Alibaba Pictures and Tencent Pictures are two companies I keep a close eye on. They are very well positioned to win big in Chinese entertainment. And they are making unconventional moves in an industry that is both emerging and being disrupted at the same time.
I recently spoke with a colleague at Alibaba Pictures. It was a fascinating talk and, honestly, I had a slight pang of envy. Entertainment is just a cool field. Much sexier than my focus on mostly healthcare. Business trips to Cannes and Sundance are more fun than those to St. Louis and Jacksonville. And to be at the center of entertainment as it emerges in China must be fascinating. Plus the parties are probably awesome.
But then a little voice in the back of my mind politely reminded me “Jeff, you would suck at entertainment”. It seems a business mostly about creativity and incessant networking, both of which I am horrendous at. I remain both a pure breed analyst and non-networker at heart. Put me at a networking event and I flounder. Put me in a bar with a math problem and I am almost giddy.
On a completely unrelated side note: I actually did take one acting class many years ago in New York City. I lasted 15 minutes before walking out. It was at the point when the teacher told everyone to get on the floor and pretend to be an animal. I felt like my DNA was going to explode.
Ok. Back on topic.
Looking at Chinese entertainment today, with my analyst hat securely on, my big question is how can you win on this rapidly changing landscape? And which of the current front-runners (Alibaba, Tencent, Wanda, Huayi Brothers and others) are likely to win?
My thinking about this, thus far, is four points.
Point 1: There is a fundamental product uncertainty problem that shapes much of the entertainment industry.
Entertainment largely defies market analysis. This is why I don’t do it. It is just really hard to predict what movies and tv shows are going to do well. And entertainment companies are forced to spend lots of time and money upfront to create movies and tv programs that then later hit or bomb in a fairly unpredictable way. And even if the product succeeds, it is usually a short-term success. The consumer eventually gets bored of it (note to House of Cards Season 5). On top of this, preferences and trends change pretty regularly – both in terms of content and how and when it is consumed.
All this results in products in significant upfront costs and unpredictable future cash flows for studios and production companies. Three big hits and your company is flush with cash and glory. Five bombs and your studio is in financial peril. I have always felt sorry for the CFOs of entertainment companies.
When I look at the successful Hollywood companies, much of what I see is tactics and structures to get around this product unpredictability problem. Plus, there are also competitive concerns. The two most common approaches I see for winning in entertainment long-term are 1) to become dominant and diversified in content or 2) to become dominant in distribution, relative to the other players. These types of dominance result in competitive strength and more predictable cash flows – despite still having fairly unpredictable individual products.
Additionally, once a company gets this type of dominance in content and/or distribution, they can often add ancillary revenue streams, such as merchandising and consumer products; advertising-based media; theme parks and licensing.
Both the competition and product unpredictability problem appear to be even worse in China. Yes, it will soon be the world’s largest entertainment market. But Chinese consumers are changing very rapidly in their tastes, their behavior and in where and how they consume entertainment. Everything is just happening much faster here.
Additionally, the whole Chinese entertainment industry is really just emerging. The regulations are still fuzzy. The capabilities of production companies – and the specialty technology and services companies they rely on – are still developing. In Chinese entertainment today, consumers, competitors, capabilities, regulations and new technologies are all changing at the same time.
Point 2: Dominance in distribution is the big, near-term opportunity in China.
In the US, dominance in distribution has historically meant control of broadcast television and/or cable television (and to a lesser degree satellite broadcast). The original three broadcast TV networks (ABC, CBS, NBC) had a long period of this type of dominance, although it decreased in the 1990’s (at just around the same time that Fox made its clever break into their oligopoly). And then there was the rise “cable cowboys” in the 1980’s and 1990’s. The deal history of John Malone in cable is worth studying in detail. I highly recommend the book Cable Cowboys.
However, control of cinemas as a distribution channel has actually been less of the story in Hollywood than it is in China today. This is somewhat due to an anti-trust case in the 1940’s that prevented Hollywood studios from owning cinemas.
And now in the US, we are seeing the rise of over-the-top (OTT) streaming by technology companies like Amazon and Netflix. These direct to consumer plays are the big distribution disruptor today.
