iQiyi Has Burned Cash for Four or Five Years and Tried Every Business Model. Now It Is Talking About Making Money Three or Four Years From Now

Count from the founding of Youku and China's video sites have gone ten years without a profit.

iQiyi has been busy lately.

On Tuesday afternoon it held a "Partners Summit" in Beijing. The several hundred people in the audience were not only reporters and invited guests but also professional users of the iQiyi platform — small and mid-sized film and TV production companies, for instance.

iQiyi built its audience by buying copyrights and financing its own dramas and films. Now, like Youku Tudou and YouTube, it wants content made by professional users, and it will share ad revenue with them.

The words repeated all afternoon were "business model" and "monetization." iQiyi has set up a 1-billion-yuan venture fund to invest in content producers.

Wang Xiaohui, iQiyi's chief content officer, said that this year the company has been "exploring the path from an IP ecosystem to multiple dimensions of service," including "an online mall, games, a community, movie tickets, livestreaming…" — all of it meant to "maximize the value of IP" and hand PGC (professionally generated content) creators a bigger cut of the ad money.

What iQiyi announced today is, of all its recent moves, the one that has the most to do with film and television.

In late November, iQiyi said it would work with New Oriental Online, EF Education First and other education providers on "iClass," a paid educational video service.

Around the same time, the website of a Shenzhen phone maker began selling phones carrying the iQiyi brand; buyers got iQiyi Gold VIP privileges. iQiyi put out a statement saying it had never made a phone, but the box was printed with the words "an iQiyi film-and-TV cooperation product."

Stranger still, an app called "iQiyi Toutiao" launched recently, aggregating content the way Toutiao does.

Without the iQiyi name and the green color scheme, you would never connect it to the video site.

Senior vice president Geng Danhao says all of this belongs to the IP industry chain. iQiyi Toutiao is "a powerful complement" that can bring feed-based ad revenue to partners — and, of course, to iQiyi.

CEO Gong Yu told Tencent Tech recently that "once the model matures in three or four years," advertising, membership, and games and other content will each supply a third of revenue and together fill iQiyi's pockets.

Six years after launch, and several billion yuan later, iQiyi is still talking about a business model that matures in the future.

Baidu Can No Longer Bankroll Cash Burn That Brings Nothing Back

Video sites burning cash is not news. Counting from Youku's listing in 2006, this has been a business of burning cash to buy users for a decade.

Video is now a spending contest among three companies — Baidu, Alibaba and Tencent. Youku Tudou has Alibaba behind it; Tencent Video has Tencent. But Baidu, which pays iQiyi's bills, is unlikely to put in much more.

Baidu's third-quarter results this year put content costs, a line inside its cost of revenue, at 2.211 billion yuan, exactly double the same period last year. Baidu's own note in the filing says this cost comes mainly from iQiyi: buying copyrights, producing original shows, and so on.

More than 12% of Baidu's revenue now goes to subsidizing iQiyi — three times the share of two years ago.

The spending has not produced a profit. iQiyi's revenue comes mostly from advertising, and that number keeps climbing, but copyrights cost so much that the site's losses keep widening too. They are now three times what they were two years ago.

Baidu's own advertising business, which supplies 90% of its total revenue, has run into trouble as well.

Most of Baidu's ad money comes from healthcare. After the Wei Zexi case, Baidu made changes under public pressure and a government order to clean up its practices. Its profit fell 30% in the second quarter this year, and total revenue did not grow in the third. The bad stretch will clearly continue.

To make its books look better, Baidu tried to carve iQiyi out of its listed assets. That would have suited both sides: iQiyi could raise money in China, or even list there, and Baidu could shed a huge source of losses.

In February, Robin Li and iQiyi CEO Gong Yu, representing a consortium, offered to buy 80% of iQiyi's equity from Baidu at a valuation of $2.8 billion. Baidu's share price rose on the news.

But Acacia Partners, a New York hedge fund holding $400 million of Baidu stock, led the opposition, calling the price too low: Youku Tudou had sold to Alibaba for $4.8 billion.

A few months later, the privatization was called off.

Unable to spin it off, and with its own revenue sliding, Baidu will not keep transfusing iQiyi without limit. That explains why iQiyi looks anxious.

Look back, though, and iQiyi is one of the better performers among Chinese video sites when it comes to making money. It has tried nearly every business model video has to offer.

