Entertainment Industry Focus 2010

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Foreword The Indian entertainment industry is on the threshold of emerging as a large mar ket globally. Future growth of the industry is expected to be led by rising spen ds on entertainment by a growing Indian middle class, regulatory initiatives, in creased corporate investments and the industry's dynamic initiatives to make str ategic structural corrections to grow. In addition to the Indian middle class’ enh anced spends projected towards entertainment, the rising global interest in Indi an content is expected to fuel growth in this industry. With this focus, Confede ration of Indian Industry (CII) requested KPMG to initiate this study on the key sectors: films, television, music and radio, highlighting its potential and key trends to be expected with sharing insights on developments, impact and opportu nities. The report, an initiative under CII's “India – The Big Picture” focus is an ef fort to present a critical analysis of the sectoral constraints faced by the ind ustry that are impediments to its growth, the need for concerted action and henc e achieve its true potential. One of the key imperatives that can realise this p otential, as pointed out in this report, is the need for focus and effective col laboration between the key stakeholders. The analyses presented in the report ha ve been arrived at through a combination of KPMG's in-house knowledge base of th e Indian Entertainment Industry and extensive discussions with key members of th e CII Entertainment Committee and other industry experts. CII takes this opportu nity to thank Rajesh Jain and his team from KPMG, industry members and the CII E ntertainment Committee members, for making this endeavour possible and sharing t he long-term vision for the industry. Subhash Ghai Chairman CII National Entertainment Committee

Message from the CII President The Confederation of Indian Industry (CII) is taking a lead in the growth and de velopment of India's entertainment industry. CII under the guidance of Mr Subhas h Ghai, Chairman of the Entertainment Committee and Mr Bobby Bedi, Co-Chairman, is driving several initiatives under the umbrella of “India – The Big Picture” - a mot her brand - created especially for organising events and seminars to increase vi sibility of the Indian entertainment industry in the global marketplace. Over th e past few years, CII has organised major events, EnterMedia 2002, CineMint 2003 , India Pavilion at Cannes Film Festival 2003 and 2004, Film Bazaar at the Inter national Film Festival of India 2002, 2003 and 2004, in addition to various dele gations to film markets and festivals, workshops, and interaction with Central a nd State governments on policy. The spend on entertainment in India is significa ntly lower than most advanced countries, yet the growing middle class exhibits a greater propensity to spend on entertainment, when we consider the entertainmen t spend as a percentage of per capita spend. As the Indian economy grows, the re st of the population is moving towards a higher standard of living. It is this g rowing consuming class with the propensity to spend that will drive the growth o f the Indian entertainment industry. The entertainment industry in India has the potential to be the next 'sunrise' industry and is undergoing significant chang es. Increasingly, the Indian entertainment industry is being influenced by inter national trends and developments. The industry is steadily moving towards corpor atisation and globalised markets. With this background CII, in partnership with KPMG, has brought out a report: “Indian entertainment industry - Focus 2010: Dream s to reality”, providing In-depth analysis of its key constituent segments televis ion, films, radio and music. The report is aimed to assist industry to get an an alytical understanding of the entertainment sector. CII is committed to facilita te the Indian entertainment industry to achieve new levels of success. Sunil Kant Munjal President Confederation of Indian Industry

An action plan for the Indian entertainment industry India ranks among the top five economies of the world in terms of purchasing pow er parity, while its GDP ranks eleventh in absolute terms. Combined with the fac t that India has the second largest population in the world with over a billion people, this makes India one of the most exciting marketplaces for any consumer products or services industry. Given the average Indian's cultural affinity for entertainment, the Indian entertainment industry's growing contribution to the e conomy cannot be understated. KPMG and CII have come together to create this vis ion document on the sector which aims to provide a critical evaluation of the In dian entertainment industry, with in-depth analysis of its constituent segments - television, films, radio and music. The report evaluates whether the industry' s potential can become a reality if the various participants, including content providers, distributors, infrastructure and technology providers, investors and the Indian government, work together with a shared vision to address the issues and constraints faced. In this context, the report articulates the KPMG-CII 10/1 0 Charter. The charter aims to form the strategic blueprint for the industry and the government to undertake concerted action that will result in strong growth based on stable fundamentals. We trust that this report will be useful to all th e stakeholders as well as to those tracking the Indian entertainment industry. Ian Gomes Country Managing Director KPMG, India

Contents Executive summary Industry overview Television Film Music Radio Bridging the gap The tax perspective 1 11 23 45 81 93 107 145

Executive summary Let the fun begin Over the last few years, there have been discussions on the Indian entertainment industry being on the verge of take-off, powered by new delivery platforms and technological breakthroughs, increasing content variety and favourable regulator y initiatives. This is expected to transform the entertainment landscape, with m ore players entering and traditional players being forced to adapt or perish. On e can already witness changes that have the potential to alter the industry stru cture. New delivery platforms and technological breakthroughs: Increasing penetr ation of new delivery platforms is one of the key drivers of the media and enter tainment industry today, that has the potential to change the way people receive content. These platforms, resulting from fundamental technological breakthrough s, are likely to see most of the action in next few years. For example, the spre ad of inexpensive and stable storage media will also enable people to store cont ent and view it at their convenience. Some other examples are: ! Introduction of DTH and IP-TV ! Digital distribution of films ! Immersive content media like IM AX theatres ! Coming of age of Satellite Radio and FM Radio ! Emergence of new t echnologies like podcasting, etc Together, these are expected to change the view ing habits of people. Increasing content variety: New forms of content will emer ge to cater to select viewers, as the industry evolves. Content like community r adio and local television, that were unviable earlier, will also emerge stronger through new delivery formats. Moreover, content innovation will be necessary to sustain the interest of the increasingly jaded urban population. A few instance s of rising content diversity are: ! Newer programming categories like reality t elevision, ! Crossover content in music and films, ! Niche programming on radio like sports and comedy, ! Newer genres like lifestyle television, religion chann els, etc. Regulatory initiatives: The regulatory framework for media is still ev olving. Looking at the policies announced by TRAI, it seems that a liberal frame work is likely to be developed in order to allow the industry to flourish. Along side regulating broadcasting and distribution, it will be important to create st ronger protection mechanisms for copyrights and royalties. If intellectual prope rty is protected to a fair extent, the industry could capture far greater value, giving its growth rate a significant boost. 1 A CII - KPMG Report

A few examples of such regulatory actions are: An implementable regulatory frame work for introducing addressability of cable television ! Policy framework for D TH, satellite radio and community radio ! Migration to a revenue sharing regime in FM radio ! Superior copyright protection for films, music and home video, etc ! The past and the future The entertainment industry is thriving on the current ec onomic upswing and is currently estimated at INR 222 billion. Due to its sheer s ize, television has been the main driver for the industry's growth, contributing 62 percent of the overall industry's growth. Films contributed another 27 perce nt, while other segments like music, radio, live entertainment and interactive g aming constitute the balance 11 percent. Growth of the entertainment industry (INR billion) 515 262 309 371 432 588 196 222 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Source: KPMG Research Propelled by innovation across its value chain and a series of enabling regulato ry actions, the entertainment industry is expected to grow annually at almost 18 percent to reach around INR 588 billion by 2010. However, even with such growth , it could be just scratching the surface of the Indian market's true potential. Reaching this targeted growth rate will not be easy for the sector. Television sector has witnessed a significant bit of transparency, process orientation and discipline, except for the last-mile which is completely fragmented. The film se ctor, on the other hand, still remains relatively opaque and persona-driven. Ove r the past few years, the film industry has made some progress in getting instit utional and corporatised funding. However, the progress on this front has not be en as dramatic as had been expected when the institutional funding norms for fil ms were relaxed a few years ago. Even though different sources unanimously agree that the entertainment industry is a sunrise sector, it has seen no major fundraising efforts, apart from television content and broadcasting where the impact of professionalism and organised financing is evident. 2 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The industry growth drivers Over the past decade, India has been the second fast est growing economy in the world. In 2004, it grew by 8.2 percent, breaching the psychological 8 percent barrier for the first time. In terms of purchasing powe r parity, it is already the fourth largest economy in the world. Most major glob al companies are of the opinion that it will become a key market in the years to come. As the Indian economy continues growing, the Indian middle class will als o expand significantly. Compared to other nations, the 300 million strong Indian middle class allocates a higher percentage of its monthly expenditure on entert ainment. The increasing consumerism of middle-class India is seen from the sharp growth in the sales for various products like automobiles, colour television se ts and mobile phones and the burgeoning increase in credit cards and personal lo ans. There is an increase in the direct consumer spends on entertainment and adv ertising revenues have also been on the rise. With the average Indian getting yo unger, and hence more likely to spend on nonessentials, the entertainment indust ry has the potential to grow explosively in the future. Digital platforms will d rive the next wave of growth Availability of new products and services First wave of growth Second wave of growth DTH PDA 3G mobile Wireless broadband Basic analog cable Console CD, CD-ROM Singl e screen theatres Music cassettes FM radio Terrestrial television Vinyl records AM radio Multiplexes Multimedia PC Broadband internet Interactive television Pay -per-view IP-TV The industry is ready to enter a second stage of growth, powered by technology a nd an enabling regulatory environment Spending power and awareness Source: KPMG Research The forthcoming metamorphosis The entertainment industry is now at an inflection point. The earlier phase of growth has run its course. Now the industry is read y to enter a second stage of growth powered by the twin engines of technology (a vailability of quality infrastructure and the accelerated penetration of digital connectivity) and an enabling regulatory environment. 3 A CII - KPMG Report

