The DVD Debate

How big is the market for pirated DVDs really, and what does Hollywood have to do to crack the China market? We put the two ends of the issue – a Hollywood movie executive and a pirated DVD seller – into the same room with an interpreter in the middle and the conversation went in unexpected directions. For a start this appears NOT to be not a national problem but more an urban one. For obvious reasons, the names are changed to protect both the innocent and the guilty.

Mr. Chen operates a stall on a street in Shanghai most evenings. He has bought a Buick van with his DVD profits and earns extra income from it during the day. The wholesale distribution point for this clandestine trade is Yiwu in Zhejiang province. The traders bring the DVDs in bulk into Shanghai from there by a circuitous route, and Chen buys them for cash 4 RMB each at his home. On a good night he can sell 100 to 150 DVDs at 4 RMB profit per item. Good money.

Mr. Smith is a senior executive with a major Hollywood studio on a short visit to Shanghai, where he bought some pirated DVDs.

Chen: How much did you pay for the DVDs?

Smith: I got three for 20 RMB.

Chen: Too expensive. I can give it to you cheaper. That is a foreigner price. I can give you 3 for 15 RMB.

Smith: That would be good! I have around 2,000 pirate DVDs, so I am interested in a discount.

Chen: You have all the old ones, right? You have the Godfather?

Smith: Got it. I like the TV show sets.

Chen: You have 24 Hours?

Smith: I need seasons 3 and 4.

Chen: I have them.

Smith: You smoke?

Chen: Yes, thanks.

Smith: The smart people in our industry like the pirates in China. Only a few of our movies can be shown here in the theaters legally, so the pirates have educated the people about our products. But now, of course, Hollywood is trying to sell legal DVDs in China. But the legal distribution is not as good as yours. Pirated DVDs are available everywhere, whereas legal DVDs are only available in a few places. The lowest price for a legal DVD in China, I believe, is 22 RMB. So now you are 5 RMB, we are 22 RMB. Also we can only release certain titles and can only release them at a certain time, whereas you can release everything. But the thing that always gets us to go "wow," is that a movie opens on Friday and by Monday it is everywhere in China, every street corner. Three days, so fast.

Chen: What happens is there is a gang in Hong Kong who work to get all the movies from around the world as early as they can, then they shift them into Guangdong, and they manufacture huge quantities of DVDs in Guangdong. Then they move them to Shanghai to sell. The biggest sales point in China by far is Shanghai. The reason is firstly because of Shanghai's big population, but also because the level of education and international awareness is high, so the acceptance of foreign movies here is much higher. The biggest sales are in the major cities – Shanghai, Beijing, Guangzhou. In other parts of China, there is a lower acceptance level of the foreign DVDs, people don't understand English, people don't have the awareness or the education level. Also, it is worth keeping in mind that these foreign movies are something they can watch or not watch, it is not an essential element of their lives, and 20 RMB for ordinary people in Shanghai is still a reasonably large sum of money for an hour's worth of entertainment that may be good and not be good. It is not like cigarettes, something that you are going to become addicted to.

Smith: Many people in Hollywood don't understand China. They see there are 1.5 billion people here and they think sales should be huge. They don't understand how much money people have, they don't understand the level of interest in this product. They don't understand the market. People thought China would be like the US, where people go to a big store like Wal-Mart BECAUSE of DVDs and then while they are there, they buy other things. That gives the studios big power in the US. So Wal-Mart will work with them on release and placement and price. They do not understand that in China, people would not go to the store because of DVDs. So Wal-Mart US – big DVD display, front of store. In China – small display, back of store.

Chen: Forget other places, just Shanghai. People in Shanghai earn more than in most places in China, and they love to watch DVDs. Why? Movie tickets are expensive. It costs 100 RMB for two people to go to the cinema, and it takes extra time, and there are travel and other costs. Chinese people are cautious on spending, not like in the West where people will say ?I just earned US$5,000 dollars, I am going to spend US$4,000 of that and have a good time.? In China, if you earn US$5,000, you want to save US$5,000, you are not looking to spend extra money. So there is a market for the DVDs that you guys are selling. It is a matter of price. The way to beat the pirates is on price. If you can match the price, you will beat the pirates and you can hit that whatever revenue number you want to hit.

Smith: We can never match the pirate price because we have to pay royalties.

Chen: I know.

Smith: There have been marketing surveys done about whether people would be willing to pay for guaranteed good quality, and their answer is: only a little more.

Chen: That's exactly right.

