Online Video Industry in China:

Past, Present and Future

Shiwei Zhang1

Pomona College

ECON165 Industrial OrganizationProfessor Filson

December 14, 2012

1 Email: shiwei.zhang47@gmail.com1

1. Abstract

Online video industry in China is a fast growing industry with high potential. In this paper I first

examine the development and organization of the online video industry. Then I analyze the future of

this industry and project the direction it will move towards. The current industry involves several big

players. They each adopt different strategies when competing with other players, including forming

cooperation group, vertical and horizontal integration, etc. These strategies make online video a

more concentrated industry. Going forward, firms will need relocate their focus to mobile experience

and further differentiate with each other with unique content.

2. Introduction

The online video industry in China has been growing at exponential speed. It is important to

understand this market mainly because of the huge growth and investment potential based on the

following factors:

1. Relatively low but fast growing internet penetration rate

2. Large population

3. Relatively low online advertising

Given the above motivation, my goal for this paper is to analyze and understand the

development and organization of online video industry in China. In the end I will attempt to make

strategy suggestions based on learning from Industrial Organization and trends observed in the

internet market.

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The data quoted in this paper mainly come from two sources –comScore and iResearch. Both

sources are well-respected third party internet analytics companies, the former in US and latter in

China. I first look at the industry landscape back in 2009. Then I analyze the strategies each company

adopts to keep themselves competent and shield from the skyrocketing price of content. I examine

the industry organization again in 2012 and observe the aftereffect of the various strategies on the

market concentration. Lastly looking at the development of internet and user behavior in China, I

make suggestions on what firms can do to help themselves get leading market position in online

video industry.

The market of online video industry in years before 2009 has been rather fragmented. Many

players were involved and each had approximately 10% of market share. As more and more people

start to move TV watching from offline to online, online video sites begin to compete for the best and

most popular shows from producers by raising bidding price. As a result of this form of competition,

price of popular shows skyrocketed since 2009, the highest deal being $321,000 per episode in 2011.

Hurt by the high cost of content acquisition, firms realized that they could not afford to compete this

away going forward. Therefore several kinds of integration took place in the market—vertical

integration, horizontal integration and forming cooperation groups among firms. A direct result of

these market movements is an average 60% drop in content price in 2012. They also result in a more

concentrated market with revenue share CR4 increased from 46% to 58%, CR2 from 24% to 46%.

Even though the industry as a whole manages to bring down the price of content, they still lack key

factors to differentiate one from another. Going forward firms need to acquire unique content either

from outside producer or through self-generated content. Besides, with mobile internet users

surpassing desktop users in China in 2012 and 300% average growth rate of 3G users in the past 4

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years, firms will also need to change their mindset of user experience design to cater more to mobile

users.

The way data is collected through both comScore and iResearch is that they have a large number

of self-selected users (in comScore’s case 2 million) to form a panel. The users grant permission for

the research firms to install monitoring programs that can track what websites they go to, how much

time is spent on each site, how many transactions took place, etc. However, one problem associated

with this approach is the lack of representativeness of the actual internet population due to the very

nature of self-selection. Research firms usually try to correct for this problem by reweighting the

sample according to demographic information. In comScore’s case however, they admitted that some

users were signed up without registering demographic information. Thus reweighting would be

impossible for some portion of the sample. In this analysis I assume that this part of the sample error

is marginal enough relative to the rest of the sample that it can be ignored.

At this point not much systemic research has been done to analyze the organization and

development of online video industry in China. Internet analytics companies like comScore would update

with recent data on the market size and market share of the industry, but no full range literature about

this industry was found during my research.

3. Motivation

The motivation for this paper mainly stems from the huge potential market for advertising market in

online video industry. According to a recent report by China Internet Network Information Center

(CNNIC), by the end of June 2012, the number of internet users in China has surpassed 538 million,

penetrating roughly 41% of the population. Compared to developed regions such as North America

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78.6%, Europe 61.3% and Oceana 67.5%. there is still plenty of room for growth. Internet users grow an

average 25% every year from 100 million in 2005 to 538 million in 2012. Among the 538 million internet

users, 450 million of them are watching videos online. What dwarfs the growth rate of internet users is

the growth rate of revenue generated in online video industry –300% annual growth from 2010 to 2012.

Given the above data, it is obvious that online video industry market is growing very fast with solid

foundation that supports continued expansion. Thus it is important for us to understand how this industry

develops and what it will be like in the future. Please refer to Figure 1 in Appendix for a full description of

data mentioned above.

4. Background Information

4.1 Business Model

Business model of online video industry mainly involves: ad support, paid membership and content

distribution. Ad supported sites usually play a commercial before a user can watch a video online. Paid

members however, will be granted an ad-free user experience when watching popular shows. Lastly,

companies can also purchase exclusive internet copyright from content producer and make profit by

distributing the content among other sites.