A panoramic view The coming of age of the television sector has been the primary driver of the growth of the entertainment industry The coming of age of the television sector has been the primary driver of the gr owth that the entertainment industry has seen over the last decade. The private sector enterprise seen across the television value chain in the nineties drove t he sector to newer heights. It is now the most important component of the entert ainment industry, contributing over 60 percent of its revenues. It is expected t o continue powering the industry in the digital era, through various innovations like DTH, interactive television, etc. Though in revenue terms, films contribut e just 27 percent of the entertainment industry, its visibility and impact is mu ch more than this figure suggests. It is also a major driver for other sectors l ike music, live entertainment and television. It was accorded the status of an i ndustry in 2000. Since then, some progress has been made in developing transpare ncy and professionalism in this sector. Music, radio and other emerging segments like animation, interactive gaming and live entertainment together account for remaining 12-13 percent of entertainment revenue. Segment-wise composition of th e entertainment industry Segment-wise break-down Television Film Music Radio Others (live entertainment, interactive games, etc.) Gross unadjusted revenues Add: overseas' distributor's margin from sale of Indian films Entertainment revenues at retail value Note: The summation of the figures may not match due to rounding off Source: KPM G Research (INR billion) 2004 139 59 10 2 11 222 6 8 222 2005E 164 69 10 3 16 261 7 8 262 2 006E 189 83 11 4 23 309 8 7 309 2007E 228 99 11 5 30 373 11 8 371 2008E 266 114 11 6 39 436 13 9 432 2009E 325 129 12 7 48 521 16 10 515 2010E 371 143 13 8 60 5 95 18 11 588 2003 122 52 10 2 9 195 8 196 Less: overlap (sale of film broadcast and music rights) netted off 7 Piracy and revenue losses at the last-mile are the bane of the entertainment ind ustry. They prevent the rightful owners of the content from realising its full v alue. All sectors of the industry, except radio, suffer from these twin predicam ents in some way or the other. Currently, such losses are estimated at INR 4.3 b illion, which amounts to over 40 percent of the industry's total revenues. While such losses are expected to continue for another two to three years, a reversal is expected eventually as a result of a combination of a technology push (with a wide repertoire of film and music becoming available through a variety of legi timate and convenient platforms and options) and a demand pull (with increased i nternet penetration and the advent of broadband). 4 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Television With total revenues of INR 139 billion, television is the goliath of the entertainment industry. It is now ready to advance to the next stage of its evolution, grasping the opportunities presented by the digital age, which will c ompletely change the home entertainment landscape. In the process, it is expecte d to continue its rapid growth and reach INR 371 billion by 2010. Some of the tr ansformational changes are: ! Additional distribution platforms: The last-mile of television distribution will see a lot of action in the near future due to entry of new Direct to Home (DTH) broadcasters, Internet Protocol based Television (IP-TV), broadcasting services using Digital Subscriber Line (DSL) technologies, etc. They will also give broa dcasters direct access to consumers by enabling them with the ability to provide customised value-added services, such as video on demand. Presently the distrib ution of subscription revenues is heavily skewed towards the cable operator beca use of lack of transparency in the declaration of subscribers by the Local Cable Operator to the pay television broadcaster. The introduction of these new platf orms and the consequent addressability will facilitate a more equitable distribu tion of revenues. ! More entrants in niche genres offering additional content variety to the viewer: Niche genres have significantly strengthened their value proposition and more e ntrants are expected in spaces like animation, business and lifestyle, among oth ers. Conducive and liberalising regulatory intervention: A beginning has already been made through an amendment of the Telecom Regulatory Authority of India Act . This is expected to deliver addressability in the currently fragmented distrib ution market, thereby increasing broadcaster's shares of revenue and encouraging greater participation. ! Films Though films contribute just 27 percent to the entertainment revenues, the y form the heart of this industry. Indian films, especially the mainstream Hindi film industry (Bollywood) dominate segments like music and live entertainment a s well as television, where popular films and film-based programmes attract the highest viewership. Compared to television, this sector is rather unorganised an d individualistic, with a low level of discipline and process orientation. This, along with the fact that it was not recognised as an industry as late as 2000, restricted its access to 5 A CII - KPMG Report

institutional funding and forced it to rely on other sources that charged usurio us rates of interest. In the recent years, though there has been a distinct shif t in the mindset and the willingness to tap institutional debt and equity funds. Some of India's largest corporate houses have entered this sector and large int ernational studios are reportedly evaluating the Indian opportunity. However, th e lack of transparency and discipline is preventing them from fully tapping this opportunity. The film industry is at a cusp in its evolutionary path. If conven tional players are able to implement the changes needed to unlock its growth pot ential, the second phase of corporate and institutional growth could see the ind ustry grow at around 16 percent annually to reach INR 143 billion in six years. Music The Indian music sector is quite unique compared to other global markets. Songs from new Hindi films comprise 40 percent of the total industry revenue and the box office popularity of the film typically drives sales. In India, growing piracy and free downloads have reduced music buying. Consequently, the industry has shrunk to around INR 10 billion from around INR 13.5 billion, three years a go. The silver lining is that though music buying from legitimate sources might have reduced, the delivery of music through new formats, like FM radio, internet and mobile phones has actually increased interest in music. The future growth i s likely to come from non-physical formats like digital downloads, royalty incom e, ringtones, etc. The rollout of additional distribution platforms like DTH, di gital cable and IP-TV with the growing popularity of large format retail stores will create many more channels selling music. Based on the current trends, the i ndustry is expected to grow only moderately to INR 13 billion in 2010. With the right technology and regulatory push to curb piracy, it has the potential of ach ieving a double digit growth. Radio Though radio reaches out to 99 percent of In dia's population and is considered to be the most cost-effective mass medium, it was only recently that private participants were allowed to enter ths space wit h a view to unlocking the latent commercial potential. With private FM radio cha nnels rolling out in several cities, the long stagnant advertisement revenues fr om radio have doubled in two years. Compared with other nations, radio currently has a very small share of the total advertising pie in India. This is indicativ e of the promise it holds if the current and proposed licensees are allowed to m igrate from the current stifling and unviable The future growth of music industry will come from non-phyical formats like digi tal downloads, royalty income and ringtones 6 Fo c u s 2 010 : D r e a m s t o r e a l i t y

licence fee structure to a revenue sharing regime, and if foreign direct investm ent is allowed. Share of radio in the total advertising pie Country India Sri La nka USA Spain World Source: KPMG Research (In percentage) Share of radio in advertising 2 21 13 9 8 Going forward, enabling regulation that allows radio to develop in its fledgling years and technology-driven policy initiatives like introduction of satellite r adio can help it grow exponentially. Additionally, with the introduction of new genres in programming with tailored content, the number of listeners are likely to increase; and radio could provide an efficient mechanism to reach out to nich e consumer segments. Emerging opportunities in the entertainment space Apart fro m the second wave of growth that various sectors of Indian entertainment industr y are set to witness, there are emerging opportunities spanning across genres an d markets. Some of the more interesting areas to look out for are: Animation: In dia's large pool of software talent has made it an appropriate resource base to develop animation and graphics-heavy content. Many international organisations o utsource their animation requirements to leading Indian software players. As the industry grows and establishes its quality credentials, India will emerge as a serious animation hub. Outsourced production facilities: With the relentless ris e in Hollywood film budgets, the pressure on cost control is also increasing. In dia can tap this opportunity by offering Hollywood an overall low cost structure combined with high-quality technical talent and production facilities. However, significant investment in infrastructure and equipment are required to be made before this becomes a reality. Organised home video: The Indian market for home video entertainment - VHS tape, VCD or DVD, is largely unorganised with mainly l ocal outlets. A demand for quality and convenience remains to be exploited by la rge organised retail players, who could leverage economies of scale in content p rocurement and distribution. 7 A CII - KPMG Report

Leisure entertainment like theme parks: Till date, outdoor entertainment in Indi a has seen limited action with few significant investments. This is changing as leading international players are exploring the Indian opportunity. The challeng e here will be providing a cost-effective and profitable value proposition to th e Indian consumer. Live entertainment: The live entertainment industry in India is largely unorganised with few players having the requisite critical mass. The gradual reduction of entertainment tax across states will make the sector more a ttractive, drawing in large corporates and multinationals. This is likely to res ult in increased marketing investments and creation of world-class infrastructur e like convention centres. Going forward, there could be collaboration with othe r constituents of the entertainment industry, like films, television and music. Reaching for the heights - A need for action A number of factors continue to hol d the industry back and significant efforts still need to be undertaken The Indian entertainment industry has matured significantly in the past decade t o evolve into a truly multimedia industry. Its fundamentals indicate strong grow th in the future. However a number of factors continue to hold the industry back and significant efforts still need to be undertaken. Based on a thorough unders tanding of the industry, the interaction between its drivers and discussions wit h various stakeholders, this report articulates a 'Charter for Change' by all th e stakeholders that can help the industry to move into overdrive. As the stakeho lders are responsible for championing growth, the report classifies these initia tives for action by two main categories of stakeholders: ! The industry players and ! The Indian government The importance of this stakeholder classification is two-fold: ! It allocates the responsibility for championing the cause and imple menting the change explicitly with a particular set of stakeholders, leaving no ambiguity for responsibility for change ! It makes it extremely clear that the i ndustry itself will need to wake up to the realities of a changing and dynamic e nvironment The industry initiatives can be grouped under two major heads: ! Impr oving operational effectiveness Raising organisational efficiency through tightl y-run projects Improving consumer connect Developing transparency and process-or ientation ! Maximising revenue earnings Building alternative revenue streams Dev eloping new markets through aggressive promotions Leveraging technology 8 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The evolutionary process followed by different segments of the industry defines the need, nature and rationale for such changes. Consequently, the nature and sc ale of the issues that they face presently differ, since the stage and pace of e volution and the willingness to evolve vary widely between segments. The nature of interventions required, therefore, range from correctional measures and marke t development in the case of certain segments to yield improvement and instituti onalisation in the case of others. The government initiatives can also be classi fied into two categories: Assisting structural correction of the industry Evolvi ng a framework to regulate cross media / value chain holdings Rationalising last -mile licensing Providing a level playing field for competing value chains. ! De veloping a conducive environment for growth Liberalising programming code and ce nsorship laws Constituting a national anti-piracy force Establishing a unified r egulator ! The realisation of opportunities would depend on the aggressiveness of the indus try players and sagacity of policy makers and regulators These regulatory initiatives will acquire different levels of meaning and import ance for various sectors of the entertainment industry, once again based on its position in its life cycle and the prevailing market dynamics. The Indian entert ainment industry has the opportunity to enter an exciting phase of growth driven by favourable socio-economic changes and smarter distribution technologies. The realisation of such opportunities would depend on the aggressiveness of the ind ustry players and sagacity of policy makers and regulators. The suggested stakeh older charter is intended as a strategic blueprint for the industry to undertake concerted action that could result in a stronger sustainable growth. 9 A CII - KPMG Report

