China's Entertainment Industry: Ready to Boom

I was skeptical about the media and entertainment sector's ability to achieve healthy - profitable - growth.

I have changed my tune.

Recently, I had the privilege of moderating a panel on China's media and entertainment scene at JP Morgan's Global China Summit that takes places every year in Beijing. The discussion was optimistic, fueled by the insights of icons such as Lan Kwai Fong Group's Allen Zeman - he is a naturalized Chinese citizen and has lived in Hong Kong for 48 years - and Youku Tudou's founder and CEO, Victor Koo. Other panelists included Oriental DreamWork's James Fong, Ivanhoe's John Kimmel and Infinity Picture's Dede Nickerson.

Headwinds

There are valid reasons for doubt. The Communist Party hopes to rebalance the Chinese economy away from exports and investment and towards consumer spending and services. But there is more smoke than fire. Ham-fisted stock market and currency interventions, continued investment in zombie state owned enterprises, failure to promulgate a concrete reform agenda and intensified social media crackdowns bode poorly for structural reform. The Chinese government is simply unwilling to loosen the reigns of control. President Xi JinPing will always choose order over creative liberation.

True, by 2017, the Chinese box office is poised to eclipse America's in terms of absolute size with $10.4 billion in ticket sales. Mega-hits such as Stephen Chou's Mermaid frequently outperform Western blockbusters.

But barriers to sustained profitability within media and entertainment sectors abound. Progress in enforcing intellectual property rights is slow. This is due to both the lack of judicial independence - courts, even commercial ones, still exist to serve the Party's interest - and cultural factors. A famous maxim of unknown origin states, "To steal a book is an elegant offense." Why elegant? Unauthorized dissemination was a "noble crime" because it reinforced strong central control. This attitude is rooted in Chinese history. The culture of the literati in imperial eras deemphasized original creation, largely because of the backward-looking nature of Confucian thought. Imperial information, an expression of heaven's mandate, was sacred.

IP protection will strengthen when Chinese companies have more to lose. But progress will be halting. The institutions required to protect individual economic interests are embryonic.

Relatedly, China's entertainment landscape is handicapped by low margins, largely due to lack of developed ancillary revenue streams. In the United States, box office sales represent only a small fraction of any property's potential revenue. DVD sales, video games, apparel merchandising and even theme parks extend the value of a brand's franchise. In China, these markets are nascent, held back by substandard marketing and, again, unenforceable IP laws.

Finally, China's government is hostile to creative expression. From reality television with winners are chosen by text votes to provocative films, anything that smacks of controversy is verboten. This limits the range of films in theaters and television fare on internet portals.

Hope

Despite financial and cultural headwinds, however, several factors merit optimism.

First, the Mainland market is both gigantic. As Oriental DreamWorks' James Fong puts it, "In China, niche is mass." After decades of limited diversion options, the new middle class, now 300 million strong, is clamoring for choice. The Communist Party seems more open to foreign investment in entertainment companies than "strategic" sectors such as health care, education and financial services.

Shanghai Disney's Magical Kingdom, now in the middle of a soft launch, is already drawing huge crowds. Under the watchful eye of municipal cadres, the park has been designed with Chinese characteristics. Main Street USA and Space Mountain are out. The Wandering Moon Teahouse and a vast central garden aimed at older visitors, are in. In partnership with Li RuiGang, the well-connected former CEO of the Shanghai Media Group, Oriental DreamWorks will open the Dream Center, a five million square foot entertainment complex, on Shanghai's South Bund. Attractions will include a Broadway musical theater, a stadium for concerts and sporting events, a Lego Discovery Center, several art galleries and a next-generation Apple store.

Second, China's mass market is apolitical, unbothered by censorship regulations. Most folks are eager to take a break from the stresses of modern life and like light-hearted fare. Big hits such as Goodbye, Mr. Loser, Tiny Times, Lost in Thailand and Pancake Man are irreverent comedies that depict a regular guy striking it rich or getting the girl.

Third, a dynamic, expressive online creative community has blossomed. It is only a matter of time before internet celebrities become creative forces, both on- and offline.

Chinese story telling skills are evolving quickly. Web series such as Go Princess Go, Surprise S1 and Year Hare Affair are hugely popular. Writer Chai JiDan's Heroin, China's first gay-themed internet series, was so popular during 2016 Chinese New Year that it was quickly banned by SARFT, the government arm responsible for enforcing film, television and content regulations.

Tang Jia Shan Shao is the king of web novel. (In 2014, he received royalties of more than RMB 50 million.) He harnesses the immediacy and speed of the online universe. Although he bases his novel on classical stories, he creates fresh characters, coins new words and provides continuous updates for fans addicted to his work. Mr. Tang is not alone. Digital platforms such as Douban - a quintessentially Chinese fusion of Amazon , IMDB and Facebook - allow artists of all stripes to congregate as a virtual community and attract a mass following.

Fourth, e-commerce presents opportunities to experiment with new monetization models. Online shopping is instant for consumers and cheap for companies. Content-hungry consumers do not drive to DVD stores to buy a Toy Story video game or the Frozen sound track. The ubiquity of mobile phones eliminates set up costs and lowers incremental cost per unit sold. Marketers also anticipate convergence of online and offline properties. IP-based content, easier to enforce online than offline, will drive offline merchandising, and vice versa.

China's infatuation with digital transactions is difficult to overstate. In 2016, the country is projected to spend $911 billion dollars online, or almost 20% of total retail sales. The United States will spend only $384 billion. Meanwhile, per capita in China income is only 14% of America's.

There are many reasons for this intoxication. Some of them - lack of bricks-and-mortar choices in lower-tier cities as well as frequent online promotions - are functional.

But online shopping is also emotionally satisfying. A great deal on TaoBao, the country's leading consumer-to-consumer (C2C) online retailer, facilitate ego affirmation and demonstration of clever resourcefulness. On 2015's Singles Day, a November 11 holiday in which single people are encouraged to buy gifts for themselves and each other, online retail behemoth Alibaba reported sales of $14.3 billion, 60% above 2014's haul. Single's Day is state-sponsored retail therapy writ large. Tencent, another mammoth internet company, derives the much of its revenue from virtual items that provide emotional release or self-expression - for example, video games and an immense array of emoticons.

In conclusion, mainland media and entertainment companies are poised for take-off. The dynamics of China's commercial landscape and emotional drivers of Chinese consumers suggest that the sector is on the cusp of a boom.