Follow its history and you can watch the whole online video industry struggle to turn a profit.

At First, Video Sites Talked About Advertising, and iQiyi Plugged Into China's Biggest Internet Ad Platform

Buy good copyrights, pull in viewers with the content, sell more ads at higher prices — that is the basic formula for a video site to make money.

From its first day, iQiyi has talked about "advertising technology."

Baidu put the site together and launched it in 2010. Gong Yu, formerly president of 12580, ran this video site built around "licensed, high-definition online video." Back then it was still called Qiyi.

The story Qiyi told from the start was tied to Baidu. Advertising is what Baidu does best; it is still the largest ad platform on the Chinese internet, with 90% of the search-marketing market and tens of billions of yuan in revenue a year. To serve that core business, Baidu set up branch offices in first-tier cities across the country, and hundreds of agencies in third-, fourth- and fifth-tier cities sell its ads for it.

Seen this way, iQiyi had an advantage no competitor could match. Because of Baidu, iQiyi passed Sohu Video in its fourth year, 2014, to rank third by market share.

The "advantage" was not only traffic. It was data. Six billion searches are typed into Baidu's box every day. In 2013 Baidu handed all of that search data to iQiyi to analyze, and the two released "Yisou Baiying" — one search, a hundred impressions — a precision advertising technology. The algorithm built "user profiles" out of browsing records and search history, then served matching ads on iQiyi.

Search "car purchase tax" this month, for example, and iQiyi will greet you with pre-roll ads for Land Rover, BMW, Volkswagen and Fiat.

In 2013 iQiyi merged with PPS and pooled the two data sets; iQiyi said they had "built China's largest video ad platform."

There were several products like it. Take "Green Mirror" in 2013: iQiyi used big data as an "editor," analyzing how users watched a video to judge what they liked, then automatically pulling out the footage that held the most attention to generate a "highlights" cut.

Advertisers found this more appealing. Knowing which part of a show viewers liked best is the first step toward "precision placement."

Or take "video in" in 2014, which used post-production to drop ads straight into a video. In a restaurant scene in Loser Brothers 2 (《废柴兄弟 2》), twenty or thirty cans of JDB herbal tea fill the frame; an actor sits down, picks one up and pours it into a glass — and out comes a clear liquid, because the JDB cans were spliced in later. "It's a bit like Photoshop in a three-dimensional world," iQiyi's CTO said. Gao Xiaosong's Xiaosong's Talk (《晓松奇谈》) used the same technique.

"We are a technology company," Gong Yu said in 2014. Close to half of iQiyi's staff were engineers.

Competitors were trying similar things. In 2015 Youku Tudou started working with Tmall to slip purchase links into some videos.

These experiments did drive revenue up. Analysys International puts the Chinese online video market at twice the size it was in 2014.

But the market has stopped growing. In the first quarter of this year, China's online video operators took in 6.69 billion yuan, 6% less than the quarter before.

Ad Money Is Not Enough, Because the Copyright War Will Not Stop

Video sites spend most of their money buying copyrights, and this is truer of iQiyi than of anyone. When it launched in 2010 iQiyi promised "licensed, high-definition video content, with piracy completely eliminated."

But competition kept pushing content prices up, and the copyright war has not paused since it started.

In 2011 a single episode of a TV drama sold for 700,000 to 800,000 yuan on average, and as much as 1 million. That year Youku lost 172 million yuan, Tudou 511 million, iQiyi 500 million.

The copyright war hit the smaller sites with thinner wallets hardest. You may remember Ku6.com, which once competed on licensed content too; in 2011 it announced it would stop doing long-form video.

Things eased in 2012. The Youku-Tudou merger cooled the copyright market for a while, and a hit licensed drama like Empresses in the Palace (《甄嬛传》) went for about 300,000 yuan an episode.

Sohu, Tencent and iQiyi tried to push prices down by buying together. Their alliance held the rights to twelve TV dramas: each company contributed four it had already bought online rights to, and the three then redistributed them.

The "alliance" was pulled apart by competition over "exclusive content" soon enough. In 2013 Youku Tudou signed an exclusive copyright deal with Hong Kong's TVB, Sohu positioned itself around "licensed American dramas," and iQiyi bought Alpha Animation's entire catalog.

In 2014 iQiyi bought distribution rights to more than 1,000 Hollywood films. A month earlier, at the Busan International Film Festival in South Korea, it had signed for 90 more.