Industry overview

Industry overview The macro-economic environment Consistent commitment to economic reform over the last decade has spurred the st eady growth of the Indian economy. The emphasis on creating an enabling environm ent for investment and the inherent potential of the Indian economy have togethe r pushed India's annual Gross Domestic Product (GDP) growth rate beyond 8 percen t. GDP growth rate 9 8 7 6 5 4 3 2 1 0 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01 01-02 02-03 03-04 (In percentage) Source: Reserve Bank of India A growing consuming class with an increased propensity to spend will drive the g rowth of the Indian entertainment industry While India's GDP ranks eleventh in the world in absolute terms, it ranks among the top five economies of the world when assessed in terms of purchasing power p arity. It is the growing consuming class with the proclivity to spend that will drive the growth of the Indian entertainment industry. Adding to this positive o utlook is the fact that the average Indian is getting younger and is showing a g reater propensity to indulge and entertain himself. Moreover, there are over 20 million Indians living abroad who are increasingly opting for India-oriented ent ertainment, as the availability of such content increases. Globally, a clutch of international films with Indian content, themes and performers are receiving wi de visibility and acclaim. This broad acceptance of Indian entertainment is like ly to give a further fillip to the expansion of this industry. To be able to app reciate the contours of this industry, it would be useful to take a closer look at the key drivers of the entertainment sector. Regulation Consumerism Technology Key drivers Advertising spend Pr i cin g Con tent 11 A CII - KPMG Report

Consumerism and demographics The emergence of the Indian middle class with greater earning power and a higher disposable income is one of the key factors that will drive the growth of the I ndian entertainment sector. Demographic analysis clearly shows the evidence of t his growth. The consumption chart below indicates the continued progression of p eople into higher income and consumption segments. Rise of India’s earning and con suming classes As the average Indian’s basic needs are met, his propensity to spend on discretion ary items, such as entertainment, increases The Classes Rich (Above USD 4600) 1994-95 1 million households 1999-00 3 million households 2005-06E 6 million households Consuming (USD 970 - 4600) 29 million households Climbers (USD 470 - 970) 48 mil lion households Aspirants (USD 340 - 470) 48 million households Destitutes (Less than USD 340) 32 million households Source: NCAER 66 million households 75 million households 66 million households 78 million households 32 million households 33 million households 24 million households 17 million households A number of economic trends are testimony to this advancement: Automobile sales are rising across the country. In two wheeler sales, India now ranks second in t he world, while car sales are over 1 million per annum, growing at about 25 perc ent annually. ! India is the sixth largest market for mobile handsets (16 millio n units per annum) and is growing at 50 percent a year. ! The country is the fif th largest market for colour televisions and is growing at 25 percent per annum. ! As the average Indian gets richer and his more compelling needs are met, his pro pensity to spend on discretionary items such as entertainment increases. Further , as his consumption of various goods and services rises, companies would try to reach out to him through more marketing and advertising. Higher 12 Fo c u s 2 010 : D r e a m s t o r e a l i t y

demand and an increased investment would result in an expansion of the entertain ment industry in the years to come. A non-homogenous market As the Indian entert ainment market grows, it is essential to recognise the heterogenous nature of th e market. All too often, the specific appetite of certain segments such as the r ural population, women and children, is under-estimated and their financial valu e proposition continues to be under-recognised. Illustratively, here are some im portant facts about the rural sector: There are nearly 42,000 ‘haats’ (rural superma rkets) in India. In 2002-03, LIC sold 50 percent of its policies in rural India. Small towns and villages account for over one million cellular telephone users. ! Of the 25 million households that bought television sets over the last three years, 19 million, or 77 percent were rural households. ! Of the 20 million who have signed up for a popular horizontal portal, ecommerce and free mail service, 60 percent are from small towns. Of the 100,000 persons that have transacted on its shopping site, 50 percent are from small towns. ! ! ! Companies and businesses that have managed to differentially cater to the varyin g segments of the population have benefitted in the long run Companies and businesses that have managed to differentially cater to the varyin g segments of Indian population have benefited. As a corollary, the entertainmen t sector too has begun to witness the advent of a broader set of offerings which are aimed for specific segments: e.g. television channels for children. On the other hand, the ‘children's films’ genre, for instance, has yet to grow and mature i n India. There is a case for a proactive and sustained targeting of specific, ni che segments of the market. In fact, given the size and potential of India's nic he segments, niche may be a word which is likely to be replaced soon. Advertisin g spend As per industry estimates, the total advertising spend in India in 2004 was approximately INR 118 billion, a growth of 13.4 percent over the last year. However, India continues to have a low 'advertising spend to GDP' ratios compare d to other economies, underscoring the untapped potential. 13 A CII - KPMG Report

Relative advertising spend for various countries GDP Australia China Hong Kong I ndia Malaysia Singapore South Korea USA France Germany United Kingdom Source: KPMG Research (USD billion) Total ad spend 4 6 4 2 1 1 4 134 1 16 14 Ad spend to GDP 1.0% 0.6% 2.1% 0.5% 1.0% 0.9% 0.8% 1.3% 0.8% 0.8% 0.9% 412 904 164 485 88 86 477 10,384 132 1,984 1,560 India continues to have one of the lowest ad spend to GDP ratios, underscoring i ts untapped potential In 2004, the advertising spend for India stood at 0.50 percent of the GDP up fro m , 0.48 percent the previous year. This is expected to increase significantly d ue to rising consumerism and growing interest from global brands attracted by th is huge and expanding market. Total advertising spend and GDP 0.53 (In percentage) 0.53 0.54 0.52 0.51 0.50 0.48 0.52 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Source: KPMG Research Given the increasing number of media channels that consumers are exposed to, bra nds will have to advertise more frequently and across more channels to generate brand recall. As television channels have multiplied and the content available h as become more diverse in the last decade, their viewership has 14 Fo c u s 2 010 : D r e a m s t o r e a l i t y

increased, niche channels have emerged targeting specific demographic segments a nd the cost of advertising on television has reduced. Number of brands advertised on television 10914 12759 8994 7875 6830 8041 7673 3906 3973 4496 4774 1994 1995 1996 1997 1997 1999 2000 2001 2002 2003 2004 Source: TAM Adex While the broadcasters can dwell on this shared optimism, they must also recogni se that advertising budgets are very sensitive to economic downturns. Advertisin g budgets are not only easily brought down, but the productivity of such expense s is also challenged. Companies are increasingly demanding their advertising age ncies to link their fees to performance indicators such as sales increments. Wit h increasing access to state-of-the-art technologies, addressability issues are being put to test, thereby exposing the limitations of current media research fi ndings and measuring the true efficacy of media. Content Any new media market attracts an initial swell of content players. Such a scenar io invariably leads to a stage where the smaller players find it unviable to con tinue and are eventually weeded out. After the initial shakeout, the industry co nsolidates and grows until it reaches a stage of maturity. Thereafter, in a stab le environment, it is the quality of content, with an accentuation on innovation and creativity that drives the industry. In the television medium, the differen t genres are in different stages of their life cycle. Several channels have emer ged recently in the space of children's entertainment and education. The news ch

annels are in the next stage of evolution with an influx of players in the last two years, but market limitations and more transparent viewership patterns will lead to an inevitable shakeout. Up the maturity curve is the mass entertainment genre, which has established itself with 3-4 major players and the quality of pr ogramming (including innovative formats) 15 A CII - KPMG Report

determining their fortunes. With the introduction of newer distribution channels , such as DTH and IP-TV, the demand for premium/ alternate content will increase and this is expected to spur the growth of new genres such as education, teenag e entertainment, mature content (subject to liberalisation of the programming co de), etc. The number of films produced annually has been declining as producers are increa singly valuing quality over quantity With a legacy of over 50 years and 1000 films a year, the Indian film industry h as reached a phase where the focus is on the quality of content. The increase in the number of films made has not seen a proportionate increase in their commerc ial success. In fact, there is now a decline in the number of films being produc ed annually and this trend is expected to continue as production houses now valu e quality over quantity. To combat the pressures of television programming, the Indian film industry, like its western counterpart, is being forced to attract t he audiences through technological advancements like advanced visual effects, sp ecial effects, sound sync, animation and sheer star power. In the late 80s, the Indian music industry saw an end of the existing duopoly with several new player s emerging. A spurt in content availability and new genres such as Indi-pop drov e the rise in music consumption. However, technology has facilitated easy access to music through illegal downloads, pirated CDs and tapes, music television cha nnels and radio FM channels. With little value realisation by music companies an d minimal regulatory support, music companies are struggling for survival, as a result of which there has been very little experimentation in content. This situ ation could change with the increasing popularity of non-film music in India and globally, signs of which are being observed. Pricing India has the potential of becoming an attractive destination for international broadcasters and production houses, despite its low per capita income, as the la rger population base makes a viable case for high volume consumption. However, w hile prices are significantly lower in India than in other parts of the world, a ccess to volumes is restricted by fragmentation in the distribution chain. Subsc riber declaration by cable distributors to broadcasters in India is extremely lo w resulting in very inequitable distribution of subscription revenues. According to an independent research, the operator-broadcaster split of subscriber revenu e in India has possibly the worst skew in the world. 16 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Distribution of revenues Market United States United Kingdom Australia Japan Ind ia Source: Media Partners Asia (In percentage) Operator 60 63 65 65 83 Broadcaster 40 37 35 35 17 Such low levels of declarations have been attributed to the lack of transparency in the last mile distribution end of the business, which is controlled by the 3 0,000 odd local cable operators and independent cable operators across India. A price differentiation strategy needs to be adopted for media products with a v iew to maximise revenues Similarly, in films, there is low transparency of actual gate receipts, outside of multiplexes and few organised theatre halls. This is particularly true in sma ller towns where receipts are not accounted for. According to industry experts, the total revenues lost to the film industry due to unaccounted receipts coupled with video piracy range between INR 15 - 20 billion annually. Film piracy throu gh illegal DVD and VCD releases and the open screening of new releases by cable channels, is forcing film producers to pre-sell the television and video rights, before the release of the film even if it means an erosion of theatrical ticket sales. Piracy of music through illegal downloads, unauthorised CDs and remixed versions of popular music is taking its toll on music recording companies. The p altry royalty sums, if any, paid by music television channels and FM radio only adds to the difficulties faced by these companies. Differential pricing India ha s seen improved income levels across a large section of its populace, with a sig nificant number of people willing to spend on entertainment. However, a substant ial difference in the affordability levels between various sections of society c ontinues to exist. As a result, a price differentiation strategy needs to be ado pted for media products, with a view to maximise revenues. Establishment of zone s and creating a zonal pricing structure for different cable subscription packag es could be an effective pricing strategy. Through a differential pricing system , broadcasters will be able to earn more from higher income groups through compe lling content packages, and the same can be used to subsidise subscription fees of lower income groups with minimal content packages. This will help increase th e size of subscribers thereby resulting in increased revenues. In the film secto r, price differentials already exist both at the point of distribution (territor ies for distribution) as well at the point of exhibition (theatre hall tickets). 17 A CII - KPMG Report

