Spotlight on China: Media & Entertainment

Summary report

Spotlight on China Building a roadmap for success in media and entertainment

About our report To gain insights into the opportunities and challenges for media and entertainment (M&E) companies in mainland China, we interviewed leaders of large global M&E companies, as well as leading Chinese M&E companies. We have used proprietary Ernst & Young analyses and secondary research to augment our interview findings, and to provide depth and context. This document represents a summary of findings from our full-length report of the same title. To obtain a copy of the full-length report, or to discuss the contents of this document with an Ernst & Young professional, please contact one of the professionals listed on the back page of this report.

Using the “cultural sector” Tapping into the to drive new growth vast potential With one of the highest economic growth rates in the world, mainland China has emerged as a global economic powerhouse. Once primarily a manufacturer of inexpensively made goods for mature-market companies, domestic Chinese companies are now global brands in their own right. This kind of economic growth has spurred increased per capita income and the creation of a consumer class that numbers in the hundreds of millions. However, in the last year, a sluggish real estate market, global economic uncertainty and weaker global consumption are slowing China’s growth trajectory. In search of a new economic model, China’s 12th FiveYear Plan (2011–2015) is looking to move the Chinese economy from export- and investment-driven growth to more consumption-led growth.1 As a part of the Plan, China wants the “cultural sector,” which includes the M&E industry, to become a more robust economic growth engine for the economy. Regulatory restrictions historically have limited market access for many M&E companies. However, the government is easing rules and encouraging investment. M&E companies still face a range of regulatory hurdles. Nevertheless, as almost every sector of China’s M&E market grows, China provides fertile growth opportunities for M&E companies — both foreign and domestic.

“Every global strategy needs to include China.” — David McGregor, Asia-Pacific M&E Leader

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The Chinese people are enthusiastic consumers of all forms of media and entertainment, resulting in vigorous growth in nearly every sector. Between 2010 and 2015, China’s M&E market is estimated to have a compound annual growth rate (CAGR) of 17% — significantly outpacing economic growth. Virtually every home has a television. In the film sector, China has the secondlargest film market in the world after the US and is on its way to surpassing the US box office by 2020. Other M&E sectors are thriving as well — including sectors that may be struggling in mature markets, such as publishing. However, the real M&E story is digital. From social media and online gaming to online video, the Chinese are avid digital consumers. China has become the largest internet market in the world — with less than half of its population online. Ernst & Young sees seven trends in particular that are driving growth in China’s media and entertainment economy: 1. Increasing disposable income. In 2000, the average per capita disposable income was US$760 per person. By 2011, that figure had grown to US$3,438.2 Chinese consumers are increasingly willing to spend their growing wealth on M&E products and services. In 2010, spending on entertainment and recreation was US$350 billion; in 2011, that figure had grown to US$547 billion.3 2. Convergence of networks, devices and content. Internet penetration in China is low by developed-country standards, but the potential is staggering. By the end of 2012, China will have an estimated 569 million internet users, with a penetration rate of only 42%.4 In terms of devices, China already has 1 billion mobile subscribers, with a growing number using their devices to access the internet. From a content perspective, the availability of digital content in China is as robust as other parts of the developed world. The rapid convergence of networks, devices and content is driving significant growth in anytime, anywhere digital consumption.

Global Media & Entertainment Center

Understanding the challenges 3. Digitization of distribution infrastructure. China is in the midst of strengthening its network infrastructure by improving the reach, speed and capabilities of its telecommunications infrastructure. Part of this includes “tri-network convergence,” which aims to combine telecom, broadcast and internet on a single platform to deliver voice, data and video content.5 When completed in 2015, the project is expected to create US$250 billion in new M&E demand by driving higher demand for subscription internet protocol television, along with value-added services such as video on demand and interactive services.6 4. Advertising expansion. China is currently the world’s third-largest advertising market, and it is expected to surpass Japan in 2013 to become the second largest behind the US.7 And there is plenty of room to grow, as China’s advertising-to-GDP ratio is less than half that of the US and lower than the world average of 0.70%.8 As most M&E companies in China are ad-driven, the expansion in advertising bodes well for future growth. 5. Growth of second-tier cities. Consumption in China is dominated by large cities. However, smaller cities have been growing at a faster pace than the larger urban centers.9 M&E companies will see increased opportunities as the demand for M&E products and services grows and as advertisers increase spending to reach consumers in these cities. 6. Emerging business models. Although advertising is the predominant model for most digital M&E companies in China, many digital media companies are looking to supplement advertising with other revenue streams. They are experimenting with different models to incentivize customers to pay. Online video and gaming are two sectors making headway. 7. Regulatory reform. Regulatory restrictions still exist in most M&E sectors. However, while certain controls remain over content, the government’s attitude toward private investment is relaxing.

