BEIJING — Chinese competition regulators are considering a crackdown on Tencent Music Entertainment to bring the streaming giant down to size, but the company may already be losing its edge in the country’s rapidly developing music market.
Since its formation in 2016, TME has built its strength by relying on exclusive distribution deals with record labels and artists like Mandopop star Jay Chou to muscle out competition for the streaming services it owns. Lately, though, those arrangements have been unraveling even without the direct interference of regulators. In the past two years, Universal Music Group (UMG), Sony Music and Warner Music Group (WMG) have decided to diversify their distribution and leverage intensifying competition for better deals offered by companies like NetEase Cloud Music.
If regulators act, TME could essentially be penalized for dominating the industry, despite the key role it played in shifting China’s music business away from piracy and into licensed streaming. Over the past five years, China’s recorded-music business has grown at an unparalleled pace: up 278% from $209.4 million in 2016 to $791.9 million in 2020, according to IFPI, with streaming accounting for 90.5% of last year’s revenue.
As of December, among China’s top five streaming apps, TME’s three platforms -- QQ, Kuguo and Kuwo -- controlled 77% of China’s monthly active users, according to QuestMobile, a Chinese research company. And since TME went public on the New York Stock Exchange in 2018, its market cap has grown from $21 billion to $26 billion.
The company has also capitalized on listeners who do not use its services, sublicensing its exclusive distribution deals to its competitors for two to three times what it pays, NetEase CEO William Ding claimed publicly last year, while cutting major labels out of the market with direct artist deals like the one with Chou -- for whose songs NetEase paid TME nearly $3 million to sublicense in 2018, according to court filings in China.
Still, “I really don’t think we are dominating the market,” counters Andy Ng, TME group vp. “We were just doing whatever we could to make the pie bigger so everybody could get a nice piece of it.”
Ng says the perception that the company has overcharged competitors to sublicense content is unfair. He claims that NetEase is paying major labels more this year for nonexclusive distribution deals than TME charged it to sublicense the labels’ content in 2020. (A NetEase representative declined to discuss terms but said that through the new direct arrangements, “the uncertainties of facing huge price increases proposed by third parties is now greatly reduced.”)
The Chinese competition authority has a history of targeting companies that it perceives are growing too dominant. Last year, it issued a record $2.8 billion fine against Alibaba Group Holding, before taking action in April against over a dozen other companies, including TME parent Tencent Holdings. The crackdown began after Alibaba founder Jack Ma said in a speech last October that the Communist government’s “outdated supervision” of financial markets hamstrings innovation. But it broadly stems from China’s desire to slow the rapid growth of its tech giants, which control reams of personal data and hold cultural sway, analysts say.
Reuters has reported that regulators may fine TME 10 billion yuan ($1.54 billion) and force it to divest Kuguo and Kuwo, which would knock down TME’s market share by about 68%, based on data from QuestMobile. Already, though, WMG’s exclusive arrangement with TME expired in March and the companies announced they would form a joint label.
China’s competition authority opened an anti-trust investigation against TME’s major-label exclusives in August of 2019. While that probe wound down the following February without penalties against Tencent, Universal rearranged its deal with TME, signing its first-ever distribution deal with NetEase Cloud Music last August. Sony Music followed suit in May with its own NetEase deal, while all three also renegotiated nonexclusive deals with TME.
That should be good news for the Chinese music ecosystem, says Andy Mok, a senior research fellow at the Center for China and Globalization, a Beijing think tank, who foresees more negotiating, deal-making and -- ultimately -- opportunity. “[The labels’] catalogs will be everywhere, more like the West,” says Mok.
NetEase Cloud Music -- which applied May 26 to go public on the Stock Exchange of Hong Kong and intends to raise $1 billion -- could benefit most from regulatory action against TME. The app, part of video-game giant NetEase Inc., is a popular music curator for Generation Z consumers in larger, more affluent cities like Beijing and Shanghai than TME, which is stronger in lower-tier cities, label executives say.
Analysts think that forced divestitures by TME could also usher a third major competitor into China’s streaming market. That would likely be either Alibaba, which shut down its Xiami music app in February amid intense competition from Tencent, or TikTok owner ByteDance.
Piracy-Ridden Market Spurred A Scramble For Copyrights
Only a decade ago, more than 99% of music downloads in China were pirated, according to IFPI. But in 2011 China punished leading search engine Baidu for providing illegal mp3 downloads, and in 2012, seeing PSY’s “Gangnam Style” go viral, China sought the same success for its own domestic repertoire. Then in 2015 the government launched the “Sword Net” initiative that ordered streaming platforms to take down unlicensed music. Within days, streamers removed more than 2.2 million songs.
Tencent was ready to take advantage of the new music landscape. In late 2011 Ng, a Hong Kong native, joined Tencent’s QQ Music from Nokia, where he had experience handling copyrights. He urged Tencent founder Pony Ma to focus on cleaning up the company’s music rights issues and secure exclusive licensing deals, after Tencent’s challenging experience with pirated video games.
Entrepreneurs also sensed opportunity. In 2012, Xie Guomin, a lawyer who specialized in music copyrights, formed Ocean Music with a group of investors and set out to build a powerhouse digital distributor. At a time when licenses were cheap, Guomin hoarded copyrights and waited to make a fortune. By the end of 2013, Ocean Music had reached agreements with nearly 100 record companies and exclusive contracts with more than 40 music and copyright agencies -- and had close to 20 million pieces of music in its library. The company also did the first exclusive deal with a major in China -- for EMI’s catalog.
By 2016, Tencent had acquired China Music Corporation (the former Ocean Music) -- which by that time had bought Kuguo and Kuwo -- and renamed it Tencent Music Entertainment, solidifying its position as China’s leading music streamer. That year Tencent also purchased Beijing music distributor R2G, which had been aggregating Chinese publishing rights since the early 2000s, when it won a string of lawsuits against Internet companies that provided music for mobile ring-back tones.
In its zeal to sign exclusive deals, some competitors say, TME routinely overpaid for its deals with the majors, which involve minimum guarantees. (Ng says the prices were in line with projections of streaming users.) With the large up-front advances, royalty reporting was almost an afterthought, frustrating artists and managers -- something that will improve as the market moves away from exclusive deals, says Alex Taggart, head of international for label services firm Outdustry, which last year formed an independent publishing company specializing in China.
“We learned the best way to get better reporting out of everybody is to play them off against each other,” Taggart says. (Ng says TME issues monthly reports and is working on a system for real-time reporting that will more closely match global standards.)
The TME exec says NetEase’s planned initial public offering illustrates how rapidly the music landscape is changing. “I’m sure there will be more competitors coming in the future,” Ng says. “Everybody is still talking about how the China music industry is doing great. Everybody is still trying to jump in.”