The differential pricing mechanism can be examined more closely and transparentl y to determine price levels that will draw larger audiences to films. In the mus ic sector, pricing CDs at a premium end and cassettes at the low end may help mu sic companies compete with the prices of pirated cassettes. A marginal drop in C D sales may be offset by increased cassette sales. At an overall level, differen ce pricing should be driven by the objective of revenue optimisation. In all the se sectors, differential pricing would require a thorough understanding of the d emand for media and price sensitivities of various segments, gained through rese arch at the ground level. Regulation Further growth is difficult without facilitative regulation Regulations give form and direction to the free play of market forces, according to the social and economic objectives of the nation. Therefore, regulatory inte rventions are typically driven by a vision for the future, which can be shared b y all stakeholders. The need to have such a vision is very important now in Indi a, as the entertainment industry prepares for the introduction of several new te chnologies and business models that have the potential to revolutionise the dyna mics of value creation in this space. The guiding principles of such a vision sh ould include: ! Ensuring consumer choice and protection ! Achieving sustainable growth ! Ensuring a level playing field ! Providing equitable distribution of va lue ! Adoption of new technology In most media markets, the consultative process leading to formulating regulations, has served as defining steps for charting t he growth path. In India, most segments of the industry have grown to their pres ent structure and size in a largely unregulated environment. Such growth has res ulted in the creation of lastmile monopolies in cable television, established th rough informal agreement among the unorganised last-mile operators. However, fur ther growth will be extremely difficult without facilitative regulation to ensur e structural and behaviourial changes amongst the industry players. Such changes are necessitated by the following ground realities: ! Lack of consumer choice i n several segments of the industry value chain, most notably in the last-mile of cable distribution ! Piracy-related revenue and tax leakages across all segment s of the entertainment industry ! The need to establish a level playing field fo r new distribution platforms like Direct To Home (DTH) broadcasting and digital film ! The need to protect sovereign interests like national security. 18 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Revenues losses due to leakages and piracy A substantial portion of the industry revenues is not captured at the last mile, through leakages and piracy. This do es not even include unaccounted for revenues, the impact of which cannot be quan tified, arising from: ! live entertainment events hosted by the unorganised sect or ! black market sale of film tickets ! end-user revenues from pirated home vid eo rentals ! unaccounted income from marketing of pirated home videos overseas S plit of industry revenues (INR billion) 126 120 101 95 Any regulatory intervention should be supported by a comprehensive framework and effective Implementation 83 61 135 2003 66 156 2004 77 185 225 276 330 395 462 2005E 2006E Revenues to rightful IPR holders Source: KPMG Research 2007E 2008E 2009E Leakages at last mile, piracy 2010E Going forward, it is expected that the ratio of illegitimate revenues to total r evenues will go down to less than 25 percent from the current 30 percent, though in absolute terms, it will continue to increase. It is important to note that a ny regulatory intervention should be supported by a comprehensive framework for industry evolution, and followed up by efficacious implementation. Otherwise suc h interventions can only lead to chaos and uncertainty as demonstrated by the ab orted attempt to introduce Conditional Access Systems (CAS) for television in 20 03 - 04. Technology Technology has played a key role in influencing the entertainment industry, by r edefining its products, cost structure and distribution. Empirical evidence sugg ests that technological innovations create discontinuities in the industry, with the initial dissonance evolving into eventual realignment to effectively create and realise value from it. Content creation has benefitted significantly from t echnological breakthroughs, especially in the areas of sound, visual effects and animation. This has benefitted audiences by providing them with a high-tech con tent viewing/ listening experience. The growing adoption of digital television a round the world has forced leading global broadcasting companies to put developm ent and use of new 19 A CII - KPMG Report

technologies at the centre of their core strategies. For a content distributor, future will come by specialised offerings, such as high-resolution pictures, hig h-speed Internet access, online games and information, pay-per-view electronic c ommerce services and voice telephony. New technologies, such as satellite radio, are characterised by their ability to reach out to larger audiences than ever b efore, reducing the cost per contact. While these technologies typically require high initial capital expenditure, the same may be set off by incremental volume gains through increased reach. It is this trade off that needs to be evaluated before an investment is made in any new technology. If one were to look at emerg ing trends in technology and their impact on entertainment consumption, the most significant trends are seen in the areas of media distribution, though some may be regarded as product innovations. Some such technology trends are: Digital di stribution Digital distribution of content in television and film will help plug the leakage of last-mile revenues due to the under-declaration among cable oper ators and film theatre owners. The Personal Video Recorder The Personal Video Re corder (PVR) expands users' ability to decide when and how they will watch progr ammes. It allows the viewer to pause a television programme when required, and p rovides the luxury of skipping commercials entirely. The PVR allows viewers to c reate their own programming schedule to fit their time requirements. Technologie s such as this will lead to more audience 'fragmentation'. In such a scenario, i t is the programming content that will ultimately drive the industry. High Defin ition Television As digital video signals begin to appear, High-Definition Telev ision (HDTV) sets are getting the most attention. Digitalisation allows HDTV bro adcast and transmission with incredibly sharp and detailed pictures. However, at present, current-generation television sales have not demonstrated a downwards trend. In fact, consumers continue to pay more for large screen models with pres ent-day technology. Even in the US, viewers are not expected to switch to HDTV s oon, due to the very high price differential. Interactive services Digital broad casters are working on ways to include interactive services into their over-theair digital video transmissions, primarily as video signal enhancements. Cable a nd satellite television companies are also moving towards interactive 20 Fo c u s 2 010 : D r e a m s t o r e a l i t y

services that vary from simple video-on-demand to more complex internet access p roducts. Such interactive technologies are expected to be platform-neutral, prov iding service providers with new products and services to offer. Fixed broadband wireless systems Fixed broadband wireless systems are another way to bring inte ractive digital services to consumers. The wireless debate currently centres on the use of pointto-point or point-to-multipoint technology. Point-to-point, a te chnology already entrenched in some regions of Asia, beams data over the air fro m a transmitter to one receiver. It is widely used for business-to-business comm unication. Point-tomultipoint, still an embryonic technology, operates like sate llite distribution, beaming data to as many reception antennae as the signal can reach. Internet radio stations As internet connections have become faster and s oftware for cyberspace has become more sophisticated, audio aficionados have ben efitted significantly. Free, downloadable audio players for computers have made listening to audio via the computer commonplace. Traditional over-the-air radio stations have begun to take advantage of the new software, as well as the intern et's ability to deliver graphics, data and video at the same time, to enhance th eir audiences' listening experience. The internet has also extended the reach of radio stations beyond their own markets, which was determined by the strength o f their broadcast signals, to the entire world. Downloadable digital audio As te chnology has enabled internet users to download digital audio tracks, online mus ic download sites have rapidly sprung up, presenting a challenge to existing rad io stations. Marquee artists are opting more often to debut new albums or tracks online rather than through traditional radio stations or video music channels. Recording artists and record labels are also moving toward offering their music online. For both artists and producers, digital distribution is a way to bypass radio stations and, more recently, video music channels. Satellite radio Satelli te radio is a digital radio broadcast system that uses direct-to-home satellite technology to offer listeners up to 100 channels of commercial-free audio music, news and entertainment. However, not all the new technologies listed above will succeed. In order to succeed and become a mass phenomenon, they will have to de monstrate that they are adding value for the consumers and the providers. 21 A CII - KPMG Report

The increasing penetration of technology is a major force shaping the entertainm ent landscape today. It will completely revolutionise content delivery as well a s the viewership experience. Once these technological changes attain a critical mass, they can have a shattering effect on the existing industry equilibrium. Du e to the imminent impact of these and other technologies, the successful media a nd entertainment companies will be the ones that are prepared for their disrupti ve effects on their business models and the industry structure. The future of entertainment will be governed by the interplay of consumerism, ad vertising spend, content, pricing, technology and regulation The future of the entertainment industry will be a function of the interplay of each of the above factors, namely consumerism, advertising spend, content, prici ng, technology and regulation. Estimating the industry size over the next 5-10 y ears, would require a crystal ball, given the number of variables involved. Howe ver based on current trends, the industry is expected to breach the INR 500 bill ion barrier in five years. For the Indian entertainment industry, this is the mo ment of truth. Beyond the linear growth projections, there is a bigger story wai ting to happen if a concerted and accelerated effort is made now. The industry i s entering a second phase of growth, which will have technology as one of the ke y drivers. This growth phase will be the consequence of a combination of quality infrastructure and the gradual penetration of digital connectivity, which will redefine the way entertainment content is delivered and consumed. This phase of growth needs to be supported by an enabling tax and regulatory infrastructure, a s the government begins to understand the long term potential of this sector, an d starts according it the priority status it deserves. For the purpose of this report, we have limited our detailed analysis to the fou r traditional sectors – television, film, music and radio, which together account for 96 percent of the entertainment industry revenues. The balance 4 percent is made up of revenues from live entertainment (currently a fragmented segment with few small players) and IT-enabled businesses like interactive game development and visual effects (engaged in outsourcing work primarily in areas of 2D animati on, 3D graphics, post-production, etc.). These sectors are now taking off and co uld become significant drivers of growth in the future years. 22 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Television Box Populi

