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Netflix will have a tough time expanding to China

Netflix says it will add closed captioning for

Netflix says it will add closed captioning for all its streaming content by 2014. Photo Credit: AP, 2010

It's no surprise that Netflix wants to expand to China: The country's video streaming market, bolstered by the world's largest smartphone market, is already worth $5.9 billion, and it's set to grow in the years ahead. Nor is it a surprise that China seems interested in Netflix's offerings. The Chinese public, like its U.S. counterpart, has found it hard to resist the melodramatic intrigue of the Netflix-produced show "House of Cards." It was a runaway hit in China, reportedly counting Wang Qishan, China's feared anti-corruption chief, among its fans.

But despite all it has going in its favor, there's no guarantee Netflix will succeed at navigating the Chinese media market. And that shouldn't come as a surprise either.

Consider how "House of Cards" has fared in China. Sohu, the Chinese site that streamed the first two seasons of the show with Netflix's permission, never received government approval to stream the third season. But that hasn't stopped Chinese fans from accessing it. Just days after season three's late February premiere in the U.S., pirated DVD copies were available for purchase in big Chinese cities. And according to Variety mainland China quickly became the country with the most illegal downloads of the series.

Piracy of this sort is widespread in China, and it has long been a mixed blessing for U.S. entertainment companies. On one hand, it has seeded interest in China for American entertainment; on the other, it has allowed Chinese audiences to get accustomed to avoid paying for it.

It's not that China's upwardly mobile middle class refuses to spend money on Hollywood entertainment it considers it to be of sufficient quality. Last year, despite the widespread persistence of physical and digital piracy in China, the country's box office revenues were $4.8 billion, the world's second largest following the U.S.

But Netflix will have a tougher sell in China than the producers of, say, "The Avengers." Chinese audiences understand they can't easily recreate at home the experience of watching an action movie in a theater. But if they want to watch a movie at home, turning to an app that charges a subscription fee may be less tempting than finding a free copy on the Internet. (It's not an accident that the most popular Chinese streaming sites don't charge subscription fees, relying instead on display advertisements for revenue.) It's also not lost on the Chinese public that authorized and paid content streamed in China is censored(often heavily), while pirated and bootlegged versions aren't, and often even come with DVD extras.

Netflix will also be hampered by its inability to stream many of the recent films that it currently offers to subscribers in the United States (the company's back catalog will be of less interest to Chinese audiences). U.S. production companies have already started cutting their own deals with Chinese media companies. For example, Lions Gate Entertainment, producer of the "The Hunger Games" (which has a large following in China), has a streaming deal with Alibaba that gives the e-commerce giant exclusive rights to stream the studio's content in China; in late 2014 HBO cut an exclusive streaming deal with internet portal Tencent.

Even if Netflix plans to primarily promote original productions like "House of Cards," it will almost certainly need to find a Chinese business partner of its own. Companies that want to stream video in China are required by the government to acquire a license -- so far only seven have been issued, all to Chinese companies.

That's unlikely to change anytime soon -- but even if it did, Netflix would be wise to seek a Chinese partnership, given Beijing's insistence that streaming video sites devote no more than 30 percent of their offered content to foreign programming.

(Netflix, in other words, would need to find a lot of locally produced Chinese programs to pair with Frank Underwood.) A partnership with a well-connected Chinese company would also help Netflix to clear its programming with government censors.

The leading candidate in Netflix's search for a Chinese partner appears to be Wasu Media Holding Company, which is backed by Alibaba's Jack Ma. That seems like a good choice, for both sides. Wasu and Alibaba have already partnered on building a "smart television" and collaborated in securing rights to Lions Gate content. And Alibaba has said that it views its partnership with Wasu as a way to meet growing demand for "integrated TV, mobile, and Internet services." Becoming the exclusive provider of Netflix programming in China would certainly help. (Alibaba has flirted with outright buying a stake in Lionsgate, as well.) Netflix, meanwhile, would benefit from Ma's ambition to become a player in global entertainment, as well as his connections with Chinese officials and widespread celebrity. Teaming up with him would allow Netflix to take what is perhaps its most important step to meeting its recently announced ambition of becoming "nearly global by the end of 2016." Without China, and the compromises required to operate there, that goal is simply unattainable.


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