By Melanie Lee
SHANGHAI (Reuters) - Hollywood studios are set to break into China's massive Internet market as domestic video sites scramble to screen U.S. movies and dramas on their digital platforms, a move which could also curb rampant piracy.
China's Youku's and Sohu's online video platforms have already cut deals with Disney and CBS Corporation to stream U.S. drama serials such as "Desperate Housewives," "Grey's Anatomy" and "Gossip Girl," and more such deals are expected.
This represents a lifeline for Hollywood studios who have struggled to make money in China due to persistent piracy and the country's quota system that limits the number of foreign movies screened in theatres to 20 per year.
"Major Hollywood studios have struggled to find a viable business model in the China market and cooperating with China's online video sites for paid viewing of their content finally gives them a way to make money here," said Mark Natkin, managing director of Beijing-based consultancy Marbridge Consulting.
China is the world's largest Internet market, with more than 450 million Internet users, and online video firms are stepping up their fight to secure a bigger piece of the market share to win advertisers.
Advertising revenue in the domestic online video market, which was virtually non-existent five years ago, is now estimated to be worth 1 billion yuan ($155 million). This is expected to grow at double-digit rate for the time being.
Online video providers such as Youku have also started pay-per-view for some movies, thus giving them a new source of revenue.
Analysts say it's still too early to assess these deals' financial impact on Hollywood studios over the longer term, but agree that this offers a long-awaited entry point for Disney and others to the world's second biggest economy.
For online video providers, buying international content is not cheap, with payments for licensing fees needed upfront. But it's well worth the risk given the rapid growth in the world's biggest Internet market and growing appetite for Western movies.
Avatar, James Cameron's blockbuster flick about an alien race, was the highest-grossing movie in China last year, raking in 540 million yuan in only 15 days. Although they form a small percentage of movies screened, Hollywood movies drew 44 percent of all 10 billion yuan in sales receipts in 2010.
Vincent Tao, chief executive of online video site China PPLive that has a deal with News Corp's Fox Network, said Hollywood studios are now finding an avenue to expand into China though the regulatory landscape is still tricky.
"We want to introduce a lot of (Hollywood) movie content and of course we need to get permits but the online permits are much more flexible than the theater quotas," Tao said.
Youku, China's largest-listed online video player, launched its Premium Channel in June, after signing a deal with Warner Bros Entertainment's local joint venture to offer pay per view movies.
Under the three-year deal, Youku will add 400 to 450 Warner Bros movies to its line-up. The deal is the second major Hollywood deal Youku has signed in less than a year. Last September, Youku bought 259 episodes from Disney.
Analysts forecast Youku to break even next year after an expected loss of $17 million loss this year.
Warner Bros, Youku and Disney all declined to comment on the financial size of the deals. Buying broadcast rights for a Hollywood series with 20 episodes costs about $300,000, according to a Reuters calculation based on available industry data.
Youku is contracted to buy at least another 259 television serial episodes this year from Disney with an announcement likely to come in September, a source familiar with the matter said.
"We see many positive signs for the relationship to develop," said Jean Shao, a spokeswoman for Youku and declined comment on the contracts.
In China, which has long been under fire from Western countries for widespread violation of intellectual property rights, it is often difficult to find legitimate Hollywood DVDs or CDs in shops.
According to the latest research by Motion Picture Association of America, China had a piracy rate of 90 percent causing a total revenue loss $244 million on its member companies in 2005.
The Motion Picture Association consists of the six major film studios Disney, Paramount Pictures Corporation, Sony Pictures Entertainment, Twentieth Century Fox Film Corporation, Universal City Studios and Warner Bros.
The latest move by online video sites to offer some Hollywood movies for free to its customers will help stamp out off-kilter videos and pirated DVDs and CDs from the streets.
"It's a significant win in terms of respect for IP (intellectual property)," said Michael Clendenin, managing director at technology consultancy RedTech Advisors.
"The key competitive edge for online video service providers is to expand their video library, thus spending heavily on movie and TV content," Muzhi Li, a Hong-Kong based analyst for Mizuho Securities said in a note.
The country's biggest search engine Baidu has also ventured into this sector. Its Qiyi joint-venture with Providence Equity Partners has cut deals with Disney to show all seasons of Desperate Housewives, Cougar Town and Grey's Anatomy.
It also signed a music deal with record labels, ending lawsuits between all parties.
(Additional reporting by Lisa Richwine in LOS ANGELES; Editing by Kazunori Takada and Frederik Richter)