4.2 Key Players

The current key players in online video industry are summarized in Table 1 in Appendix. They include

independent comprehensive online video sites like Youku and Tudou, also subsidiary companies for

internet giants like Tecent, Baidu and Sohu. The majority of business model adopted by these companies

are a combination of ad support and paid membership, although the payment system has been able to

generate only very little fraction of the total revenue.

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5. Observations and Analysis

5.1 Early Market In early days before 2009, the market for online video industry is rather fragmented. The top 6

players each had roughly 10% of market share. CR4 in terms of revenue was 46% and CR8 78%. Not much

differentiation was observed among the firms. After entering 2009, the online video market started to

heat up as more and more people transfer their TV watching platform from offline to online. Advertising

spending in online videos began tripling in size every year. The transition of user watching behavior

therefore spurred fierce competition for popular shows among the online video sites. Every firm was

trying to bid the most popular shows already aired on TV or shows not yet aired but feature very popular

stars. The price of shows went on a sky-rocketing route. Before 2009 the average price for content was

$350 per episode. By the end of 2009 the number became $6,500 per episode. As shift in user behavior

trended more clearly, the price continued to rise to $24,000 in 2010 and as high as $321,000 in 2011. By

the end of 2011, firms all realized that this business model is no longer sustainable if companies keep

paying such high price for content. Therefore each of the major players adopted different strategies to get

themselves out of this vicious cycle.

5.2 Market Integration Movements

Horizontal integration: March 2012, two of the largest players at the time, Youku and Tudou,

announced merger agreement. Youku would purchase all of Tudou’s share with its own stocks. Besides a

combined bigger market share, the horizontal integration provided Youku and Tudou synergies including

more efficient ways to share resources, cut down cost and manage marketing campaigns. The resulted

giant media group also acquired higher bargaining power when negotiating with content producers.

Cooperation group: In order to combat the increasing market power of the combined Youku and

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Tudou, Tencent Video, Sohu Video and iQiyi agreed to form a resource sharing cooperation group in April.

The three companies would coordinate with purchase of content so that they would have higher buyer

power. Also the companies would share copyright with each other so that each member would have

access to the collective content database. Similar to the horizontal integration between Youku and Tudou,

the forming of cooperation group among some of the largest and most influential players gave the group

significant more bargaining power than each of the company individually combined.

Vertical Integration: Tencent invested in content production through two channels: 1. Direct $70

million investment in Huayi Brothers Inc., the largest media production company in China. 2. Set up an

$80 million fund to invest in video content production in other studios and companies. Through vertically

integrating with upstream firms in video production, Tencent successfully hedged the risk for continued

rising price of content. Tencent will be able to secure unique content and also benefit from a rising price

by getting involved in the production.

Vertical Integration: Baidu fully purchased iQiyi from Providence Equity Fund. iQiyi started as a joint

venture between Baidu and Providence Equity fund, each investor owning roughly 50% of equity stake. In

2012 November, Providence announced exit from iQiyi by selling all its shares to Baidu. The new iQiyi is

now backed up by the largest internet advertising and media company in China, which provides great

resources to potential clients. For Baidu, this also adds a strategic advertising source to Baidu’s advertising

platform portfolios. The strengthened relationship between iQiyi and Baidu also increases bargaining

power of iQiyi when purchasing content.

5.3 Post-integration market

The efforts put into lowering the price of the content turn out to be very effective—price of content

dropped on average 60% from its peak in 2011. After a series of integration movements among firms in

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online video industry, in 2012 the market has become much more concentrated than it was in 2009.

Youku and Tudou combined now comprise of 34% of market share in terms of revenue, 31% in daily active

users and 37% in total time spent on video sites. The biggest player accounts for almost one third of traffic

in all aspects, compared to merely 13% in 2009. Please refer to Table 2 in Appendix for a full

concentration summary. Something worth noting is that although iQiyi account for roughly 20% of time

spent on video sites, they only have 7% of revenue in the industry. This is because of the “ad-less”

strategy iQiyi has been pursuing. As an entrant established only in 2010, iQiyi hopes to provide a better

user experience by playing less commercials before the start of the video. It has been successful in terms

of attracting users, as demonstrated by the statistics. However, adopting such a strategy also means iQiyi

is less able to monetize its video content. During 2009 to 2011, the firms in online video industry in China

were falling into “Bertrand Competition” where they all try to outbid the other for copyright to air the hot

shows. As observed in the evolution of many other industries, firms will attempt to escape Bertrand

competition in this situation. All major players adopted strategies to increase their bargaining power and

differentiate with each other.

