By Lex Davidson

The fastest growing online video audience in the world is currently China.  With highly developed video sharing websites and social networks that have learned from the US versions and enhanced their capabilities, the Chinese online video market should be a prime example of a successful digital media industry, right?  Absolutely wrong.

I spent the better part of six months researching the social industry in Beijing and Shanghai.  I met with the CEO’s and heads of corporate development for each of the top online destinations along with the leading Venture Capital firms that have been investing in these companies since the birth of the market.
Let me first give you a short synopsis of each company I met with while in China:

Alibaba – The leading b2b portal in China, Alibaba connects merchants with retail establishments from around the world and enables commerce to occur. One of the most successful technology firms in China, Alibaba owns the largest online auction site, Tabao, which maintains an 80%/20% market share advantage over Ebay in China.  Adding to their “Ebay” model, Alibaba also founded Alipay, which is the Chinese version of PayPal.  Alibaba also runs Yahoo! China, which they acquired for $1 billion dollars worth of stock approximately two years ago from Yahoo! US.

Youku.com – Youku, not to be confused with Youtube is the largest video sharing website in China.  When I first met with their CEO, Victor Ku, in August, they were streaming 50 million videos daily, when I met with him in December, they were up to over 100 million video views daily.  This company was launched in January of 2007 and has seen growth rates that far exceed Youtube’s initial expansion in every major metric.

Tudou.com – Tudou is a hybrid video sharing/social networking website.  Considered by many the top social network in China, Tudou is one of the least well funded portals in China that is ranked in the top 100 in terms of traffic.  This means that they are the most active with pursuing a true revenue model since they need cashflow in order to continue operations.  Still nowhere near profitable, Tudou is a prime example of the issues that plague the online ad supported video business in China.

Ku6.com – This is the ‘Revver’ or ‘Metacafe’ of China.  They give a revenue share percentage to all of their qualified uploaders.  They told me that they were getting the highest CPM’s in the industry, approximately $10 CPMs.  However I spoke with an analyst who informed me that they were only getting around $100k revenues per year.  So their ad fill is very small which will make it difficult for them to stay in business since they are not well capitalized.  The one bonus that Ku6 has is that they are viewed positively by the Government and have partnered with the top search engine in China, Baidu.com.  I expect Baidu to acquire them for a small price point, much like Live Universe purchased Revver a few months ago.

Yahoo! China – Yahoo! CN is owned and maintained by Alibaba, however they view the two enterprises as completely different companies.  Alibaba is viewed as a hometown hero for the Chinese people, whereas Yahoo! China is considered a failed attempt from a US company to enter the Asian search market.  Yahoo! CN has attempted to launch several different types of social products and services, with little traction.  They have not attempted to offer an online video player, like Yahoo! Video in the US.  When I interviewed their SVP of product development, he informed me that they did not want to enter the video market since the bandwidth costs far exceeded the in-stream advertising revenue that would be generated.  Possibly a smart maneuver.

HDT – HDT is the PointRoll of China.  They currently serve and sell 75% of the rich media advertisements in China.  They also sell a large percentage of the video ads, they are having a very difficult time placing their ads associated with user generated content, which means that they actually have the opposite problem of the US comparables: too many ads and not enough distribution.  Out of all the companies I met with in China I was the most impressed with HDT’s knowledge of the industry and what they had to do in order to become successful.

I also met with an innumerable list of other companies and executives in the social space along with the venture capital firms that have funded them, and I used all the information gained from these meetings to form this editechial.

The problem Culturally {bargaining to the bone}
The ‘bargaining’ culture of China has created an issue in the online advertising landscape.  When I visited the silk district in Shanghai I discovered only the suckers pay full price for items, even everyday items like shirts and socks.  And this cultural phenomenon affects online advertising since advertisers will bargain with each website and have them compete against each other for their campaign.  That occurs in the US, however they take it to the extreme in China.  For example: in the US if you go to Tremor Media and tell them that Broadband Enterprises is going to run your video campaign for a $25 CPM, they may offer to run it for $20, but not a cent lower than that.

In China, an advertiser will go back and forth between websites until they have taken the price down to essentially nothing.  The COO of HDT, Tao Li, informed me that he had seen a video advertising campaign start at a $15 CPM that was negotiated all the way down to under a $1 CPM.  And this problem will continue as long as the online advertising networks bend to the negotiation ploys of the advertising agencies.

