Read on for a great opportunity to make a fortune.
The Wall Street Journal yesterday reported that U.S. entertainment companies, despairing of combating rampant piracy of DVDs in China and CDs in Mexico, are "cutting prices on legitimate DVDs and CDs low enough to challenge the pirates at their own game." Since piracy is stealing essentially all revenues in those markets, the American companies are hoping to grab back at least some market share for their legitimate products. Time Warner Chairman Richard Parsons told the Journal that slashing prices sharply for legitimate, higher-quality DVDs would create an environment in which "good behavior drives out the bad."
When it comes to confronting the challenges of digitalization, established media companies haven't exactly distinguished themselves. This Crazy-Eddie price-cutting in China and Mexico is bold, one of the first examples of American entertainment companies thinking outside the sleeve. But will it work?
First, can U.S. companies ever hope to price their goods cheaply enough that they seem like a bargain to comparatively poor consumers? Even with massively reduced prices, they won't be matching the pirates. According to the CIA Fact Book, in 2003, purchasing power parity was $37,800 per capita in the United States, $9,000 in Mexico, and $5,000 in China. In China, where illegitimate copies of The Aviator sell for a dollar, the Journal reported that Time Warner will sell basic DVDs for $2.65 and DVDs loaded with extras for $3.38. Sounds cheap. But if you adjust for income levels and costs, that translates into about $20 for the cheap DVD and $25.55 for the one with bells and whistles. In Mexico, the Journal reports, legitimate CDs retail for $12—about $50 given the typical Mexican's income!—while pirated CDs cost about a buck. Giant record companies, including EMI and Sony, are testing a program in Guadalajara to sell special releases for $4.50. Adjusted for purchasing power, that's still more than what most new CDs sell for in the United States.
Second—and here's your great moneymaking play—will slashing foreign prices lead to margin-killing DVD reimportation? Companies that do business on a global scale price locally to account for differences in buying power and regulation. Lipitor costs less in Germany than it does in the United States. The Mandarin version of Microsoft's Windows retails for less than the English-language version produced for the U.S. market. And a bottle of Coca-Cola in Cape Town, South Africa, doesn't cost as much as it does in Galveston, Texas.
Now, when your core consumers discover that foreigners are paying a lot less for the same product than they are, they sometimes get angry—especially if the product is one that can be imported at relatively low cost, like, say, drugs. The same is true for entertainment. Why should law-abiding Americans pay $15 for Martin Scorsese's latest masterwork when Chinese consumers, thanks to the rampant culture of fakery, have to pay only $3 for the exact same product?
Markets being what they are, mechanisms—legal, quasi-legal, illegal—spring up to allow American consumers to gain access to the goods at something like the same terms that foreign consumers enjoy. Think of Canadian Internet pharmacies. Or the New York subway vendors who sell Duracell batteries made for the Brazilian market for 99 cents.
Offering videos at cut-rate prices in Beijing seems like an invitation for some enterprising person to acquire oodles of legit DVDs in China and then sell them to buyers in the United States or Europe. Even allowing for shipping costs and a small markup, a middle-man in the Middle Kingdom could undercut even Wal-Mart. Importantly, these would be perfect, studio-made DVDs and thus avoid all the doubts about quality and reliability that are associated with pirated materials.
Ultimately, the prospect of reimportation could prove more damaging to Hollywood in the short term than China's piracy. The motion picture industry now makes far more from DVDs than from the box office. Americans spent $9.4 billion at movie theaters in 2004. But according to the Digital Entertainment Group, they spent $15.5 billion buying DVDs (up from $12 billion in 2003) and another $5.7 billion renting them in 2004. Plainly, millions of Americans are willing to pay $17.99 to buy a legitimate copy of Shrek II or $74.99 for the boxed set of The Sopranos 2003 season. Will they still pay those prices when they realize the studios are selling identical DVDs overseas for a fraction of the price?
Update: As several readers have hastened to point out, the get-rich-quick scheme for importing cheap DVDs sold in China to Americans isn't as friction-free as described. Because DVDs are coded for several different zones, DVDs made for sale in China are designed not to play on DVD players built for the U.S. market. In order to play the cheap DVDs, customers would first have to purchase code-free DVD players.
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