5.4 Industry Analysis using Value Net

To analyze this industry using Brandenburger—Nalebuff Value Net model, I conclude that the online

video industry in China will keep growing fast in the foreseeable future, with multiple major players in the

market. The potential customers for online video industry include every internet users in China, both

through computers and mobile devices. The current customer base is 450 million. As the internet

population base continues to grow and more people prefer to watch videos online, the audience base can

only increase over time. The supplier of this industry is content producers. They used to have strong

market power in the midst of bidding for hot shows in past 3 years. Since 2012 however, supplier power

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has been significantly reduced and buyer power increased due to the market integration movements.

Complementors in this industry are advertisers. Advertisers fund the majority of videos in the market and

they are expected to spend more given the increasing demand. There currently exist more than ten

players in online video industry but no one has absolute dominant market share over 50%. Many of the

players either have already achieved leading market position or are backed by another internet giant.

Each of the top players is capable to sustain their operations with great capital supply. Every player

understands the great potential lying ahead and is aware the fact that the market has not settled with one

or two dominant powers, which I believe will motivate every firm to keep playing in the market.

6. Strategies going forward

6.1 Mobile

Companies need to focus on the user experience on mobile side and shift significant corporate

resources to support video playing and sharing on a mobile device. By the end of June 2012 China has

surpassed 388 million mobile internet users, which forms a user base larger than the 380 million PC

internet users. What has been happening is the phenomenon of bypassing broadband and entering

directly into mobile internet in countryside China. Many peasants in countryside do not necessarily own a

computer, but they would be using a handset to communicate instantly. Among the 388 million mobile

internet users, 27.7% watch videos on their phone. What is more important is the fast adoption of 3G

service among mobile phone users. Number of 3G users grew from almost zero 4 years ago to 300 million

expected by the end of 2012. Equipped with 3G internet, watching videos on mobile devices will become

as high-quality experience as on a PC. With high speed mobile internet technology matures and cost

lowering in the coming years, we can expect the percent of mobile internet watchers will increase

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significantly.

6.2 Unique content

The key differentiator among different video sites is content. Currently only very little differentiation

is observed among all the players in the market. However, despite the small number, almost every

attempt of differentiation has been a success for video sites. Youku produced several successful talk

shows featuring well-known movie directors and respected entrepreneurs. Each of episode received more

than one million views. More importantly, this talk show series is only available on Youku’s site, not even

on TV. Tudou also made similar attempt to produce weekly shows that make comment on the

entertainment industry. The humorous comment and moderating style on the shows draws huge

audience to watch. Compared to shows aired on TV, which need to be approved by relevant government

authorities, shows shared on video sites do not need to obey such rules. Thus more room is available for

innovation.

For firms in an industry to stay competitive, they need to be able to offer superior products. In the

context of online video industry in China, differentiation with either unique content or better user

experience becomes essential.

7. Conclusion

Online video industry in China is a fast growing industry with great potential. It has got huge

expanding market to further penetrate and capture. It has been observed that firms adopted various

strategies to increase their bargaining power over upstream firms, stay competent against their

competitors and appealing to the audience. I believe this trend will continue and we will see more

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differentiation along the lines of mobile and unique content in the future.

To further extend understanding of the online video industry, some natural next steps include

analyzing how the relationship between subsidiary online video companies and its holding company

affects the operation and decision making for firms such as Tencent, Baidu and Sohu. It is also worth

investigating the probability of online video companies becoming professional content producers

eventually and thus eliminating the externality in between.

Going forward there still exist many aspects to be learned about online video industry. In this paper I

hope to have provided the knowledge and analysis for readers to understand this industry and be able to

read more on their own.

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Appendix

Figure 1 –Number of Internet Users in China

2006 2007 2008 2009 2010 2011 20120

100

200

300

400

500

600

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

137

210

298

384

457513

550

80 100150

230

330

390

450

China Online Video Users to Reach 450 Million by 2012

Internet User

Online Video Users

Penetration

Source: CNNIC

Table 1 –Summary of key players in online video market in China

Name Year Founded Company Affiliation

2012 Revenue market share

Business Focus

Youku 2006 Youku 22% Comprehensive

Tudou 2005 Youku 12% User Generated Content

Tencent Video 2011 Tencent 6% Copyrighted Content

Sohu Video 2009 Sohu 12% Copyrighted documentary and US shows

iQiyi 2010 Baidu 7% Copyrighted content

Source: Company filing and research compiled by iReseach

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Figure 2 Summary of Market Share

2.1 Revenue Market Share in 2009

2.2 Revenue Market Share in 2012

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2.3 Daily Active User Coverage Share in 2012

2.4 Total Time Spent Market Share

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Sources: Research compiled by iResearch and comScore

Table 2—Summary of market concentration

CR4 CR8

2009 Revenue 46% 78%

2012 Revenue 58% 85%

2012 Daily Active User 64% 94%

2012 Total Time Spent 67% 97%

Sources: Research compiled by iResearch and comScore

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