han Huang is a graduate candidate at the Annenberg School for Communication and Journalism, University of Southern California. He focuses his research on East Asia’s media industries and has written articles on Taiwanese, Korean, and Chinese film and television sectors. His graduate capstone project “The Competitive Strategies of Private Chinese Film Companies in the Era of Post-World Trade Organization’s Ruling.” goes into more detail on the full implications of the potential legislative change.
Contact: chien.han.huang@gmail.com
 
Zak Shaikh is Attentional’s Head of US consultancy. Zak specializes in monitoring the latest trends in the American film and TV markets, and does regular content consultancy for a number of international and US based studios and production companies. He has spoken at many conferences on trends in global content and the motivations behind audience preferences. He works closely with research and development executives, analyzing scripts, treatments, filmed shows and marketing and promotional materials.
Contact: zak.shaikh@attentional.com
 
 

References

 

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28 Tain-Dow Lee, personal communication, October 22, 2011