Television Box Populi The significant growth in the entertainment industry in the last decade of the t wentieth century was largely triggered by the coming of age of television. For m ost of the last fifty years, it was a monopoly of the public sector broadcaster. However, the nineties inspired private sector enterprise across the television value chain. Since then, the rapid growth of the television industry has made it the most significant component, in value terms, of the entertainment sector. Wi th increased hours of mass entertainment programming during prime time and bette r coverage of popular events, it has seen an explosive growth in consumer mindsh are. Its status as the preferred mode of entertainment of the people is obvious from the fact that it now contributes more than 60 percent of the entertainment industry's revenues. Today and tomorrow Out of its total current revenues of INR 139 billion, subscription contributed 5 3 percent, i.e. INR 73 billion. That is one-and-a-half times the advertising rev enues, which are at INR 49 billion. However, due to the large skew in the 'last mile', as discussed later, the broadcasters' share of pay revenues amount to onl y around 17 percent, or INR 12.5 billion. Other revenues, which include internat ional distribution right, amount to INR 14 billion. The growth of the Indian Television industry is decelerating and a number of new initiatives will be required to power a fresh round of expansion As any industry matures, inevitably its growth starts slowing down. The Indian t elevision industry too is following this dictum, seeing its growth decelerating from over 20 percent, till a few years ago, to less than 15 percent currently. H owever, it would be completely wrong to say that television has become a mature, sunset industry. While the current sets of growth drivers are gradually reachin g saturation, there are a number of new initiatives which can power a fresh roun d of expansion. Some of these key factors are: ! Introduction of addressability: In spite of apprehensions, public debate and litigation, CAS was eventually lau nched in Chennai, providing valuable lessons for future attempts to bring in add ressability across the country, though the impact of the same is yet limited; ! Alternative distribution platforms: DTH broadcasting has introduced the power of choice to the consumer. The last mile distribution segment is expected to see f urther action with the entry of new DTH players, IP-TV, broadcasting services on DSL technologies, etc; ! New players in niche genres offering more content choi ce to viewers: Niche genres have significantly enhanced their proposition over t he last few years with the entry of several new channels. While, news and childr en's programming segments accounted for most of the new entrants, other niche ge nres like religion and health also experienced the launch of several new channel s. ! Meaningful regulatory intervention: The government needs to create a conduc ive regulatory environment for rapid but stable growth by supporting 23 A CII - KPMG Report

initiatives like digitalisation of cable television, regulatory policy for DTH p layers, etc. These trends have the potential to redefine the landscape of the br oadcasting industry in the country. The significance of such a redefinition shou ld be understood in the context of the overall evolution of the broadcasting and distribution market in India. The high growth that took place in a relative reg ulatory vacuum in the last decade created a distortion in the distribution of va lue amongst industry players. This has fostered an opaque transactional environm ent, resulting in: ! Lack of consumer choice for last-mile access; ! Under decla ration of subscriber numbers resulting in revenue loss for broadcasters and tax loss for the government; ! Absence of uniform pricing with prices varying across geographies and consumer segments; ! Lack of level playing field for alternativ e platforms like DTH, IP-TV, etc resulting from 'unreal' cost structures of incu mbent access providers and non-uniform licensing conditions. A combination of pu rposeful regulatory interventions and technology adoptions can go a long way in correcting such structural imperfections. The initiatives being undertaken and b eing proposed to be undertaken, to correct these structural imperfections, will drive the second wave of growth of the industry. Television revenues Subscription Advertisement Others 39 78 35 30 68 24 20 17 12 5 35 37 60 65 73 39 14 43 49 163 136 90 107 54 58 213 250 63 73 (INR billion) 43 Source: KPMG Research In this new phase of growth, the sector is expected to grow at an annual rate of almost 18 percent to reach INR 371 billion by 2010; with subscription revenues forming the lion's share at INR 250 billion. It is also expected that the broadc asters will get a fairer share of the subscription pie. Advertising revenue is 24 Fo c u s 2 010 : D r e a m s t o r e a l i t y

expected to grow at a modest rate of 8 percent to reach INR 78 billion in six ye ars. The true potential of television advertising however is much higher. It cou ld touch INR 150 billion by 2010, depending on the following factors: ! Speed an d effectiveness of the roll-out of the broadcasting sector reforms; ! The quantu m of investments made by various players over the next few years on rolling out digital platforms; and ! The entry of telecom companies into the distribution se ctor. The ensuing sections discuss the various drivers of growth that could take telev ision to the next phase of evolution. Advertising As per industry estimates, the total advertisement spend in India last year was approximately INR 118 billion. However, at 0.50 percent, India continues to have one of the lowest 'Advertisin g spend to GDP' ratios amongst peer economies. This underscores the significant potential India has yet to achieve vis-à-vis advertising budgets. However, this is set to change. A growing middle-class will spur the increasing tide of consumer ism and a growing lineup of global brands will continue to be attracted by this expanding market. Consequently it is expected that the 'ad spend to GDP' ratio w ill increase steadily over the next four years. Shift in advertising over last t hree years Medium Spend Television Press Radio Cinema Out-of-home Internet 39.1 44.0 1.5 3.3 6.9 0.3 2002 Share of total spend 41.1% 46.3% 1.6% 3.5% 7 .3% 0.3% Spend 43.0 47 .5 1.8 3.6 7 .9 0.4 104.2 2003 Share of total spend 41.3% 45.6% 1. 7% 3.4% 7 .6% 0.4% Spend 48.6 54.5 2.2 3.75 8.5 0.6 118.2 2004 Share of total sp end 41.1% 46.1% 1.9% 3.2% 7 .2% 0.5% (INR billion) Ad Industry Size Source: TAM Adex 95.1 The above table indicates the allocation and growth of the advertising spends in India across various media. Print is still the largest recipient of advertising revenues, accounting for 46 percent of the advertising pie and, after a tempora ry 25 A CII - KPMG Report

slump, is currently growing at a rate faster than that of television. The share of television seems to have stabilised at around 41 percent, after increasing co nsistently for about 6-8 years. The overall media mix in India mirrors that in m ost advanced countries, where television and print jostle for dominance in the s pace of advertising expenditure. Advertising pattern in developed countries 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% US Japan Germany Source: World Assoc iation of Newspapers UK France Others Radio Magazines Television Newspaper For the next three years, print and television will command equal share of the a dvertising market In the Indian context, there is further potential for television to increase its ad share. It is expected that over the next three years, both print and televis ion will each command around 43 percent of the market, with the balance 14 perce nt being split between radio, outdoors and others. Who is advertising Until rece ntly, FMCG companies and consumer durable marketers were the main advertisers on TV channels. Today, the advertiser segment has expanded to include youth and te en products, financial products and services, educational products and services, corporate image building, telecommunications, computing, vehicles, and mobile t elephony, to name a few. It is interesting to note that according to TAM Media R esearch, on-air promotions that are carried out by the channels themselves accou nt for almost 40 percent of the total airtime, with a significant portion of the m being shown on prime time. Going forward, with capacity utilisation of airtime improving, the opportunity cost of self-advertising will increase and it is exp ected to decline. 26 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Top ten spenders on television in 2004 2500 (INR Million) 2000 1500 1000 500 0 S m ha os po ile To s s rs s es te ep d) ids ele as ice te on Je he rv ra iqu hp ph s/ se /l ot (ae -w ar ar l o er C To ne ks llu b Tw ho wd rin Ce e/ po ll p at td of or Ce ng S rp hi as Co W ps oa ts nd ra im e ag Source: TAM Adex Mass entertainment channels are slowly ceding viewership to niche channels Where does the money go Mass entertainment continues to attract maximum ad-spend s, but its share is being gradually ceded to niche channels. The major beneficia ries have been News, Regional and Sports channels. Share of ad revenues among te levision genres 100% Others 80% Music Sports 60% English Entertainment Films News 40% 20% Regional Mass 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: TAM Adex Some of the key aspects of television advertising in India are: ! Mass entertain ment channels have the largest loyal advertising base. Around 17 -18 of the top 25 advertisers advertise only on mass entertainment channels. ! Consumer goods a dvertise mostly on mass entertainment, films and Hindi news. ! Luxury and lifest

yle products are advertised across all major genres. ! Financial products like b anking and insurance advertise primarily on English news and business channels. 27 A CII - KPMG Report

! Organised retail, which is one of the larger advertising segments in developed e conomies like the US, has yet to impact the Indian advertising industry in a sig nificant way. As the retail industry in India develops and begins to realise its potential in the near future, it is expected to follow its global counterparts and become a major advertiser on television. Is advertising volume reaching saturation point? An analysis of television progr amming indicates that advertising in India, on an average, amounts to 192 second s (3.2 minutes) per hour. It is still significantly lower than several other cou ntries. Of course, in the case of prime time for mass entertainment channels, th is number could go as high as 600 seconds (10 minutes). International norms on a d clutter The norms and standards for the amount of advertising that can be show n on television vary from country to country. TAM Media Research has compiled an illustrative list of standards, some of which are mentioned below: ! Australia Broadcasting Authority recommends 10 minutes of advertising per hour of children 's programming and up to 15 minutes for non-prime programmes. ! Philippines stip ulates a commercial load for television in Metro Manila to 18 minutes per hour, while for provincial television stations, commercial load permissible is a maxim um of 20 minutes per programme hour. ! In China, a maximum of 9 minutes of ad ti me per hour of programming is allowed. ! Canada recommends 8 minutes of advertis ing per hour for children's programming and 12 minutes per hour for other progra mming. ! The average for other Asian countries is around 8 minutes of ad time an d 2 minutes of programme promotion time, i.e. a total of 10 minutes of break dur ation per hour. Pure advertising time for every hour of programming in India 219 208 With addressability, the effectiveness of ad spend will become more transparent Average Secs/Hour 192 102 DD Source: TAM Media Research FTA PAY All Channels Type of Channel 28 Fo c u s 2 010 : D r e a m s t o r e a l i t y

