Unlocking the music market in China

John Kennedy, Chairman and CEO, IFPI

Speech delivered at the China International Forum on the Audio Visual Industry, Shanghai, May 25 2006

Good morning ladies and gentlemen.

I was delighted and honoured to be invited to participate as a keynote speaker at the 2nd China International Forum on the Audio Visual Industry. Observers from all over the world are fascinated by this ancient country that is making its entrance into the global economy and which will undoubtedly be one of the biggest players of the 21st century.

Shanghai is a perfect location for this event. I find myself a relatively frequent visitor to this country and every time I come back I am struck by how fast it is changing. In Shanghai, new buildings seem to go up every day. There is no doubt that this city is a great symbol and a powerhouse of the new China.

The Rolling Stones came in April, another milestone in the international music industry's growing partnership with China. Today that partnership is extended a little further through this impressive gathering of the Chinese public and private sector, and your intermediaries, trading partners and potential investors from across the world.

I can't promise to be as lively as the Rolling Stones were - but I hope today that I can take this opportunity to elucidate my vision under the well-chosen theme for this event - "The new epoch of the recording industry".

I am chairman and CEO of IFPI, a position I took up in 2005 after a career of nearly three decades working in and heading record companies. Before moving to IFPI I ran Universal Music International, part of the world's largest record company. Today I am speaking to you on behalf of my members, numbering some 1,400 major and independent record companies who are present in no fewer than 70 countries around the world.

IFPI's mission is to promote the record industry's interests worldwide - to help the industry find new markets for its music, physical and digital; to fight piracy, on the internet and in our physical markets; to work for good copyright laws and enforcement practices; and to promote awareness of - and policies that reflect - the economic and cultural value of music.

Today, I would like to talk to you about the extraordinary growth potential for the music sector in China, both as market for indigenous and international music and as a source of repertoire to export to the rest of the world. I want to put this in the context of the development of international trends in the music business. And, finally, I want to discuss what I believe are the essential steps that need to be taken in order to unlock the economic and cultural opportunities which China presents to the music world.

There are many industries represented in this audience today, with different strategies and business models. Let me start by recalling how the recording industry does its business. First and foremost, unlike any part of our sector, record companies are investors in music, and on a huge scale. Depending on the national market, between 15 and 20% of our industry's turnover, goes into discovering new talent. A great deal more goes into nurturing, promoting and marketing that talent. Of all the artists that we invest in, a tiny minority will be successful, and it those very few successful artists who finance the investment in thousands of artists who will never achieve commercial success. This is what I call the "virtuous circle of investment" and it is essential to understanding the role, and in turn, the priorities of our industry.

Many benefit from this virtuous circle: record companies, new artists, established artists, music retailers, music distributors, radio stations, film companies, advertisers, TV companies, your businesses and the public. And of course one of the biggest beneficiaries of all is society at large that is given the opportunity to listen to and enjoy recorded music over a broad range of styles.

In this sense the recording industry is an engine for a great swathe of economic activity. We estimate that if you take into account all the activities which recorded music helps generate - from live music to publishing - our global value is approximately US$100 billion - three times the actual size of our retail sales.

The role of the record company as an investor in music cannot be overstated. Across the world, about three billion dollars a year is invested in new music. No other sector in the music industry, from publisher to retailer, invests on any similar scale nor shoulders the substantial risks involved.

But the virtuous circle of investment depends critically on a simple idea: that music is properly licensed and paid for. It is at the heart of our business model, and what we act to protect. And it is underpinned by one essential requirement - adequate copyright protection. Copyright underpins the music industry and diversity of choice for consumers. Intellectual property protection underpins the business of the music industry globally.

Copyright is the means by which creators and innovators can be rewarded for their works and thereby provides the incentive for creative business. Copyright, and its effective enforcement, is the most essential ingredient to our success in any market, be in it the physical or digital environment. Effective enforcement of copyright is more relevant to the future of the music sector in China today than it is in any other market.

Today China is the most exciting new market in the world for the international recording industry. The major international record companies have built up their presence in the China market over recent years. EMI launched a joint venture with Shanghai-based Push Sound; Sony BMG created a partnership with Shanghai Audio and Visual Press; Universal Music linked with the Shanghai Media Group and Warner Music Group created Warner Music China. Independent companies are looking for new opportunities, knowing however that there is no simple solution to investing in China and building commercial relationships is a long-term process. Companies are experimenting with new forms of business model often untried in other markets. The success of artists such as Xu Wei and Jay Chou, backed by international investment, point the way the future. So does the emerging picture of the fascinating diversity of consumer taste in China.