Costs rose to match, year after year. From 2013 to 2015, the "content cost" line in Baidu's results grew by more than 90% every quarter.

Even now copyright prices have not fallen. They keep rising.

A year ago Tencent and LeEco jointly bought The Legend of Mi Yue (《芈月传》) at 3 million yuan an episode. Six months later five video sites jointly bought Ice Fantasy (《幻城》) and the price jumped to 4 million. Three months after that, Tencent and Youku jointly bought Ruyi's Royal Love in the Palace (《如懿传》) at a record 9 million yuan an episode.

"[The price war] disgusts me, it sickens me, and yet every day we are still fighting it, still spending huge sums on it," Gong Yu said at an industry forum in April.

Original Content Saves Some of the Copyright Bill, but It Has Not Replaced It

Licensed content brings viewers and traffic, and that converts directly into ad revenue. Probably that is why video sites are "still fighting it."

Making your own content, which you can control, is the sensible answer. Original content is sometimes a form of copyright purchase too, but buying it outright saves a great deal of overpriced licensing. Both Youku Tudou and iQiyi have said more than once that they want to be Netflix, or beat it.

Netflix, which made its name with the original series House of Cards, was also running from rising licensing fees. Unable to agree on price, it once lost thousands of films and shows from Warner Bros. and Universal Pictures.

iQiyi put out its first original TV series in 2011, but the business plainly did not start in earnest until 2014. By then Sohu Video's Diors Man (《屌丝男士》) and Youku's Who Would've Thought (《万万没想到》) had been popular for a while.

iQiyi's first successful original show was U Can U Bibi (《奇葩说》). In 2014 Ma Dong, who had left CCTV to become iQiyi's "chief content officer," brought in Gao Xiaosong to start this debate program. It is still the high point of web variety in China, with a Douban score of 9.0; the second season alone drew more than 600 million views.

There is a problem, though: competition has gradually taken iQiyi's control of its own content away. As the chart above shows, iQiyi's output is uneven, and its best work keeps leaving.

In September 2015 Ma Dong left iQiyi with the U Can U Bibi team and founded a production company, Miwei Media. At the launch, Kai-Fu Lee, CEO of the investor Sinovation Ventures, gave Ma Dong a "golden egg." iQiyi CEO Gong Yu said: "We burn gold every day. We can't afford a golden egg, so we're giving you a partnership agreement."

U Can U Bibi went from being iQiyi's "only child" to its "partner," an independent production team. Its list of partners now includes Youku Tudou as well as iQiyi.

Three years ago Gao Xiaosong "transferred" from Youku to iQiyi and joined its "studio" program. This week his Xiaosong's Talk announced it would stop producing new episodes, formally parting ways with iQiyi.

Splitting the Money With TV Makers Is Not an Easy Business Either

iQiyi has also tried to sell its service to more set-top-box owners.

LeEco was the first to bundle video with television sets. The company, which says it is building an "ecosystem," has been developing and releasing TV products since 2009.

In 2013 iQiyi signed with TCL on an "Inside" strategy and released TV sets with iQiyi membership preinstalled.

In 2014 Xiaomi put 1.8 billion yuan into iQiyi to build a "content ecosystem," the largest outside investment Xiaomi had made since it was founded. Xiaomi TVs and phones became a priority distribution channel, and iQiyi's shows and films turned up on Xiaomi televisions, boxes and phones. By now iQiyi is the only source of video content left on a Xiaomi TV.

This year iQiyi started investing outward itself. In September it put 150 million yuan into Coocaa, a Skyworth subsidiary, for a 5% stake — its first investment in a TV hardware maker. Starting next year, Skyworth's internet-connected televisions will come with iQiyi's VIP service preinstalled through the Galaxy Internet TV integrated broadcast-control platform.

Working with the companies that make TVs and boxes gave video sites a policy opening. Rules from the broadcasting regulator, SAPPRFT, have tightened, aggregator TV apps have been declared illegal, and commercial rivalry does the rest: watching everything through a single box is now basically impossible. For iQiyi, holding more TV terminals means more places to distribute.

But the policy sweeteners — energy-efficiency subsidies, trade-in programs — are gone, and people replace televisions rarely. Neither the internet hardware companies like Xiaomi and LeEco nor the traditional TV manufacturers appear to have enough margin left to share with a video site.