The opportunities for domestic and foreign M&E companies in China are vast. However, there are also tremendous challenges. These include:  Market complexity. China is a complex market with many sub-groups and constantly shifting consumer tastes. Customer groups are fragmented across income groups, age groups, regions and behavioral characteristics. M&E companies must understand how this diversity impacts purchasing behavior so they can tailor their products and services, marketing, sales and distribution strategies accordingly.  Evolving and highly competitive digital landscape. Digital adoption is increasing, but the online media industry is still evolving. This continued state of evolution presents a number of challenges, including fierce competition. As well, data analytics and media measurement — key enablers of digital success — are still in their infancy.  Price sensitivity. Consumers have historically paid little or nothing for traditional content, and have easy access to pirated digital content. This environment has limited opportunities to generate multiple sources of income.  Intellectual property rights infringement. The Chinese government is taking steps to reduce piracy. However, M&E companies still struggle to get fair value for their products and services.  Government control and regulatory restrictions. Government control of the industry has historically limited M&E economic activities in China. To stimulate growth in its cultural sector, China has taken steps to liberalize some rules in some sectors. However, the restrictions that remain limit or close certain sectors from either domestic or foreign private participation.

“China presents huge opportunities for global M&E companies, but to reap the benefits requires careful planning and execution.” — John Nendick, Global M&E Leader

Spotlight on China — Building a roadmap for success in Media & Entertainment

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Building a roadmap for success To help M&E companies navigate the complex challenges to achieve profitable growth, Ernst & Young has identified four key factors that can help M&E companies build a roadmap for success in China. Build strong brands

Succeed in digital

 Align brand strategy with core market segments

 Select partners that support digital distribution objectives

 Emphasize the brand’s story and quality

 Foster a culture of innovation

 Localize brands

 Anticipate and adapt to changing mobile consumption habits

 Use the power of social to build relationships

 Use data to develop insight into consumer behavior

 Adapt to changing market dynamics

 Experiment with evolving monetization models

Form and operate successful partnerships

Navigate the regulatory landscape

 Align the JV’s scope and choice of partner(s) with the company’s strategic objectives in China

 Make regulatory considerations a core pillar of growth strategy and operations  Identify and develop relationships with key regulatory stakeholders

 Embed the JV’s long-term goals and governance model in the partnership agreement

 Engage reputable local advisors to help guide regulatory interpretation

 Develop JV corporate infrastructure to support both traditional and digital media

 Continuously assess evolving regulations to identify opportunities and risks

 Establish a trust-based approach to management and be sensitive to cultural nuances

 Factor visible and hidden compliance costs in your business and operating plans

 Consider the impact of a JV exit, buyout or IPO on your short- and long-term goals

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1. Build strong brands

2. Succeed in digital

In an increasingly crowded and competitive market, M&E companies need to build strong brands to stand out. China’s consumers have a reputation for being value and price conscious. Other factors M&E companies will need to consider include associating personal identity with a brand, geographic, cultural diversity and consumer behavior.

Digital media is revolutionizing the way the Chinese consume M&E. The rapid adoption of connected devices and wireline and wireless broadband access is driving fundamental shifts in how the Chinese — youth, in particular — consume content. China had 350 million online video viewers as of June 2012.10 More than half of the country’s online users use some form of social media.11

However, as companies that have already penetrated the market have demonstrated, M&E companies that can differentiate themselves with a strong brand message have a much better chance of gaining the attention and loyalty of Chinese consumers than those that don’t. M&E companies can differentiate themselves by:  Aligning brand strategy with core market segments. In a country with many markets, M&E companies must determine which markets have the greatest potential and craft their products and brand strategies accordingly.  Emphasizing a brand’s story and quality. Successful brands have a unique “story” that feeds into Chinese consumers’ desires and aspirations. Chinese consumers are also attracted to quality goods and services. M&E brands that have a well-defined brand message and deserved reputation for quality will perform better than those that don’t.  Localizing brands. With such a diverse population, M&E companies need to localize their brands to meet the needs of different market segments.  Using the power of social media to build relationships. Social media has become a powerful force in the shaping of brands globally. M&E companies must become familiar with the social media ecosystem, in China, in order to effectively use it as a brand-building tool.  Adapting to changing market dynamics. China’s M&E market is constantly shifting. M&E companies must be ready to react to changing tastes and desires.

