By Paul Carsten and Jane Lanhee Lee
BEIJING (Reuters) - The website of China's biggest Internet video company Youku Tudou Inc was once a haven for illicit Hollywood blockbusters and hit South Korean soap operas, until it realised piracy really doesn't pay.
Now the company that controls almost a third of China's booming online video market forks out more than a billion yuan ($164 million) a year on licenses so it can legally distribute movies and shows like "The Walking Dead", a strategy expected to result in its first ever quarterly net profit.
And to protect this market share, Youku Tudou employs a dozen sleuths who scour the web for pirated content, highlighting how China's online video industry is courting higher advertising revenues and better relations with foreign media firms by cracking down on illegal content.
"The biggest challenge is that there are more new ways to pirate video as the technology develops," Lu Changjun, the head of Youku Tudou's Internet police squad, told Reuters.
In the past, China's video websites were rife with pirated films and TV programmes, often put there by users. Companies also repeatedly sued each other for copyright infringement.
Youku Tudou and rival Baidu Inc, China's search engine giant with the second largest market share of online video, both told Reuters via email this week that they never deliberately ignore pirated material on their websites, and never wilfully upload unlicensed content.
Tencent Holdings Ltd, which runs China's fourth-largest online video site, also told Reuters it never ignored or engaged in piracy.
All three companies, however, also said they have lost copyright infringement lawsuits filed by other Chinese firms in local courts.
Better technology has now helped these firms police their sites more vigilantly.
Advertisers willing to put money on legal content, and the popularity of online video, have also provided incentives: China's online video market is expected to grow by more than a third this year and see annual revenues of 12.3 billion yuan ($2 billion), according to data from Beijing-based Internet research firm iResearch.
Youku Tudou and Baidu, as well as rivals Sohu.com Inc and Tencent, all say they are fighting piracy.
Piracy leaves companies open to costly lawsuits, and also eats into the viewer numbers, and advertising revenues, of those sites that have spent big on licensed content. It also hurts the sales of foreign entertainment production firms.
"We pay so much money to buy content," said Charles Zhang, chief executive of Sohu.com, China's third largest online video provider.
"So we can't sell ads, or the revenue from ad sales can't cover our content costs. If piracy continues we won't be able to survive," he added. "We bleed and lose money."
Sohu.com has seen online video advertising revenues increase 123 percent year-on-year in the first nine-months of the year, according to its latest earnings statement.
Market leader Youku Tudou, which makes the bulk of its money from advertising, said it saw a more than 70 percent year-on-year increase in its net revenues in the third quarter.
The third quarter results of Tencent Holdings Ltd also show online advertising revenues rose almost 40 percent year-on-year to 1.39 billion yuan ($228 million), with video driving most of the growth.
Baidu did not give a specific figure for online video revenues in the third-quarter, but said overall revenues grew more than 40 percent year-on-year to 8.892 billion yuan ($1.45 billion).
Baidu also shelled out $370 million to acquire online video site PPStream in May, to merge with its own iQiyi.com video site, and in September announced the launch of a line of Smart TV products.
China has long been known for its weak intellectual property protection and enforcement, leading to numerous disputes with the United States.
But a salvo of lawsuits announced in November underscores how the industry has changed.
Last month, Youku Tudou, Tencent, Sohu.com and Chinese conglomerate Dalian Wanda group joined forces with the Motion Picture Association of America to sue Baidu and smaller Internet video software-maker QVOD for 300 million yuan ($49.2 million) in damages for copyright violation.
Baidu, in a statement sent to Reuters this week in response to the lawsuits, said it "deeply regrets the sensationalistic litigiousness".
"At present, we've already agreed to work together with many copyright holders, and together provide better resources for legal high-definition video for our users," the statement added.
QVOD was not immediately available to comment. A spokeswoman, responding to the lawsuits, had previously told Reuters the company did not provide content. "We are just a video player," she said, declining to elaborate on the piracy allegations.
Michael Clendenin, managing director of technology consultancy RedTech Advisors, said the lawsuits would help Chinese online video firms gain more clout with foreign media providers as it showed how serious they were about piracy.
"From Youku's perspective they gain some points with people they license content from, that's Hollywood," he said.
"In the future they need to be able to license content and be able to say they take a strong stand against piracy."
CONTROLLING THE ROUTES
According to Youku Tudou, about a quarter of the 20,000 links it finds each week that lead to pirated content on Android systems alone are on Baidu's portals.
The company's Internet police chief Lu said the number has dropped to one-fifth since the lawsuits were announced, but analysts note that there are plenty of other portals in China that host links to pirated content.
Baidu and QVOD pose a different challenge to their rivals because of their dominance on mobile Internet which is fast becoming the method of choice for Chinese audiences.
More than three-quarters of China's Internet users access the web through smartphones and tablets, according to the State Internet Information Office.
Controlling the routes from your home page to content, like Baidu and QVOD do, is key to getting eyeballs.
Baidu says it is the default search provider on over 80 percent of Android handsets shipped to retailers in China, the world's biggest mobile phone market by sales.
QVOD's Kuaibo video app accounted for almost one-quarter of all video content app downloads in the past four months, nearly matching the total for the Youku Tudou and Baidu video apps combined, according to data from Wandoujia, China's second biggest Android app store by monthly active users.
The app lets users pull content from websites onto their phones and tablets, stripping away the ads in the process.
"Consumers spend more and more time watching videos on mobile devices, mobile phones and tablets," said Xiaofeng Wang, a Beijing-based analyst at Forrester Research.
"All these video platforms need to go where consumers go. Revenue is increasing very fast, and they can see lots of traffic actually driven from mobile users."
As faster mobile Internet becomes the norm in China, more viewers are willing to put up with online video advertising to get higher-quality, easy-to-find legal content than go hunting for poorer-resolution pirated versions.
"At the end of the day piracy is going away in China. There's no use going to the DVD store on the corner -- you can get it online," said RedTech Advisors' Clendenin.
"The online video industry has just been happy it's moved to this point and user habits are changing very quickly." ($1 = 6.0924 Chinese yuan)
(Additional reporting by Anita Li; Editing by Miral Fahmy)