China's music market today is a picture of untapped potential. The country has a population of 1.3 billion - one sixth of the world's population. A rising middle class with disposal income, and a young demographic, is driving consumer demand. Yet music sales in China last year stood at only US$86 million, making the country only the 20th ranked music market in the world and the fifth in Asia, behind Japan, Korea, India and Taiwan. We have a very, very long way to go.

I am cautiously optimistic that there will be exciting growth in the coming years for two key reasons. First, because I trust that China - and its leaders of government and industry - will recognise that a flourishing commercial music sector is entirely in their own self-interest. Music is just one part of a large sector of entertainment, media and innovation industries that have the potential to drive China's economy in the future. PWC estimate this broad entertainment and information sector at already over one trillion dollars globally and likely to rise to $1.8 trillion in 2009. This is the "knowledge" economy, the key to future employment and economic growth.

Second, China has a market promise also unseen elsewhere in the world. Because of the exceptional combination of an undeveloped piracy-dominated physical market and a rapidly-developing wireless environment, China is now uniquely placed to become the world's showcase digital music market. Look at the statistics. China accounts for nearly half of all the broadband lines in the whole of Asia. Only the US has more broadband lines installed. And it has the region's largest mobile phone market, with nearly 400 million subscriptions. Mobile music is already far advanced. For the international record companies operating in China, sales of music via mobile phones already accounts for about 15% of industry revenues. This is a very small sum in total, but as a proportion of total sales compares impressively with the global average for digital sales in 2005, which was just over 5%. Worldwide, only Korea shows a larger percentage for digital sales.

There are five legitimate digital music services in China and we forecast there will be many more setting up in the next few years. In the past two years the volume of music made available online has increased more than six-fold to more than two million songs.

China's transition to digital is of course being mirrored across the world. Record companies have rapidly transformed themselves in years from a business dominated by two revenue streams - physical retail sales and radio - to one of countless different licensing channels, from ringtones to subscription services, from mobile downloads to music videos. Even today, I am asked sometimes if digital delivery is a long-term destination for our industry or the cherry on the cake of our physical markets. The answer is emphatically that digital music is key to the industry's future. In 2005 worldwide revenues from digital music surpassed US$1 billion. In 2010 most in our industry think digital will have risen from 5 to 25% of our revenues.

So China is heading rapidly into the digital era, and the music industry is helping lead it there. This is incredibly exciting opportunity for a country that has been tarnished for years by rampant physical format piracy. Today, the predominance of mobile music channels gives China the chance to leap ahead of Europe and America. Mobile music has two big advantages - first a workable customer billing system that is already established; and second, for the time being, unlike the internet, piracy in mobile music appears to be better controlled, largely with the help of the mobile telecommunication operators. The window of opportunity is there for a new thriving legitimate business.

But there are many challenges for us, and for China, to confront if the opportunity is to be seized. It must develop a sound legal environment, promote legitimate music channels and above all, crack down on the culture of music piracy before it can destroy the value of creative content.

So what is the blueprint for unlocking the music market in China? It starts not with a wish list of specific priorities, but with one big fundamental principle - namely, that if China is to develop a successful music sector it has to be rooted in the protection of creative content and in the effective enforcement of intellectual property rights. We are looking for profound support for that principle from our partners in both Chinese industry and government.

What does that mean in terms of the practical changes that are needed inside China? First and foremost, it needs a wholesale sustained attack on piracy levels which have long debilitated a fledgling legitimate music sector in China. Illegal sales of music are China is valued by IFPI at around US$400 million, with around 90% of all recordings being illegal. No creative or knowledge-based industry can hope to survive in such an environment. There have been misplaced suggestions that record companies should tackle piracy by lowering their prices. It is true that, faced with the dramatic impact on their business, some companies have experimented with lower prices but this is only a reflection of desperation at such prolific piracy rates and is not, I believe, a sustainable strategy. I mentioned the music industry's very high levels of investment in developing new talent and bring it to market. Pirate operators never incur those costs and will always be able to charge their product for close to free. And that makes fair competition by legitimate producers impossible.

I do believe that in China today there is a far greater awareness of the need to tackle piracy than there was some years ago. Actions by the authorities against CD plants in recent months, and announcements from the China government indicating that the problem must be seriously addressed give me hope for the future, but it remains to be seen whether the vision articulated in recent public statements will be implemented in practice and realized in the marketplace. Specifically there needs to be a sustained programme of enforcement which has a meaningful impact of the level of piracy in China. Criminal penalties need to be enforced that act as an effective deterrent against pirate traders - this requires considerable political will from the local authorities. I believe there will be political will, once the message is clearly received that China is the biggest victim of piracy and that China will be the greatest beneficiary of proper enforcement.