Advertisers are particularly eager to reach these digital adopters. By 2015, online advertising could comprise a little less than a third of the advertising market.12 For content companies, digital offers new monetization opportunities. However, with rapid growth also comes competition. As such, content providers need to differentiate their content and distributors need to focus on acquiring customers and then finding new ways to monetize them. For M&E companies seeking to penetrate Chinese markets, a digital strategy is a must. Elements for success in digital include:  Selecting partners that support digital distribution objectives. Content providers must choose their distribution partners carefully. They must consider several factors, such as the distributor’s brand, its ability to provide useful customer data and its history of product and service innovation.  Fostering a culture of innovation. With competition in the digital space so intense, M&E companies that simply offer the same products and services as their competitors are unlikely to thrive. M&E companies must create a culture of constant innovation to stay ahead in the competitive race.  Anticipating and adapting to changing mobile consumption habits. As Chinese consumers go mobile, M&E companies must create (or adapt) their products and services to conform to the evolving needs and habits of mobile consumers.  Using data to develop insight into consumer behavior. M&E companies can now capture and analyze previously inconceivable amounts of data each day. Analyzing data helps move M&E companies from “we think” to “we know” by generating fact-based and objective insights.  Experimenting with monetization models. Digital companies want to diversify their revenue sources beyond advertising to include direct consumer payments. As such, they are experimenting with several monetization models, like creating “VIP” packages and “omnimedia strategies.” M&E companies must add differentiated value to drive consumer willingness to pay.


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3. Form and operate effective partnerships Chinese and foreign M&E companies alike have found that going it alone is not always the best strategy for market success. Partnerships between domestic and foreign M&E companies allow both parties to leverage each other’s strengths. Of the 43 M&E companies listed on the Forbes Global 2000, 14 have formed joint ventures (JVs) in China since 2008. Some have more than one.13 However, forming and operating partnerships requires careful planning and skillful execution. There are many types of partnerships, ranging from licensing deals to strategic alliances and JVs. But for Chinese and global M&E companies, JVs have become a preferred method for coming together. Advantages of JV partnerships include:  Overcoming regulatory restrictions  Leveraging local market knowledge  Pooling resources and sharing financial risk  Gaining access to domain knowledge and intellectual property (IP)

Elements of a successful JV partnership should include:  Aligning the JV’s scope and choice of partner(s) with the company’s strategic objectives in China. M&E companies must evaluate how a JV will help it meet their strategic objectives in China. Success requires developing clear, realistic objectives, understanding how a range of potential economic and political scenarios may impact the venture, and selecting a partner that brings the right mix of attributes.  Embedding the JV’s long-term goals and governance model in the partnership agreement. Partnerships are most successful when all parties agree to a corporate governance structure and to a long-term vision for the venture and embed these within their agreements. The parties are also careful to include provisions on how to optimally use and protect IP.  Developing JV corporate infrastructure to support both traditional and digital media. The JV must invest adequate resources in critical M&E back-, middle- and front-office functions to support its business objectives.  Establishing a trust-based approach to management and being sensitive to cultural nuances. Partners must help to ensure progress and track the venture’s performance yet also allow the JV’s management enough latitude to manage the organization on a day-today basis. Trust and open dialogue are also critical when the JV involves a foreign and Chinese partner.  Considering the impact of a JV exit, buyout or IPO on short- and long-term goals. Successful venture partners should consider early on what the long-term goals and potential end-game options for the JV are. Each partner must consider the financial impact of each option in the short term, and how those options impact their longer-term strategic objectives in China.