Overall, a quick reading of the financials of companies like Viacom, Comcast and Liberty Media shows lots of cash flow and competitive strengths coming mostly from their strength in distribution. When Warren Buffett invests in Liberty Media, that tells you where some of the competitive power lies.
Today in China, we can see a lot of players scrambling for dominance in distribution on a changing landscape. This is the clearer path. Broadcast TV is a focus but few licenses are available and this is pretty State controlled. There are also tons of DVDs on street corners and pirated downloads, but nobody really controls any of this.
So much of the focus in China has been on achieving dominance in cinemas (thus far) – and the release windows for films within these cinemas. Wanda has taken this approach the most aggressively – including internationally with their purchases of AMC Theaters in the USA, Odeon-UCI in Europe and now Nordic Cinema Group in Scandinavia. Wanda Chairman Wang Jianlin has said his goal is to own 20% of the world’s movie screens. Recent financial concerns and government actions related to Wanda may be changing this.
Outside of cinemas, much of the focus on Chinese distribution is now on online video and streaming. It’s an emerging area where Alibaba, Tencent and a few others are doing an aggressive push into a still grey regulatory area. Note: typically what happens is the regulations are eventually clarified and the market leaders are grandfathered in. But online video and streaming is really the area to watch in 2017.
Point 3: Dominance in content is much harder in China than in the West
In the US, content strategies have typically been about getting to negotiating scale against powerful distributors, having lots of IP, creating popular TV networks and creating or buying popular franchises. Basically, by bundling lots of content under one studio or tv network, companies are in a stronger position to negotiate with distributors (particularly cable companies and cinemas) and can diversify their product risk. The right content is still king.
TV networks like ESPN and the Disney Channel are a good example of this. A quick reading of the 10-Ks of 21st Century Fox and Disney show (historically) a lot of cash coming from their ownership of certain television networks. In movies, strength in content has been more about creating franchises where possible (Star Wars, Marvel, etc.). Having a big IP library also helps. But overall, the film studio divisions of the entertainment companies are usually much less predictable and appear to be a much more difficult business.
In China, these content strategies and core creative capabilities are just now being developed. It’s kind of the Wild West. Local production companies and studios are struggling to build their own development capabilities and creating content at a frantic pace. Achieving “creative excellence”and getting to international levels of quality is proving to be more difficult than many anticipated. Plus there is the usual crazy competition of a new China industry. And all this is driving a lot of the partnerships with foreign studios. Competition in content in China today is currently a pretty brutal free-for-all between local production companies, local studios and Hollywood studios. I think there is going to be shake-out in this over the next couple of years.
One interesting approach within Chinese content is the “pure play” strategy seen at Oriental Dreamworks in Shanghai (whom I also interviewed). They entered the Chinese market via a joint venture with Shanghai Media and China Media Capital and have focused exclusively on creating the highest quality animated movies in China. And this pure-play approach naturally focuses management’s attention on creating a creative culture. ODW is more like an artists’ colony than a business. However, animated movies also have a particularly long development period and the financials are more unpredictable. ODW has recently announced lay-offs but I think a pure-play in content is a nice approach overall.
Point 4 (last one): Alibaba Pictures and Tencent Pictures are starting to look like cool combinations of Hollywood and Silicon Valley.
Looking at Alibaba and Tencent Pictures, I see classic attempts to become dominant in still emerging Chinese entertainment (per the above points). But I also see attempts to solve the product unpredictability problem through technology and data. That’s what makes them so interesting. While Wanda and Huayi Brothers are doing fairly classic distribution and content strategies, Alibaba and Tencent are doing both the Hollywood and Silicon Valley approach to entertainment at the same time.
I will go into detail in this in Part 2. But I wanted to lay out a general framework for the industry to show why these two companies are so interesting. Part 2 will also be a lot less theory.
Cheers and thanks for reading, jeff
And for the record, the animal I briefly attempted to be at the acting class was a cheetah. I looked like a moron.
I write (and speak) about how rising Chinese consumers are disrupting global markets. (#ConsumerChina). This also includes work on:
- “China 2025″ – what a region transformed by Chinese consumers, companies and capital is going to look like. (#China2025)