This story appears in the December 9, 2012 issue of Forbes. Subscribe
On a tree-lined street in Tianjin, one of Asia's hottest directors, Wong Ching-Po, reclines in his foldout blue chair, one eye on the monitor in front of him. "This is the opening shot," mumbles Wong, a bundle of baggy clothes and unruly hair. The movie is about a hit man who falls for a girl he's supposed to kill on the day the world ends.
On cue, an actor climbs out of the red Hyundai sedan and the camera pivots left as he steps out onto the tarmac, then it pans upward as he runs down the street. "Cut," yells Wong. He reviews the scene in slow motion and grunts softly. "One more time," he says, slumping lower in his chair.
Wong is best known for his big-budget, blood-soaked gangster flicks, but the film he was shooting this summer was a 45-minute, sub-$800,000 featurette to run exclusively on the Web.
The loudest applause after the movie aired in November came from Victor Koo, CEO and founder of Youku, China's biggest online video site, which underwrote Wong's apocalyptic vision. Original content from big-name talent that's subsidized by advertising and product placement (Hyundai is sponsoring the film, hence the close-up on the new car) that's the formula Koo needs to pull off what he's never been able to do in six years, i.e., make a profit.
China's online video business, forecast to hit $1.2 billion, up 115% in 2012, is at a pivotal moment. Audiences are huge, but the ad dollars are not. Content licensing deals have come down but are still pricey. Bandwidth costs remain stubbornly high, the same plight that bedeviled YouTube in its early days. Video recently overtook search and social networking as China's favored online activity. Youku was already the top site before its August merger with Tudou, the number two site. The pair have a combined 400 million viewers a month, a sizable chunk of China’s 538 million Internet users, and $259 million in expected revenue this year, up 16% from 2011.
“It’s a scale game,” says Koo, a Stanford-educated M.B.A., in an interview at Youku’s offices in Beijing. But despite its size advantage--Youku gets 74% of the Chinese Web audience in a given month--it captures only 33% of the video ad revenue. The pair of sites have collectively burned through $350 million in shareholder capital since their inception. New competition is coming in from sites backed by Web giants like Baidu, Sohu and Tencent, along with independents such as LeTV and peer-to-peer download sites like Xunlei and PPLive. The threat is from the stodgy state-run broadcasters, who soak up most of the ad dollars. If the propaganda chiefs who rule them ever decide to connect with the more educated, urban audiences online, they’d push the smaller websites aside.
Koo already had seven years of Chinese Web experience (Sohu) when he started Youku in 2006, inspired from afar by then year-old YouTube. Koo insists the name, which means “best and coolest,” is neither a namesake nor a copycat. YouTube may be close to profitable--all its parent, Google, says is that it is pleased with the site’s performance--but Koo is on his own. He has to show that ad-supported video can make a profit before audience growth slows and state broadcasters start to follow their viewers online. Youku and its competitors recently extended preroll advertising on videos to 40 to 60 seconds, up from 15 to 30 seconds. Ads also pop up during pauses.
Koo has vowed to save at least $50 million in overlapping costs over the next year but refuses to predict when Youku will finally move into the black. The cuts would just about get him to break even, based on trailing 12-month losses of $50 million. Barclays Capital says the company could be profitable by the second quarter of 2013. Youku’s NYSE-traded shares have been flat for months after falling 70% from their highs 18 months ago.
Chinese Web video sites evolved quite differently from sites in the West. YouTube, with 800 million monthly viewers, has always gotten most of its content from individuals and only later made a push for produced content. In China few people owned video recorders or camera phones until recently, so the well of kooky self-expression wasn’t on tap. User-supplied videos make up 15% or so of Youku’s inventory. China makes it a lot more expensive to deal with, requiring hundreds of human monitors to screen for political and sexual -material to avoid being shut down.
Youku and Tudou and its ilk grew into something similar to a Hulu or cable TV. Youku has a Netflix-like subscription service that’s ad free, but it’s a small piece of the business.
Because it mostly comprises full-length TV shows and movies, Youku enjoys visitors who spend an average of 35 minutes a day, compared with only 14 minutes for the typical American site. The bad news is that Youku pays more than $100 million a year in licensing fees to Hollywood and Chinese studios and producers of South Korean soaps and Japanese animation.
The rash of rival sites bidding for content drove licensing deals through the ceiling. Pricking that bubble was a big factor in Koo’s merger with Tudou. Things reached their crazy peak in December at $320,000 per episode paid by Baidu’s Qiyi.com for a top-rated Chinese costume drama, ten times the going rate the previous year. Koo ended up getting outbid for most of the hit shows. “Things went so out of whack last year. Imagine a case when you pay $10 to make a buck or two. This doesn’t make any business sense,” he says.
Postmerger TV shows now average $80,000 per episode as more sites are teaming up on deals and sharing content. Youku is still feeling aftereffects, with content acquisition costs of $23 million in the second quarter, or 37% of revenue, up from 25% of revenue a year earlier. Its loss widened to $5 million, despite bandwidth costs down to 29% as a proportion of revenues, from 60% of revenue at the time of Youku’s IPO two years ago. Smarter caching of videos at distributed servers closer to viewers helps. Bandwidth in China can cost nearly four times average global rates, Dele Liu, Youku’s president, complained in 2011.
There’s really only room for three or four dominant players in China. Koo will be one of them. For now, at the very least, he can say he’s big enough to lose less than the next guy.