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4. Navigate the regulatory landscape China’s regulatory environment is complex and evolving. The Chinese government is attaching greater importance and introducing more private and foreign investment into the M&E industry. Although a number of sectors remain off-limits to domestic and foreign investors, the government is steadily relaxing certain restrictions. Successfully navigating China’s regulatory landscape will require:  Making regulatory considerations a core pillar of  Continuously assessing evolving regulations to growth strategy. Navigating regulations is critical to identify opportunities and risks. M&E companies success. As such, M&E companies will need to assess must continuously assess the impact of China’s the impact regulations will have on the organization’s evolving regulatory landscape on their business. What strategy and its day-to-day operations. Domestic and new opportunities does this provide that they should foreign M&E companies must develop a clear picture of leverage? What potential risks does it create and how can the regulatory landscape that governs their businesses. these by mitigated? And processes, systems, skills and resources that help to  Factoring visible and hidden compliance costs into navigate the regulatory environment must be embedded business and operating plans. The complexity and within M&E companies’ corporate infrastructure in China. variable nature of China’s regulatory environment can  Identifying and developing relationships with present M&E companies with a number of significant key regulatory stakeholders. Government and compliance costs. Some of these costs are visible and business interests in China are closely intertwined. relate to an M&E company’s operations and/or growth in M&E companies must understand the key decision China. Other costs are hidden. In both instances, many makers that influence their current and future business M&E companies underestimate the scope and scale of objectives and develop relationships accordingly. their compliance needs in China. To contain cost creep, M&E companies must develop an understanding of  Engaging reputable local advisors to help navigate the how regulations and compliance will impact their entire regulatory landscape. Regulations in the M&E industry business — even aspects of their business that are not are fragmented among several different authorities. core or critical to their growth. At times, multiple authorities overlap in places and can compete for oversight of a single sector. To succeed in this complex environment, M&E companies should select a local advisor or a number of advisors to help them interpret evolving regulations.


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Taking a long-term view As the Chinese government continues to relax its restrictions for M&E companies, and digital breaks down the barriers that encumbered traditional distribution and content delivery, the opportunities for market penetration in M&E sectors in China are growing significantly. Although the challenges for M&E companies seeking to penetrate or expand their market presence in China remain significant, the market’s potential is too vast to ignore. The Chinese government, as part of its 12th Five-Year Plan, is relaxing regulations and opening the doors to investment in some M&E sectors. Change has been protracted, but it is gaining momentum.

Given its geographic size and economic importance in driving future global demand, investing in China is not a short-term endeavor. Any consideration of China has to be embedded into a global business strategy with a multi-year horizon. M&E companies need to understand and anticipate both the complexity and the enormous possibilities. Companies with the agility, adaptability and patience to make a long-term commitment to the market will be best positioned to succeed.

“M&E companies cannot underestimate the importance of culture in China. A critical understanding of the cultural nuances across geography, age and income level is necessary to win the loyalty of Chinese consumers.” — Peter YF Chan, Greater China M&E Leader

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Endnotes 1

“Asia: Coming together for sound and sustainable development,” Industry Updates, 5 April 2012, via Factiva, © 2012 China Daily Information Co.

2

Annalyn Censky, “China’s middle class boom,” CNN Wire, 26 June 2012, via Factiva, © 2012 Cable News Network; “Shanghai tops urban disposable income charts,” The China Perspective — Daily Briefing, via Factiva, © 2012 The China Perspective.

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Green Paper on Leisure, 2010 and 2011 editions, the Chinese Academy of Social Sciences; “China Economic Watch: Decline in Industrial Profits Accelerates; Entertainment Receipts Near ¥2.9t,” The China Perspective — Daily Briefing, 29 June 2012, via Factiva, © 2012 The China Perspective. Normandy Madden & Michael Froggatt, “China digital media: trends in usage and advertising,” eMarketer, March 2012. “As China continues to reorganize the 187 million household CATV sector, Beijing’s operator tries to stay ahead,” Optical Networks Daily, via Factiva © 2012 Electronics International.

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“Is China’s three networks project worth up to $250 billion, still making progress,” Optical Networks Daily, 25 October 2012, via Factiva © 2012 Electronics International.

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Maisie McCabe, “Asia-Pacific to be largest ad market by 2014,” Campaign, 12 October 2012, via Factiva © Campaign.