Smith: But I think our problem aside from price is distribution. You can buy a pirated DVD today on every street corner in China. If I want to buy a legal DVD, I have to get in a taxi and go somewhere else.

Chen: If you include the full royalty fees, then it will be very difficult to do, but if you can work out a deal of some sort whereby you can bring the price down to 10 RMB, then you would do very well in the Shanghai market. But if you cannot bring the price down, then your sales are not going to go up.

Smith: Remember in the US, we charge US$20. And when legal DVDs first went on sale in China, they were selling in the stores at 150 RMB.

Chen: So why not go through the supermarkets? Why not sell direct yourselves?

Smith: Right, but we are not in that business.

Chen: In terms of the big movies, if you sell it at retail at 15 RMB, you will make a good profit.

Smith: Yes, but if we sell direct to the public, it will hurt the relationship between the studios and places like Carrefour and Wal-Mart.

Chen: No problem. You can pull your products out of the supermarkets. Because even if they are there, they won't sell. Legal DVDs in Wal-Mart sell for 22 RMB, right? But even at that price, it is uncertain people will buy. But if you are selling on the streets of Shanghai at 15 RMB, you will see good sales, no problem.

Smith: In the United States you don't have big piracy because you have police support to stop the pirates. In China, the big audio-visual companies are owned by the Chinese government, so at some point the government may decide that they can make a lot of money off DVDs if they decide to stop the pirates. Right now the government doesn't seem to care. I guess they have much bigger problems to solve, and they know that piracy, good, bad, whatever, keeps many people employed. But some day, maybe five or 10 years from now, that may change.

Chen: No, it won't change. In Guangdong it is essential to the economy. Beijing has tried to stop Guangdong producing DVDs many times, but the problem is that if you kill the piracy what are they going to do to support all those people? Selling fruit is not going to do it.

Smith: But to change the subject, what is the potential for the DVD rental market in China?

Chen: It won't work.

Smith: Why?

Chen: Because the rental cost in Shanghai is 1 RMB. So if you build out that business model, how much money can you make?

Smith: Are there places that do rental in Shanghai today?

Chen: Lots of them. Membership card for 100 RMB, and you can see 90 DVDs. But the model doesn't work because to do that in a formal way you would need to rent a store space, and the rent would eat into your profit. And if it was in a top shopping area, the rent would be high.

Smith: I agree. The point is that Block-buster and other video rental companies in the States are dying and they are looking for similar opportunities in China, but I don't think it will work.

Chen: How much to rent a DVD in the States?

Smith: US$3.

Chen: In Shanghai, forget other places, I know there is a big trade in DVDs being shipped to the US market.

Smith: I really respect the model and method of the pirates here. You guys are very good. I think the Hollywood studios should employ you guys. You know the product and know the clients.

Chen: In the Shanghai market, it is all about price.

Smith: But the problem is we can never match the pirate price. The piracy will always exist. We can live with the pirates as long as it is at a certain level. In the US, piracy is maybe only 10%, but in China it is 99%. In HK, maybe 40%, Taiwan 50%, Japan 10-15%, a big difference to China.

Chen: It comes down to income levels. As Chinese income levels rise, the situation will change.

Smith: If legal DVDs were selling in big numbers, then the replication plants would employ a lot of people, the warehouses and retail outlets would employ a lot of people. There are a lot of jobs that would be created if piracy was suppressed.

Chen: But the Chinese government is powerless to stop it right now. If they close a stall, it opens again round the corner.

Smith: I am pragmatic, but there are many people in the US movie industry who believe the piracy problem can be stopped. The strangest thing is that they believe that every time someone buys a pirated DVD copy for 5 RMB, that they have lost a sale.

Chen: Absolutely. That is true.

Smith: They don't understand that if you have a market of 1 billion pirate DVD sales, you are not going to sell the same number of DVDs if there is no piracy. But I will buy a DVD for 5 RMB that I would not buy for 20 USD. So the major studios say they lose X billion dollars a year to piracy. I don't buy that.

Chen: But I think there is a big loss.

Smith: I agree there is a loss, but not as big as they say.

Chen: But if you can open up the China market, you will have good revenues. The problem is there is no way to stop the pirates.

Smith: I know.

Chen: If piracy was stopped, then you could put the price up. If you do not cut the price, you will never open the China market. Direct retail is a good idea for you.

Smith: But if we do direct retail here, our big clients in the US will be very unhappy.

Chen: The key is that there is an imbalance in incomes.