China recently surpassed Japan to become the world’s second largest pay-TV market after the United States. But many industry insiders are already shifting focus to video-sharing websites as the way of the future. Following closely on the heels of Netflix and Hulu, Chinese websites like Tencent and Youku are pushing to develop their own original content, creating huge opportunities and challenges for both domestic and international content creators.

There are now over 200 million cable TV subscribers in China, which sounds like a lot until you compare it to the more than 500 million internet users in the country. Cable is still not available in many parts of China, and the industry is currently undergoing an expensive shift from analogue to digital, forcing some subscribers to buy new TVs. The shift should be complete by 2015, giving all Chinese subscribers access to on-demand content popular elsewhere and creating new revenue streams for Chinese cable operators. But TV will still be playing catch-up with the internet, which is already on-demand, all the time. And many Chinese internet users access the web primarily on relatively cheap smart phones, making the entry point much lower than for cable.

Internet video is also less restricted than TV in China. Websites are regulated by the Ministry of Industry and Information Technology, which so far has been more lenient than the State Administration of Radio, Film and Television (SARFT). The risqué Hollywood hit Ted is available online in China, but the film did not pass SARFT censors, and is not available on TV. SARFT recently merged with the General Administration of Press and Publication and now goes by the unwieldy name of General Administration of Press, Publication, Radio, Film and Television. Most of the top people at the new SARFT remain the same, and no one expects major policy changes any time soon.

Larry Namer, co-founder of Metan Development Group – a company that seeks to deliver Western entertainment content to China and produce original content in China for export to other countries, says that despite the restrictions, “the creative palate is easier here (in China),” because the market is less developed it is also more open. “In the U.S. you have a lot of embedded media relations and legacy technology. In China you don’t have that.”

Metan just released a new sitcom called Planet Homebuddies, which some have described as a cross between Friends and The Big Bang Theory. Rather than seeking a deal with a major cable operator or satellite station, Metan released Homebuddies only on the internet. The show went out on China’s five largest video websites, Youku, Tudou, iQiyi, PPTV and Sina, and drew over three million views in its first week. Because production costs are much cheaper in China, the Homebuddies pilot ran six episodes instead of just one. Namer says this is hugely important. “With six episodes you can learn a lot more about your audience. You can watch social media to see how people are reacting to the show and to different characters,” he said.

Lauren Ma from B13 Productions, an entertainment consulting firm helping bridge the gap between Hollywood and the China market, says the Internet is a useful testing ground for new programmes. “It’s cheaper to produce for the internet because production quality can be lower, but satellite licensing fees are still higher,” she said.

Satellite stations looking to compete with online portals are also looking abroad for help, Ma said. Many are now buying foreign intellectual property rights. “They’re buying IP and then producing Chinese versions of foreign shows, usually with the help of the original production team from Larry Namer Hollywood or wherever,” said Ma. She said although most foreign shows still come from the U.S., Korean shows have been making a major push. Chinese stations are airing subtitled versions of original Korean shows and producing Chinese versions of Korean shows, Ma said.

Pierre Cheung, BBC’s Vice President and General Manager of Sales and Distribution for Greater China, said TV subscribers have access to BBC’s factual programmes like Human Planet, but video sharing websites give Chinese viewers access to a wider variety of content, including drama series such as Sherlock, Doctor Who, and Misfits. “One challenge for us has been comedy, where the humour often doesn’t translate,” Cheung said.

It’s not just the Koreans and British getting in on the act. Yan LI recently left her job with an American pay TV content provider to become Chief Marketing Officer for the Riki Group China, Russia’s largest animation company. Li said Chinese viewers are less familiar with Russian programmes than they are with American or Korean programmes. To gain wider access to Chinese viewers Riki Group is planning to shift some of its production to China and to include more Chinese-themed content in its programmes. Li said the internet is key to Riki Group’s development strategy because foreign animated programmes are not allowed on primetime, where they would compete with domestic programmes. Li said at first Riki Group was simply making the same content available on both TV and the internet, but they found kids and parents sometimes prefer to consume content in smaller chunks, so Riki Group now has shorter episodes available online.

One challenge for Riki Group is that Chinese parents don’t like having their kids watch programmes on computer screens or mobile devices because it’s bad for the eyes. They prefer to have kids in front of a larger TV where they don’t have to sit so close to the screen. “TV is mostly for people over 40 or for kids. Those in their 20s and 30s and even teenagers prefer computers or mobile,” Li said.

The Iinternet demographic is of course the one advertisers are most focused on. Here again Namer said the openness of the market is key. “In the U.S. Coke and Pepsi are fighting over maybe one percent of the market. They’re not going to go out on a limb for new programming. But in China a good campaign can swing the market 20 or 30 points, and advertisers are willing to take more chances,” he said.

This isn’t Namer’s first time working in an emerging market. He was also among the first to bring Western content to the former Soviet Union. The U.S.S.R was much easier though, he said, because there was huge demand for all things American. He said the same is not true in China. “You have to be prepared to meet local taste, within government restrictions, and you have to be in Mandarin,” said Namer.

One of the first programmes Namer’s Metan produced in China was an entertainment news show called Hello Hollywood. Producers showed a segment on the new King Kong ride at the Universal Studios theme park to a test group who liked the segment, but had never heard of King Kong or Universal, both widely familiar in America. With all the necessary background information a segment that would’ve run for one minute in the U.S. ran for six minutes in China.

Namer said the next season of Planet Homebuddies will be made for the Internet. The show could end up on satellite, but “the internet is a very viable market,” he said. The show depicts the lives of a group of young professionals sharing an apartment is a rapidly developing economy with rapidly rising real-estate prices. It’s set in Shanghai, but Namer said, “the same stuff is happening in Moscow and Sao Paolo.” Once the show is established, Metan hopes to export it to other developing markets.

Satellite and cable are still large and growing markets in China. But lighter restrictions, lower production costs and cheaper price point for consumers are huge advantages for video sharing websites. As these companies expand their offerings and begin producing original content, pay TV will struggle to keep up.

The new SARFT

China’s broadcast regulator, the State Administration for Radio, Film and Television, or SARFT, who is always upfront about its control of the broadcast industry, is SARFT no more, but not in the way you’d think. The broadcast regulator has expanded, with new regulatory powers, after the government merged the broadcast regulator with the country’s press regulator General Administration of Press and Publications or GAPP. The combined regulator has been renamed General Administration of Press, Publication, Radio, Film and Television in March 2013. At MIPTV 2013, Wei LI (pictured on the right with CCTV’s VP Ming LUO) is the first high-ranking delegate to represent the newly organized regulator. Reed reported that “with 79 companies represented, China’s delegation, headed by Wei Li, Vice Minister of the newly-formed General Administration of Press, Publication, Radio, Film and Television, was the largest ever at MIPTV”.