Over the Past Two Years, iQiyi Has Tried a Great Deal With Memberships

After U Can U Bibi, iQiyi seemed to see the light all at once, and its 2015 original shows brought the company membership money directly.

Youku had already launched paid services by the end of 2010: movies on demand, monthly viewing memberships, high-definition concert streams. iQiyi opened a membership zone in its second year, where 5 yuan bought a licensed film and a membership removed the ads.

But membership never delivered enough extra value to become the mainstream — not until 2015. It started with The Lost Tomb (《盗墓笔记》).

The Lost Tomb, a TV series co-produced by Nanpai Sanshu and Huanrui Shidai, aired only on iQiyi. Its preview episode passed 100 million views in 22 hours, the fastest any web series had done it, and it became a talking point at once, climbing Baidu's trending list and Weibo's hot topics.

Paying members could watch every episode at once; everyone else waited for one a week. The experiment set iQiyi's membership service alight, and at one point the servers behind it crashed, leaving users unable to pay.

A few months later Legend of the Shu Mountains (《蜀山战记》) tried a second model: VIP members could watch the whole first season before the TV stations began showing it to everyone else.

Those two shows brought iQiyi a lot of members. In its first four years the site signed up only 5 million paying users. From 2015 to now — about a year — the number has grown to 20 million.

Riding the wave, iQiyi packaged VIP membership as a product in October 2015, pitched it as "affordable luxury," hired Yang Yang, Angelababy and Huang Bo to endorse it, and put ads on buses, in subways and in elevators.

More resources tilted toward original content. iQiyi said it would put 50% of its 2016 resources into membership-related services — copyright purchases, service upgrades and original shows — and would buy or produce more than 40 major dramas for members.

"iQiyi has 600 million users in total, and our goal is to turn 10% of them into paying users," the company said at the end of 2015.

iQiyi also pushed its competitors to compete on membership.

After The Lost Tomb, Youku Tudou spent 480 million yuan on Fan Bingbing's Winning the World (《赢天下》) and followed the same pattern: online first, television later.

Youku Tudou spent 600 million yuan on original dramas in 2015, up from a budget of 300 million the year before. They wanted more shows like Who Would've Thought and Luogic Show (《罗辑思维》).

Tencent Video announced a plan for "eight top-quality web dramas" this year and predicted that "the industry's paying membership will reach 1 billion visits" over the same period. Its biggest swing in 2015 was The 15 of Us (《我们 15 个》), a reality show modeled on The Truman Show.

By market share, iQiyi leads here too. In 2014 it ranked third in monthly active users, behind Youku Tudou and Tencent Video. By 2015 it had moved to first.

But original content is still not being made at scale.

And membership brings in very little so far. In November, Tencent Video said its VIP membership had grown nearly 300% over the past year, passing 20 million, the same as iQiyi. In December, Youku said its paying membership had reached 30 million.

Not everyone buys by the year, though, and no company will publish its retention figures. Add in the constant promotions and only the sites themselves know how much revenue tens of millions of users actually produce.

Netflix lives on paying subscribers in the United States, but its users got used to a credit card charged automatically every month long ago; they rarely see a prompt asking whether to renew. In China, every renewal is a chance for the user to walk away.

The Question That Finally Has to Be Answered Is Whether Video Sites Can Supply This Much Film and Television at All

iQiyi has tried every business model there is to try. And it has done none of them badly.

Advertising: it has China's largest internet ad platform behind it.

Paid membership: according to the China Netcasting Services Association, paying users, including those who buy a single title, make up 9.5% of iQiyi's user base. That is already the highest share among the major video sites; Youku Tudou and Tencent Video are both below 5%.

In the end, none of this money can support content spending that keeps climbing.

As for online education, branded phones, iQiyi Toutiao — iQiyi's recent efforts have little to do with film and television at all.

From 2010 until now, this market, kept alive by cash burned by Baidu, Alibaba and Tencent, shows no sign of making money.

The other industries big companies pushed along by burning cash are already hard to sustain. Ride-hailing and food delivery both cost much more than they did six months ago, and the so-called O2O industry has essentially ceased to exist.

Perhaps we should be asking a different question.

Whether letting hundreds of millions of people consume film and television cheaply, or free and paid for by ads alone, can last at all.

Cover image from Pixabay