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“Media: AdStats: Fact Book on Advertising Expenditures,” J.P. Morgan, 25 May 2012, via ThomsonOne.com.

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“Daily debate in media over policy,” Industry Updates, 30 May 2012, via Factiva © 2012 China Daily Information Co.

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Tobi Elkin, “Online video viewers in China: a user portrait,” eMarketer, October 2012.

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“Social network penetration in select countries and regions, Q2 2012,” eMarketer citing InSites Consulting, 24 September 2012.

12

“Global Forecast Model: 2000-2017,” MAGNAGLOBAL, June 2012.

13

Ernst & Young analysis.


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Ernst & Young Global Media & Entertainment — key contacts Telephone

Email

Global Area Leaders John Nendick, Global M&E Leader and Americas M&E Leader (Los Angeles, US) +1 213 977 3188

[email protected]

Farokh Balsara, EMEIA M&E Leader (Mumbai, India)

+91 22 6192 0280 [email protected]

David McGregor, Asia-Pacific M&E Leader, (Melbourne, Australia)

+61 3 9288 8491

[email protected]

Yuichiro Munakata, Japan M&E Leader (Tokyo, Japan)

+81 3 3503 1100

[email protected]

Peter YF Chan, Greater China M&E Leader (Hong Kong, China)

+852 2846 9936

[email protected]

Edward Chang, Greater China M&E Advisory Leader

+86 10 58152321

[email protected]

Stephen Y. Lo, Greater China Technology, Communications and Entertainment Advisory Leader

+86 10 5815 2837 [email protected]

Carrie Tang, Greater China M&E Tax Leader

+86 21 22282116

Stella Yuan, Greater China M&E Transactions Leader

+86 21 22283078 [email protected]

Greater China Service Line Leaders

[email protected]

Global Service Line Leaders Mark J. Borao, Global M&E Advisory Services Leader (Los Angeles, US)

+1 213 977 3633

[email protected]

Thomas J. Connolly, Global M&E Transaction Advisory Services Leader (New York, US)

+1 212 773 7146

[email protected]

Ian Eddleston, Global and Americas M&E Assurance Leader and West Sub-Area M&E Leader (Los Angeles, US)

+1 213 977 3304

[email protected]

Alan Luchs, Global M&E Tax Leader (New York, US)

+1 212 773 4380

alan.luchs @ey.com

Sylvia Ahi Vosloo, Marketing Lead (Los Angeles, US)

+1 213 977 4371

[email protected]

Karen Angel, Global Implementation Director (Los Angeles, US)

+1 213 977 5809

[email protected]

Matt Askins, National Accounting M&E Resident (New York, US)

+1 212 773 0681

[email protected]

Richard Golik, M&E Senior Analyst (Cleveland, US)

+1 216 583 2681

[email protected]

Raghav Mani, Knowledge Leader, (Los Angeles, US)

+1 213 977 5855

[email protected]

Jennifer Weiker, M&E Sector Resident (Los Angeles, US)

+1 213 977 3916

[email protected]

Global Media & Entertainment Center Team

www.ey.com/mediaentertainment Mobile app: eyinsights.com

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Ernst & Young’s timely and relevant thought leadership for the media and entertainment industry CEO and CFO studies 2012 CEO Study — Opportunity and optimism: How CEOs are embracing digital growth

Poised for digital growth: Preserving profitability in today’s digital world

Digital hot topics Monetizing digital media: Creating value consumers will buy

Defining digital revenue in media and entertainment

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Tune in to emerging entertainment markets: Spotlight on Brazil, Russia, India and China

Performance benchmarking Top 10 business risks in media and entertainment 2012


Spotlight on profitable growth — Media & Entertainment

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Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com.

About Ernst & Young’s Global Media & Entertainment Center Whether it’s the traditional press and broadcast media, or the multitude of new media, audiences now have more choice than ever before. For media and entertainment companies, integration and adaptability are becoming critical success factors. Ernst & Young’s Global Media & Entertainment Center brings together a worldwide team of professionals to help you achieve your potential — a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately it enables us to help you meet your goals and compete more effectively. It’s how Ernst & Young makes a difference.

www.ey.com ED None © 2012 EYGM Limited. All Rights Reserved. EYG no. EA0062 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.