The Problem with Content {UGC}
User generated content is possibly the top issue with online advertising in China.  In the US we have a wide variety of content, professionally produced, licensed, UGC, etc.  China’s online video market is 98% user driven and the videos are either poor quality or shamelessly copyright infringing.  While I was in China I thought every site I went to was a Hulu clone, since each website has all the full episodes of each of my favorite TV shows, and they had no ads (great user experience, BTW).  With this being the current state of the online content libraries, it is no wonder that these sites are not generating any revenues.  Advertisers have a zero tolerance for having their brands associated with either poor quality or illegally distributed media.

There is no quick fix to this issue; these sites are going to have to develop a combination of:

• Automated content filtering for copyrighted materials
• Invest in licensing media from qualified content creators
• Prohibit pornographic and obscene videos from the library entirely
• Place quality filters in place much like Metacafe utilizes domestically

I believe a combination of these bullet points above would help to remedy the industry.  However no one has been fast to make these changes, which is the reason why each of the video sites in China lacks a sustainable revenue model.

The problem with bandwidth {monopolies}
In the US and UK we have an incredibly competitive CDN (content delivery network) market, with each delivery network offering an innovate product with very low price points.  Some CDN’s are giving under .10 per gigabyte pricing for online video sites and platforms.  In China there is one CDN that owns the market, ChinaCache.  ChinaCache is a government controlled CDN that every site has to use unless they create their own proprietary content delivery network, which is very cost prohibitive.  Out of everyone I spoke with, Youku.com was the only company that worked off their own CDN.

Because ChinaCache has no competition they can charge whatever they please, and right now the going rate for bandwidth is .50 to $1.00 USD.  So the price points for bandwidth fees are 5 to 10 times as expensive as in the US.  Also, since they do not have to compete against anyone in terms of performance, ChinaCache chooses to many times leverage servers in Mongolia so they can further augment their profit margins.  This maneuver causes a drop in video playback performance and thus a poor user experience.

The problem with the Government {I can only post this now that I’m back in the US}
The communist Chinese government has been working overtime to polish their image in the eyes of the rest of the world.  This is being done for the upcoming Beijing summer Olympics along with the motivation that if everyone believes that China is evolving into a more capitalistic state, it will spark an increased migration of innovation and spur on additional revenue expansion.  However the truth of the matter is that the Government is fully in control and can utilize their power at anytime they see fit.  This is being clearly illustrated right now as one of the largest video sharing sites, 56.com is shut down.  56.com executives have told the public that the site is down for maintenance, however they are the third site to experience a prolonged shut down.  Youku.com and Tudou.com both were disabled in the past few months.  And my inside sources have confirmed that these outages were due to Government officials examining the content library of each site.

This is a problem that will not be going away at all, each venture in China is going to have an additional level of risk since Government interference is always a possibility.  And believe me; I experienced censorship first hand when I was in Shanghai.  I was preparing to fly out of the city to Beijing in the afternoon when it started to rain.  And then all of a sudden I received a wave of emails and calls from the US asking me if I was ok.  Turns out that a Typhoon was about to hit Shanghai and portions of the city were being evacuated.  I turned on the news to see what was going on, and guess what?  Not one mention of the Typhoon occurred; the Government did not want a panic to spread to the city’s 25 million residents, so it forced the TV stations to not cover the story.  Thankfully I was able to catch the last flight out that afternoon.  I was informed by a friend in Shanghai that many people died and the grounded all flight transportation from leaving the city after I had left.  That story was to illustrate that when it comes to media, both offline and digital forms, the Government has full control.

In summarizing the current state of online video here is the cold hard truth: the bandwidth fees from a monopolistic CDN far exceed the advertising revenue that can be generated through the sale of in-stream and display banner ads since the online video content is completely user driven which means that it is usually adult oriented or illegally uploaded, and if those issues were not enough, the Chinese government’s involvement makes organic growth prohibitive. On my travels to China I met with many very intelligent online video executives who all had their own positive spin for the industry, but without drastic changes, the user generated online video market in Asia will have a very difficult time existing in the long run.