Internet piracy is rapidly-growing problem in China and now threatens to strangle the fledgling legitimate digital music market before it has hardly evolved. While I am hopeful about the prospects for the music industry of China leapfrogging CDs to digital delivery, it is worrying that the entrenched culture of physical piracy has also shape people's mindsets at the start of the digital era.

China has seen an alarming increase in websites, streaming sites and illegal file-sharing, and this urgently needs addressing. Our industry is stepping up its attempts to remove infringing websites from the networks. In 2005 we send over 1,000 warnings requesting ISPs to take sites down. The process is far too cumbersome and slow. Long-awaited proposed new internet regulations are currently in the process of being introduced to provide incentives for ISPs to fight piracy and shift the burden of responsibility for tackling infringement towards ISPs.

Up until now the music industry's fight against internet piracy has relied heavily on litigation against pirate operators, against infringing p2p networks and against many thousands of illegal uploaders. These strategies have all been effective - but to keep piracy in check on a long-term basis we need far greater support from our partners. The telecommunications industry, in China and elsewhere, is already doing very well out of revenues from digital music. We look to ISPs to set the example and take on responsibility for fighting internet piracy. It is in their long term commercial interests to do so.

It is clear that the ISPs are far from adequately supporting us today. I have been very disappointed in recent months to see some well-known brand names among the internet companies blatantly infringing our members' rights. Baidu has already been found guilty of copyright infringement in the Chinese courts; China-Yahoo is now in a similar position, choosing to turn a blind eye to the infringements taking place on its service instead of setting the example of responsible practice which we would expect from them. We are watching China-Yahoo closely and will have no hesitating in acting to protect our members' rights if we should have to.

A major priority is to improve the legal environment for music industry in China. Since the WIPO Treaties were concluded in 1996, countries around the world have been modernising their copyright laws. These safeguard the rights of copyright owners and ensure the use of measures to protect their repertoire. We understand that China plans to ratify and implement the WIPO treaties in the current year, and we hope that the law and implementing regulations will help establish a fair framework for intellectual property rights.

China also needs to introduce public performance rights creating the incentive for record companies to license their music for broadcasting and public performance. Public performance of recordings and videos, in bars and restaurants, could amount to tens of million of dollars a year.

It is well known that international record companies face particular obstacles in investing in the Chinese market which they do not face elsewhere. Market access in China is an issue which needs to be resolved if China's market potential is to be genuinely unlocked. Record companies need to be able to operate across the whole spectrum of activity involved in our industry - from artist and repertoire to distribution. They are currently prohibited from owning and running a single company in China to develop, produce, market and distribute recordings.

These obstacles need to addressed and removed if China is to develop a successful music sector with its international partners. In addition, while we fully understand China's sensitivities and the consequent desire to maintain censorship regulations, it is important to streamline the process and to make the process as transparent as possible. At present, censorship provisions only serve to delay legitimate distribution as the distribution of pirate products is not hindered. This additional commercial advantage unwittingly granted to pirates must be addressed.

Finally, education has a critical role to play in the development of a legitimate music business in China. One of the most important areas the government can work with industry on is changing public attitudes through education programmes. The pirate market in physical music has conditioned people to devalue the creative process and believe they should get their music for free online.

IFPI has undertaken educational campaigns around the world to explain the value of the creative industries and the dangers of illegal file-sharing, from possible legal action to being swamped with the computer viruses and spyware that are prevalent on the illicit p2p networks.

Only a few weeks ago we published a Chinese-language version of our parents' guide 'Young People, Music and the Internet' with the cooperation of Hong Kong's Intellectual Property Department. We would welcome the opportunity to distribute such material in other cities in China in partnership with the authorities.

We are also asking governments around the world to consider adding copyright to the school curriculum so that young people understand the importance of intellectual property rights, the moral base on which they draw and their critical importance to economic development.

In conclusion, I hope, and must believe, the Chinese authorities will play a positive role in securing the future of the creative sector in this country Chinese economic, social and cultural self-interest demands this.

The Chinese government is extremely shrewd and has laid the foundations for an economy that could dominate the world. They have succeeded in manufacturing and acted as champions for that sector. The next industry they need to champion is the intellectual property sector.

China is an exciting country to do business in. It has a magnificent culture stretching back over thousands of years and its creative sector has a big role to play in the country's future.

We are not asking the government for subsidies or special treatment. All we want is a fair framework of intellectual property laws properly enforced so that people cannot steal music. I believe that if we can achieve that then we will all benefit: government, industry and ultimately consumers.