A movie theater in China (Courtesy of Creative Commons)

As a private Chinese media company awaits a $2.6 billion bid to go through, giving it ownership of AMC Entertainment— the second largest cinema chain in the U.S.— some have speculated if the deal was initiated so China could gain more inclusion and more knowledge of the Hollywood movie market.

Interestingly, it could be seen as the other way around.

Hollywood studios have long complained about being shutout of the Chinese film market due to a Beijing edict that allows only 20 foreign films to be shown in theaters each year. In recent years, China has become the largest potential market for U.S. film studios

On Feb. 19, 2012, DreamWorks Animation unveiled that the company had struck a $330 million deal to establish a studio in Shanghai as a joint venture with Shanghai Media and China Media Capital, two Chinese government-backed media companies.

This was just a prelude to the potential collaborations between the US and China during Chinese Vice President Xi Jinping’s U.S. tour in February. China and the United States issued a joint statement to lift the restrictions set on U.S.-made films that included exempting 14 “premium format films,” -like IMAX or 3D- from the original quota of 20 and raising box office revenue-sharing with foreign producers from 13.5-17.5 percent to 25 percent.

The office of the United States Trade Representative viewed the agreement as an achievement in “resolving the WTO film-related issues,” which had been disputed between the two countries for more than five years.

Disputes, Deals and Bribes

But the film disputes were far from being settled. At the end of April, the Securities Exchange Commission (SEC) made waves on both sides of the Pacific as information was requested from major U.S. studios, including Walt Disney, 20th Century Fox and DreamWorks Animation, about their business activities in China. The requests potentially violated the Foreign Corrupt Practices Act and some speculated that bribery was part of it.

While the SEC declined to disclose any details about the case, Robert Cain, a producer and film-industry consultant who is familiar with both the U.S. and China markets, speculated in his blog that if any questionable dealings had taken place they “likely involved bribes in exchange for film import quota slots,” which are tightly controlled by the Chinese government. Each slot may represent a chunk of business worth over $50 million.

The controversy has re-cast light on the challenge for Hollywood companies doing business in China and whether the new agreement opens the market enough to make it worthwhile for Hollywood studios to invest in China. Also, the SEC’s investigation is prompting the concern of how committed China is to open its market.

Beijing scanted around the new agreement in February.

“In a day full of meetings on Saturday with film distributors, producers, and even the powerful head of China Film Group’s production division, not one person I spoke with was even aware of the news,” Cain wrote.

The silence in Beijing led some to speculate that China was reluctant to lift the restriction; the compromise being viewed as a conciliatory move rather than openness.

In fact, the joint agreement came the same week as some talk in Beijing about banning all imported comedies, dramas and movies during primetime and limiting programs from abroad to less than 25 percent of a channel’s offering each day.

Cultural Issues and Ideology

The attitude for foreign film has been rather complex and awkward for Chinese government. On the one hand, the experience and technology of Hollywood is what top film leaders of China badly need. The decision made by the China Central Committee, the country’s top leadership, last October to boost the country’s culture power, demonstrated that it has been a national strategy for China to translate the economic and geopolitical development on a cultural level.

Its huge investments in film, animation and theme parks in China mirror the central government’s consideration of domestic consumerism; China is following the pattern of those countries where people spend more on services that enhance their utility and satisfaction as their income rises.

On the other hand, China views the establishment of a strong, cultural power as an issue of national defense to counteract the government’s negative image.

“We must clearly see that international hostile forces are intensifying the strategic plot of Westernizing and dividing China, and ideological and cultural fields are the focal areas of their long-term infiltration,” Chinese President Hu Jin-Tao said to Reuters in January about the West’s potentially pernicious effect.

Thus, it is not the Chinese film industry but Chinese government that wants to limit foreign films. The barriers for foreign films— such as import quotas— have more to do with the government’s motivation to protect the ideology than to preserve the local film industry.

However, in seeing how Avatar and Transformers 3 became box office blockbusters, it seems advantageous for the Chinese government to learn more about the Hollywood magic that lures consumers.

“Fourteen ‘enhanced’ films is interesting as it allows the Chinese government a bit of face-saving,” said Mr. Cain. “The loosening of the quota might appear as capitulation by Beijing to U.S. pressure, but the ‘enhanced’ film requirement allows the Chinese to characterize the agreement as a ‘technological advance’.”

