Shakeup in China's Online-Video Market Changes Digital Ad Game

Youku-Tudou Alliance Could Drive Up Media Prices But Also Improve Experience for Users and Brands

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China's two most-popular video sites are joining forces in a $1 billion-plus deal that will create a clear leader in the splintered marketplace and give the combined company powerful influence in setting prices for online advertising, an increasingly a key element of marketers' media mix.

Anheuser-Busch and Tudou launch BudLime with video drama.
Anheuser-Busch and Tudou launch BudLime with video drama.

Youku Inc. and Tudou Holdings Ltd. will operate as Youku Tudou Inc. but remain separate brands. They will have a 35.5% share of China's online video market, based on Youku's current 21.8% and Tudou's 13.7%, according to ZenithOptimedia data.

"One company, two brands, two websites, two sales systems ... achieving a win-win situation and realizing a shared dream," Youku CEO Victor Koo said on his microblog this week after the announcement that his company was acquiring Tudou. How he plans to differentiate the sites is unclear.

The potential impact of the alliance was summed up in a cynical quip by a user on the popular Sina Weibo microblogging platform: "The next to merge will be McDonald's and KFC, Pepsi and Coca-Cola."

YouTube is blocked by China's "Great Firewall" but there's a vibrant ecosystem of about a dozen home-grown video sites that are chipping away at TV's dominance in the battle for viewers. Unlike YouTube, where much of the content is user-generated, a major draw of Chinese sites are their extensive libraries of television programs and movies. Mr. Koo has described his company as "Hulu at a YouTube scale."

Youku, in particular, was a leader in obtaining copyrighted content, drawing ad dollars from marketers that had been skittish about advertising around user-generated videos, said Pete Wong, managing director-head of digital at ZenithOptimedia China, which counts L'Oreal as its top digital client. Youku was also one of the first to work with marketers in producing original branded content, with some of its programs garnering tens of millions of views.

Top executives at Youku and Tudou declined to be interviewed while the deal awaits shareholder approval. It is expected to close in fall of 2013.

Government restrictions on TV programming enacted this year (most notably a clampdown on "overly entertaining" shows, which has affected popular genres such as dramas and dating shows) spurred the shift to online video in China. The regulator also banned commercial breaks during dramas, significantly crimping inventory.

"The [television] content was restricted, and the entertainment was limited," said Tony Chen, president of Group M Interaction, China. "But online video is still on-demand, so people can watch programs anytime and can finish a whole drama series in one weekend. The viewership will continue to increase, and the marketing dollar follows the eyeballs."

Marketers spent $7.4 billion on online marketing in China in 2011, representing 13.5% of total media spending, according to estimates from Group M. That was up from $5.1 billion, or 10.6% of the total, spent in 2010.

Youku had 22 % of China's online-ad revenue in the fourth quarter and Tudou had 14%, Bloomberg reported, citing information from research firm Analysys International.

Chinese are spending much of their time online -- an average three hours a day, compared with two hours watching television, according to a study conducted last year by Starcom Mediavest Group. The statistic is the same for consumers even in the less developed, lower-tier markets that brands are keen to crack.

"More and more clients are coming to us and asking, 'How do we best utilize video portals?' They're the highest-engagement sites in terms of where eyeballs are," said Scarlett Lok, head of digital at TBWA /Tequila in Shanghai, which has done online video work for clients such as GE and Coach.

Chinese video sites devote more space to advertising than their Western counterparts, and 45 seconds of pre-roll ads are common. On some sites, ads flash on the screen when the video is paused, and one site even has advertising in the middle of videos.

Industry executives say they weren't totally surprised to hear that Youku and Tudou were merging, as both had been losing money because of the high costs of obtaining copyrighted content. Now they can streamline processes and share infrastructure, allowing for a better user experience and potentially even bigger audiences.

The deal "will certainly impact the future of the overall online-video pricing strategy," said Mr. Chen of Group M. "For premium markets like Beijing, Shanghai and Guangzhou ... the inventory is quite limited. So if they get a dominant position to define the price, I think it might impact the clients' overall ROI." Group M handles online advertising for clients such as KFC, Volkswagen and Procter & Gamble brands.

"The price [of online advertising] is still a bit lower than TV," Mr. Chen said. "A good mix of TV and online video can deliver a higher cost efficiency for the media investment. If the price starts to go up or go even higher than TV commercials, then that will change the game plan."

But there are also potential upsides. A marketer could, for example, sponsor a program on Youku and have it promoted on Tudou and other related properties. And the sites could offer more-attractive advertising packages, with some extra ad time or space to allow a brand to conduct testing.

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