With advances in the technology platforms available and the introduction of addr essability the effectiveness of ad-spend will be more transparent. This will fur ther redefine ad spend patterns among genres, channels and advertising segments. Addressability will give additional tools to media planners, leading to signifi cant improvements in media planning. This, in turn, is likely to cause radical s hifts in media buying on television, which presently is largely a function of TR Ps. Channels that succeed in convincing buyers of a better value for money by cl early identifying the right target group will be able to charge a significant pr emium to the market. Effectiveness of advertising Television viewing (hours /week) Television advertisements Over-deliveries & typ ically bombard certain over-exposure audience with over exposure while completel y skirting others Sub-optimal deliveries 50 This is what the audience sees at a superficial level 85 60 20 Under-deliveries & under exposure Total TG Heavy Medium Light Source: TAM Survey over a sample Target Group There is a point of view that in a more transparent market, with the introductio n of addressability, the duration of advertising will fall even as subscription revenues increase. However, this may not necessarily be the case. As has been se en in the past, the more popular channels have been able to garner almost the sa me quantity of advertisements (in volume terms) while simultaneously charging a subscription fee, compared to some of their free-to-air (FTA) counterparts. This situation is expected to continue and, barring short term dips, the average ad duration per channel is expected to sustain itself and, in fact, increase in the medium term as a result of an increase in non-prime time advertising. The fear that compulsory addressability could lead to a flight of advertisers to FTA chan nels may not be entirely justified; flagship channels, whether FTA or pay, will continue to garner premium advertisements. Subscription revenue Television reach es over 40 percent of the billion people in India, commands the highest mindshar e among consumers and cuts across rural-urban and class divides. Currently, 91 m illion households own a television, out of which 48 million households are cable and satellite households, the state-owned terrestrial broadcaster, Prasar Bhart i, accounting for the balance 43 million. Though the cable TV penetration in Ind ia continues to grow at a brisk pace, the untapped potential is still very signi ficant. Over the next few years, cable and satellite, along with emerging delive ry platforms like DTH and IP-TV are expected to close in on the 29 A CII - KPMG Report

gap further. It is expected that television connectivity in India can reach 134 million households by 2010, of which as many as 85 million, or 63.5 percent coul d be connected through cable and satellite, DTH, IP-TV or other non-terrestrial broadcast platforms. Cable television Penetration 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% a e n es re or pa pin ap Ko Ja ilip th ing u S Ph So Source: www.worldscreen.com a ali str Au ina Ch a di In an iw Ta A US na Ca da m Gr y an The wide disparity in ARPUs is not commensurate with the quality or offering or service Along with a growth in subscriber volumes, the cable subscription charges (ARPU per month) too is expected to grow at a pace faster than that of per capita GDP . At around INR 150, India has one of the lowest ARPUs in the world. In fact, th e ARPU for cable television has actually fallen in real terms, growing at sub-in flation rates over the past seven years. An average urban Indian cable connected household receive as many as 100 or more channels for which it pays anywhere be tween INR 100 to 300 per month, while in certain rural and semi-urban areas, thi s number could be as low as INR 60 per month. The wide disparity in ARPUs betwee n locations and, often, between various localities within the same city, is not proportionate to the quality of content or service offering by the distributor b ut has been guided mostly by the relative bargaining power of the cable operator with both the consumer and the broadcaster. Cable subscription rates have falle n in real terms 155 150 145 140 135 130 125 120 115 110 105 100 1997 1998 1999 2000 2001 2002 2003 2004 Consumer Price Index Cable Prices Source: Industry 30 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Global Cable ARPUs 60 50 40 30 20 10 0 K Ph ore ilip a pi ne s Ta iw an M ala ys H ia on g Ko ng Si ng ap or e Th ai la nd In do ne sia Ja pa n U K Ca na da Au st ra N lia ew Ze al an d (USD/ month) Source: worldscreen.com Apart from the low subscription fees, subscriber declaration by cable distributo rs to broadcasters in India is one of the lowest in the world, resulting in a gr ossly inequitable distribution of subscription revenues. According to an indepen dent research, operator-broadcaster split in India of subscriber revenue has the worst skew in the world. It is estimated that the LCO corners 79 percent of the total subscription revenues of the industry and leaves just about 17 percent fo r the broadcaster. The residual 4 percent is retained by the MSO who downlinks t he broadcasters' signals and transmits them through a combination of fibre and c oaxial cable network to consumers' homes via the LCO, who, almost in all cases, owns the coveted 'last mile'. The low levels of declarations are attributed to t he lack of transparency at the last mile distribution end of the business, owned by the 30,000 odd LCOs across India. This combination of low subscription fees (ARPUs) and chronic under-declaration of the subscriber base by the LCOs has sig nificantly constrained the growth in the subscription revenues for the broadcast ers. Attempts at increasing transparency have been made through a combination of technology and regulations. In 2003, an attempt was made to introduce CAS. As p er CAS, the Indian home would receive two sets of channels: ! FTA channels - a b asic bouquet of channels for which the customer would pay a flat amount, the pri cing for which may be regulated by the Government as required; ! Pay channels for which the customer would pay an amount fixed by the channel/bouquet owner. A ll pay channels would be routed through an addressable system. Ch in a In di a U SA 31 A CII - KPMG Report

However, the implementation of CAS did not take-off due to lack of uniform accep tance by all segments of the television value chain i.e. Broadcasters, MSOs, LCO s, alternate platform providers and end consumers. The CAS saga Stakeholder What they thought Most pay broadcasters wanted to avoid/ delay addressability, as th ey feared a revenue fall in the shortmedium term. Genuinely wanted early impleme ntation of CAS as such early mover advantage in seeding the Consumer Premises Eq uipment can reduce strategic vulnerability. Positions shifted between pro and an ti addressability and finally settled for addressability as the threat perceptio n of alternative platforms was enhanced. What they said Supported addressability on the grounds of increased transparency and more equitable share of distributi on revenues. Broadcaster MSO Supported addressability. LCO Conditional support for addressability, bargain for higher FTA charges. Consumers Consumer did not want addressability, as it was perceived to be a mechanism for charging more and delivering less. Confused positions arising from the lack of information. Alternate platform providers Wanted addressability as it ensures Highlighted implementation a level playing f ield. But wanted to delay the implementation depending issues whilst supporting addressability. on the level of preparedness to (DTH/ IP-TV) launch services. In the midst of the debate, CAS was finally implemented in Chennai and in some p arts of Delhi. While there were few takers for CAS in Chennai, many cable operat ors in South Delhi did not even supply their subscribers with the required STBs. To resolve the potential deadlock, the Government of India has brought all broa dcasting platforms under the regulatory ambit of the TRAI and CAS has been de-no tified, pending a clearer regulatory direction from TRAI. 32 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Making sense out of the chaos In a consumer economy, consumer interests should i deally drive the market structure and regulations. Today the consumer has little real choice regarding platforms or operators in the monopolistic last mile envi ronment, created through informal agreements amongst cable operators. Unwillingn ess to proactively intervene to correct such market distortions amounts to prote cting an informal monopoly, denying consumers their rightful operator and techno logy choices and constraining the growth and employment potential of the industr y in the long term. Therefore, appropriate regulator intervention should focus o n evolving an industry structure and a regulatory environment that facilitates t he realisation of industry potential through correction of the following anomali es: ! Lack of consumer choice in the last mile. ! Under-declaration by last mile operators leading to: Subscription revenues falling out of tax net; Broadcaster s being denied their share of the subscription revenues. Lack of level playing f ield for alternative platforms like DTH, IP-TV, etc; Lack of investments in dist ribution infrastructure upgrade and expansion; Lack of visibility of consumer vi ewing patterns resulting in inefficient media spends. Putting the issues in pers pective It is unreasonable to expect the 30,000 strong LCO & ICO fraternity (whi ch employs over 500,000 people) to either shut down or fall in line overnight. O n an as-is basis, it is unlikely that the declaration percentage will improve si gnificantly from the current level of 23-25 percent to more than 30-35 percent, unless such a move to increase declaration is accompanied by either a steep incr ease in subscription fee or a significant reduction in channel pay-outs, or a co mbination of both. This would necessitate all existing stakeholders, viz the LCO s, MSOs and broadcasters to act in unison and look at partnering solutions for t he last mile. In the interim period when the market moves towards a correction i n the imbalance, the incremental gains to the various stakeholders, including co nsumers will be disproportionate. However, if each stakeholder insists on maximi sing his own gain in the short term, it would only lead to a lose-lose situation in the long term. An effort in trying to correct the skew overnight may result in 'no correction' at all. Significant changes in the way broadcasting content i s packaged and distributed currently can be initiated through the following meas ures: ! Introduction of voluntary addressability, enabling the distributors to s elect their business model. ! Tiering of channels: Distributors should offer mul tiple tiers of programming with the basic tier offering popular general entertai nment and news channels like Star Plus, Zee, Sony, NDTV, CNN, BBC etc, along wit h FTA channels. The basic tier should be available to all consumers. Premium pro gramming tiers containing sports, lifestyle and other niche segments can be made available in an addressable environment. The existing players, viz LCOs, MSOs and broadcasters need to look at partnering solutions for the last mile 33 A CII - KPMG Report