Skimming and Shrinking Profits

Despite the import slot’s increase to 34, promoting U.S. films in China is less lucrative than in other parts of the world. The Chinese government still requires that foreign film companies cooperate with designated distributors such as the China Film Group （CFG） and Huaxia Film Distribution Co. Ltd, which remit U.S. producers no more than 17.5 percent of box office profits— far less than what the U.S. studios can get from other markets.

For each ticket of foreign films sold in China's market, the income is shared by several stakeholders: 5 percent goes to the National Film Special Fund, 3.3 percent is business tax, 48 percent belongs to the cinema and 52 percent will be shared between the U.S. film studio and Chinese distributor, CFG or Huaxia. According to the revenue share code, the most profit foreign producers can get is 17.5 percent if the film grosses over $39 million.

“For example, a ticket for Harry Potter 7 costs a Chinese audience 100 renminbi (RMB- Chinese currency). But Warner Brothers, the movie studio behind it, can just take 16.04 RMB. By the way, foreign producers need to take the cost of promotion and copy which should belong to distributor.” according to Guo Zi Li, a special film contributor of ftchinese.com.

With the new agreement that enhances the share code from 17.5 percent to 25 percent, foreign producers may receive more than before, but it still remains just a theory.

Most of the time, the reason why U.S. producers will not receive as big of a profit is because exhibitors skim box office revenue and report a shrink data to distributors and producers. Guo Zi Li revealed the trick in his article published in Financial Times that 100 RMB paid by audience for film ticket will become 70 RMB reported box office receipts and 30 RMB popcorn combo in exhibitor’s computer system. In some tier two or tier three city where the computer system is not being adopted, box office report is harder to track. 

According to Mr. Cain, some Chinese movie business insiders admitted that the skimming approach varies from sophisticated “back-door” software installed in cinema’s reporting system to primitive artificial adjustment.

Even though the skimming process is literally treated as a severe crime since it causes some punishable consequence such as tax evasion, it is still a regulatory “grey area”.

“Insufficient attention to the issue of garnering a share of the box office” is considered one of the main challenges that foreign producers face in China, said Mathew Alderson, a Beijing-based Australian attorney whose expertise is intellectual protection and film law.

Increasingly, Hollywood companies are seeking the alternative way of getting around the distribution limit and enlarging the revenue share. Another way to access China’s market is to produce a movie that qualifies as an official co-production that is free of import quota.  This applies to purely U.S.-made films and returns to U.S. studios a relatively “fair” share: 40 percent of the box office receipts.

More Hurdles for Hollywood

Unfortunately, making money from co-production is also not an easy job.

The first concern is China’s record of rarely defending intellectual property rights. The U.S. has discovered that China’s domestic film industry suffers from piracy as much as Hollywood does.

“We usually won’t take [China’s] mainland market as our first market to release a new film, since as soon as it is released there, the rest of the world can immediately see it through the Internet,” said Dr. Jeanie Han, Senior Vice President at Paramount Pictures, at an MBA seminar held by USC Marshall School.

With a political mission to promote China overseas, a qualified U.S.-China co-production is required to include at least one Chinese actor or actress, to film one scene in China with Chinese storytelling, and to accept the censorship of China Film Co-Production Corporation— a subsidiary of China Film Group— the largest state-run film enterprise in China.

These regulations make the challenge more complicated for co-production, especially when Chinese storytelling fails to please Western audiences and certain Chinese scripts written by Western writers are considered unacceptable by Chinese audiences.

“Some of them (co-production) have done well but most of them not,” said Stanley Rosen, an expert on Chinese films and a professor of political science at USC. “Karate Kid [starring Jackie Chan and Jaden Smith in 2010] made 68 percent at the box office for the whole Chinese co-production marketing abroad in 2010, but most of them have not been successful.

“It’s very difficult to please both sides.”

DreamWorks’s new joint venture is a prime example of how Hollywood continues exploring ways for U.S. film companies to advance more into the Chinese culture industry and take advantage of China’s $2 million market with double-digit growth amid sluggish demands for films in the U.S.

“It’s still a risk calculation. Given resources that China invests in this venture, U.S. companies may as well be a part of it rather than being outside of the tank,” said Professor Rose, “But it’s still early in the game. We’ll see how it will play out.”