! ! Government could cap the basic tier pricing till the market matures. The state o f effective competition can be established by the extent of consumer choice avai lable. While, within the price band, the pricing needs to be left to the broadca sters and market forces, the fundamental decision to include a channel in the FT A basic tier package could be mildly regulated, till the market matures. Viewers hip-based formula could be worked out and though such formulae are not foolproof , it could serve as a basic guideline to ensure that the average consumer is not deprived of popular content. However, in the long run, there should be no ambiguity about the fact that bette r offering is linked to higher price; adequate consumer awareness campaigns may need to be undertaken by both the regulator and the broadcaster-distributors to ensure that pay revenues are eventually aligned with service. This situation, in a way, is akin to a toll road or an urban utility project, where privatisation of infrastructure eventually results in the user paying for a similar facility w hich he was hitherto enjoying for 'free'. To ensure smooth implementation, gover nment could consider mandatory licensing for cable operators. All registered cab le operators should be given a reasonable deadline to switch over to such a lice nsing regime without any licensing fee. The licensing authority could be given p owers to conduct surprise audits to establish the declared subscriber numbers an d to invoke penal provisions, in case of any material discrepancy. Simulated rev enue flow for a large LCO Current Scenario Number of subscribers declared undeclared Subscription fee (INR/sub/month) Split (for declared subscribers) Broadcasters LCO MSO 1500 375 1125 150 75 53 22 50% 35% 15% Optimised Scenario 1500 1500 0 190 35 145 10 18% 76% 5% Increase/month 25% 75% 100% 0% 40 27% What the subscribers pay INR (LCO's gross revenues) Split (for total revenues) B roadcaster revenues MSO revenues LCO revenues Estimated tax loss Source: Industry 225000 285000 25% 28000 8000 189000 45000 12% 4% 84% 53000 15000 217000 0 16% 4% 80% 25000 89% 7000 88% 28000 15% 45000 34 Fo c u s 2 010 : D r e a m s t o r e a l i t y

A 100%-declaration is possible, through only a moderate increase in rates, throu gh partnering solutions In the above simulation, it can be seen that 100 percent declaration can be brou ght about through a moderate increase in subscription rates, and an increase in inflows for all the players, resulting in a long term win-win: ! Consumers’ outgo goes up by 27 percent. This is not a very high price to pay, considering that th e same consumer was: Paying almost the same amount, in real terms (after factori ng in inflation) around 10 years ago for only 4-5 channels; Bracing himself for a much higher increase in rates, if mandatory CAS were to be implemented. ! Broa dcasters' revenues will go up by almost 90 percent, significantly higher than wh at they can expect through organic growth in pay channel rates; ! LCO revenues w ill increase by 15 percent and therefore they have the incentive to declare thei r subscriber base fully and simultaneously secure their long term sustainability . One time Amnesty Schemes and deadlines for disclosure can be worked out as a f urther carrot and stick measure. ! MSOs revenues too will virtually double. 100 percent declaration will ensure that the consumer is now 'owned' by the MSO and this would throw open several possibilities of increasing ARPUs through value-ad ded services and premium content, which can be pushed through more rapidly. As c an be seen, the biggest beneficiary would be the government, since the taxes tha t are not paid due to a lack of subscriber declaration can be brought back into the system. The funds thus garnered could be used to form a corpus for developme nt and reforms in the distribution sector. Content Broadcasters are beginning to recognise that audiences cannot be taken for granted. An increase in the number of channels, coupled with a surfeit of “me too” content on channels within the same niche has led to fragmentation in viewership patterns. Advertisers too, now, ha ve the option of lower priced niche channels to reach a more focussed target gro up, and their advertising spend reflects this. An increasingly sophisticated Ind ian audience, now exposed to international fare, benchmarks television entertain ment with the best when it comes to quality and treatment. Capturing the mood of the viewer, sports and Hindi film channels have gained viewership, but have had to spend heavily in order to acquire prime properties. News channels registered a 100 percent increase in viewership over the last three years, as have English entertainment stations and channels for children. The success of quality progra mming in certain segments indicates the potential for entertainment channels to move up the content value chain. 35 A CII - KPMG Report

Genrewise Viewership Share in 2004 8 5 2 4 (In percentage) 3 1 40 38 Mass Entertainment Hindi Film Channels Infotainment / Kids Regional Channels English Entertainment Music Channels News Channels Sports Channels Source: TAM Media Research The shifts in viewing patterns have put a high pressure on mainstream channels, necessitating them to revisit their content strategy to attract new audiences an d to retain existing ones. Several big budget shows have been launched on Indian television in the recent past. The line-up included reality shows, professional dramas, game shows, interactive programmes, daily soaps and adult programming. These were highbudget, high star-value programmes on which channels spent millio ns on development and promotion, not all of which proved successful and were sub sequently pulled off air or thematically re-oriented. Sports channels With an in crease in cricket as well as non-cricket viewership, sports channel viewership h as gone up manifold. The boom was primarily on account of World Cup Cricket 2003 , followed by India's tours of Australia and Pakistan in 2003-04. The popularity of Indian cricket has been rising rapidly, as can be seen from the price at whi ch the television rights have been sold in the recent past. For instance, as opp osed to a mere USD 10 million which the broadcast rights for World Cup in Austra lia-New Zealand (1992) garnered, the rights for the 2003 World Cup in South Afri ca fetched around USD 85 million, an increase of 750 percent in ten years. Compa red to this, the Olympic rights have moved from USD 350 million (Atlanta, 1984) to USD 1.5 billion (Athens, 2004), an increase of just over 300 percent in twent y years. In addition to cricket, viewership of Formula 1, tennis, soccer, hockey , basketball and baseball is also on the rise, helped to a great extent by the r ise of Indian sportspersons like Narain Karthikeyan (Formula 1) and Sania Mirza (tennis) who have recently made it big in the international arena. Sports channe ls are 36 Fo c u s 2 010 : D r e a m s t o r e a l i t y

proactively trying to attract the audience with a mix of sports, entertainment a nd amusement. Indian viewers currently have a choice of five sports channels. It is expected that the share of viewership of sports channels will be cyclical de pending on the occurrences of popular sports properties in that year, with a con tinued heavy dependence on cricket. News channels The news and business channel space grew from virtually nothing in 1995, to just over INR 2 billion in 2002 (c omprising two dominant news channels, one major business channel and two interna tional English news channels). Since then, this segment has grown further - curr ently, there are around 11 mainstream news channels and a slew of regional chann els which together generate revenues of over INR 5 billion. Increased production values, introduction of tabloid news formats and entering into bouquets have he lped this segment in attracting more eyeballs in the recent past. A few more new s and current affairs channels are reportedly in the offing with large corporate houses planning forays into this segment. The business channel space, originall y an offshoot of the news channel space, hitherto dominated by CNBC, is believed to be the next growth driver, within the news and business space. Currently val ued at INR 1 billion, this space is expected to grow at 40-50 percent over the n ext 2-3 years. Children's channels Close on the heels of news channels, the chil dren's channel space is emerging as one of the fastest growth drivers. Children' s channels currently garner INR 1.4 billion in advertising revenues, while pay r evenues too are expected to kick in, in a large way. Advertisers of general prod ucts are increasingly getting interested in this space - apart from a growing ma rket for children's products, children are believed to exert a strong 'pester po wer', which influences buying decisions for a large range of consumer durable an d non-durable products. Currently, there are around ten children's channels. Int ernational majors in children's broadcasting, Cartoon Network and Nickelodeon al ready have an established presence in India, while Disney has commenced operatio ns recently. Established Indian broadcasters like Zee and content providers like UTV and Pentamedia have also entered this space over the last two years. The do mestic players appear to be well-placed to exploit the current void in localised programming, which has empirically proven to be a strong driver in other mature television economies. The international channels too currently have a high degr ee of dubbed multi-lingual programming and are reportedly looking at including l ocal programming in their offering as well. As a result of increased depth of 37 A CII - KPMG Report

programming, together with the expansion of the advertising space and the emerge nce of addressable distribution platforms facilitating pay television, the child ren's channel segment seems to have entered a period of sustained growth. Region al channels Regional channels have been jostling for viewership, in the face of increasing quality and variety of offering by mass channels, and the emerging po pularity of niche channels. In West Bengal, Maharashtra and the four Southern st ates Andhra Pradesh, Karnataka, Kerala and Tamil Nadu, though, consumers have co ntinued to establish a definite demand for regional content. However, this space is characterised by low ad rate realisations, low production budgets, “me too” prog ramming and fierce competition between various channels. Large regional variations in viewership necessitate a segmented approach in an a ddressable market The large regional variations necessitate the need for a more targeted and segme nted approach for content, in an addressable scenario. Viewership pattern across locations 2003 Total Market Hyderabad Bangalore Chennai Delhi Kolkata Mumbai 0% 20% English ent ertainment Mass Hindi Regional 40% Hindi films Music Sports 60% 80% 100% Infotainment & kids Others News 1999 Total Market Hyderabad Bangalore Chennai Delhi Kolkata Mumbai 0% Mass Hindi Regi onal 20% English entertainment 40% Hindi films Music Sports 60% 80% Others News 100% Infotainment & kids Source: TAM Media Research 38 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Viewership of other genres such as English entertainment has risen by around two thirds over the previous year. Currently, there are seven English entertainment and film channels that cater mostly to the urban households. English film chann els enjoy the highest ads-to-viewership ratio, i.e. they command a relative prem ium on a proportionately lower viewership base, as opposed to mass channels. Reg ional channels, on the other hand, have the lowest ads-toviewership ratio. Conte nt trends The television software sector, which supplies programming content to broadcasters, is currently estimated at INR 28 billion. The increasing number of programmes on prime time, a swell in the number of hour long weekly programmes and enhanced consumer interest in niche content are considered to be driving gro wth. Further, the increased use of content libraries for export to both Indian a nd non-Indian viewers abroad have also led to growth in this sector. While mains tream entertainment programming will continue to be the bulwark of Indian televi sion, other genres such as news, sports, children and special interests (viz. re ligion, home, health, etc.) will form an increasingly important part of the soft ware pie. It is important to note that despite the boom in the television sector and the spiralling demand for content, stand alone television production houses have not been able to grow their business, barring the market leader and a few others who have further consolidated their positions. Going forward, it is belie ved that both broadcasters and content producers will begin to work out backward and forward integration models respectively with broadcasters developing a high er proportion of content in-house and more production houses getting into the br oadcasting business. Another growth area in the Indian television software indus try will be adaptation of the existing content for digital and on other delivery platforms. Most of the Indian television software is generated on analog platfo rms, going digital only in the last phase of broadcasting. All content will firs t need to be converted to digital formats and then fine-tuned to suit the delive ry needs of each individual format such as HDTV, IP-TV, etc. The road ahead The television industry is now ready to advance to the next stage of its evolution, grasp the opportunities presented by the digital age and completely change the h ome entertainment landscape. In the process, it is expected to continue its rapi d growth and reach INR 371 billion by 2010. 39 A CII - KPMG Report

Over the next six years, television advertising spend is expected to grow at a l ittle over 8 percent annually, to reach INR 78 billion in 2010. Such growth will be a function of an increase in number of advertisers and an increase in paid a d seconds. Going forward, digital distribution players like DTH, IP-TV are expec ted to emerge as new contenders for the total ad pie, as new revenue streams lik e (advertising on) Electronic Programming Guides (EPG) emerge. The total distrib ution revenues are expected to grow from the current INR 73 billion to around IN R 250 billion by 2010, of which the share of declared revenues will improve sign ificantly from INR 19 billion (26 percent) to INR 134 billion (54 percent). It w ill be driven more by the conversion of existing analog subscribers to addressab le digital subscribers, rather than a plain vanilla increase in the declaration percentage, which will increase only from 25 percent to 30 percent in six years. Subscription revenues declared & addressable revenues undeclared revenues 116 110 91 83 49 16 54 19 64 26 71 36 52 72 103 134 (INR billion) 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Source: - KPMG Research The increased addressability will significantly improve both the Pay television revenues to broadcasters and to organised distributors (MSOs, DTH operators, IPTV operators etc.) which will emerge as a stronger, powerful community, as has b een seen in evolved markets like the US. (INR billion) Distribution of Revenues Pay TV Revenues to broadcasters Distributors' retention Last mile operators Total Subscription Revenues Source: - KPMG Research 2003 12 1 52 65 2004 13 3 58 73 2005E 2006E 2007E 2008E 2009E 2010E 16 5 69 90 19 11 77 107 29 16 90 136 42 23 9 9 163 62 32 120 213 82 41 126 250 Growth 37% 55% 14% 23% 40 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Broadcasters' pay revenues will grow six-fold, from INR 13 billion to INR 82 bil lion, while organised distributors, currently at a fledgling INR 3 billion, will command a significant share of the television market with subscriber revenues o f around INR 41 billion. The LCO community, though growing at a lower compounded rate, too will benefit from increasing ARPUs, seeing their revenues growing fro m INR 58 billion currently to INR 126 billion. Riding on a strong base and stron g economic indicators, C&S connections are expected to grow at a CAGR of 10 perc ent over the next six years to reach 85 million households. Content will be the key driver and demand for premium content will increase. Though the market is ex pected to be price sensitive, operators are likely to be able to charge signific antly higher fees for premium and value-added content. Demand for premium content will increase Anomalies like regional discrepancies in price will reduce and offerings will be uniformly priced across geographies and classes, which is not currently the cas e. The same consuming class currently pays the same price for consumer goods acr oss geographies and it is anticipated that televised content would also eventual ly follow a similar trend. ARPU for analog and digital subscribers 600 500 400 300 200 100 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E (INR per m onth) ARPU - analog Source: KPMG Research ARPU - digital ARPU - combined ARPUs for analog cable are expected to grow moderately, and organic growth in th is segment could eventually stagnate since the consumers in both urban and rural areas are likely to shift to digital offerings at a particular price barrier, o nce such offerings become available. The digital offerings are likely to be spli t into: Basic: These will be benchmarked at the analog cable prices of INR 125-1 50 and the offerings will include the current FTA channels and the most popular general entertainment channels and few genre-specific channels like news, childr en, etc to complete the bouquet. ! 41 A CII - KPMG Report

! Premium: The mass entertainment, film, sports and other channels which have a si gnificant consumer-pull in select consumer segments will be offered as the premi um tier. Consumers are expected to pay around INR 500-700 (inclusive of the basi c channels mentioned above). The channel's content combined with the operator's ability to bundle them attractively will determine the pace of conversion from a nalog to digital basic and from digital basic to digital premium subscribers. 2005E 213 98 53 46% 54% 25% 2006E 221 105 58 48% 55% 26% 2007E 229 112 63 49% 57 % 28% 2008E 237 119 70 50% 59% 29% 2009E 246 126 77 51% 61% 31% 2010E 254 134 85 52% 63% 33% CAGR 3.6% 6.7% 9.9% (In million) Total Households (HH) TV HH Connected HH TV penetration Connected HH to TV HH Co nnected HH to total HH Source: KPMG Research 2004 205 91 48 44% 53% 23% Value-added services: These will include pay-per-view of new films, specific eve nts like a major cricket match, interactive content like gaming, T-commerce etc. Channels may also strive to create a differentiated offering of the same conten t (e.g. ads-free telecast of cricket matches with a differentiated onground cove rage) at a higher price for this segment, which is the most priceinelastic. The ARPUs for this segment could be around INR 900-1000. Year 2010 penetration 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Top 20 cities Others Analog Cable DTH Total 90 80 70 60 50 40 30 20 10 0 Digital cable IP-TV a nd copper 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Break-down by tiered off erings (million subscribers) Analog cable Digital - premium package Digital - ba sic package Digital - value added services Source: KPMG Research 42 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The digital subscriber off-take is expected to be more rapid in metros, while th e roll-out will be slower in other cities, towns and rural areas. The price wars with existing cable offerings will be more intense. While DTH and digital cable will see a moderate subscriber off-take in smaller towns and even rural areas ( where the state-owned Prasar Bharti's low-priced DTH offerings are expected to h ave a higher market share compared to that of private operators), IP-TV and broa dband over copper will be restricted to the major cities, given the high per-lin e investment required. In 2010, out of the estimated 85 million connected househ olds (a household with C&S, DTH, IP-TV or any other form of connectivity other t han terrestrial), digital platforms will have a market share of around 18 percen t, or 13 million. There is a potential for this number to go up significantly, d epending, inter alia, on the regulatory environment which will induce new player s like established telecom operators to make the necessary investments. Break-do wn by access 80 70 60 50 40 30 20 10 0 2003 2004 2005E 2006E 2007E Source: KPMG Research Analog cable subs Digital cable DTH (million subscribers) IP-TV and copper 48 43 52 56 60 64.1 67 .9 71.9 8.6 5.7 3.5 2 1 1 2.2 1.0 2009E 2.8 1.3 2010E 1.6 0.7 2008E In terms of offerings, it is expected that the majority of subscribers, irrespec tive of the platform they are on, will continue to opt for a basic package, whic h is selfcontained and fulfils the minimum infotainment requirement. 'Light view ers' (i.e. Less than 20 hours a week) form the bulk of television viewership and watch the maximum number of genres. The behaviour of this segment in the face o f an onslaught of channels and competing platforms, and the ability of broadcast ers and distributors to tap these eyeballs effectively through attractive packag ing and pricing will have a direct bearing on the subscriber off-take. This, in turn, will determine how soon the basic subscriber, can move to the premium cate gory. 43 A CII - KPMG Report

2005 could be the turning point for the industry’s life cycle Conclusion 2004 was an eventful year for the industry. The industry saw a furthe r strengthening of the C&S dominance and increasing reliance on subscription rev enues. Persistent efforts by broadcasters enabled them to get higher disclosure rates. These superior disclosure rates coupled with higher subscription charges, post lifting of the price freeze that had been in force for around two years, i ncreased the broadcaster revenues. It also helped the broadcast industry continu e its progress from an advertisement dependant one to one with more balanced rev enue streams. 2005 could be a turning point in the industry's life cycle. The la unch of DTH, DSL and IP-TV is expected to reshape the landscape of the industry, by introducing competition in the last-mile for the first-time. The forces unle ashed by them will determine the future of the industry. 44 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Film Back to the future

Film Back to the future India is the world's largest producer of films by volume - producing almost a th ousand films annually. However, revenue-wise, it accounts for only 1 percent of global film industry revenues. Film and film-based entertainment together occupy a considerable part of the Indian consumer's mindshare. In terms of its sheer i mpact and visibility, film and film-based entertainment transcend well beyond wh at their 27 percent direct share of the Indian entertainment industry's revenues would indicate. Indian films, especially the mainstream Hindi film industry (or “Bollywood”) dominate segments like music and live entertainment as well as televis ion, where popular films and film-based programmes attract the highest viewershi p along with cricket. Apart from the growing international success of Indian the med films like 'Monsoon Wedding', 'Bend it like Beckham' and 'Bride and Prejudic e' (which debuted at the top spot at the UK box office), global curiosity about Bollywood is on the rise - Bollywood has been featured in recent issues of 'Nati onal Geographic' and 'Time'. All these point to the fact that the Indian film in dustry is now reaching the sophistication that is required to cater to global au diences. Gross worldwide revenues Film 0% 20% USA 40% Japan UK 60% France India 80% Others 100% Source: KPMG Research Film and film-based entertainment jointly command a significant consumer mindsha re Although over ninety years old, the Indian film industry was accorded the status of an industry as recently as 2000. Consequently, it is only during the last fi ve years that organised financing from banks, financial institutions, corporates and venture funds became possible. Earlier, it was almost solely reliant on pri vate and largely individual financing at extremely high interest rates. Over the last few years, there has been some change in the operating style of the indust ry. Film financing from organised sources is on the rise: around 100 films avail ed of organised funding of INR 7 billion in 2004, compared to virtually nil a fe w years ago. This number could be higher in the future if ! on the demand side, the industry responds pragmatically, by creating an environment conducive to org anised funding; and ! on the supply side, more financiers from the organised sec tor enter the fray spreading the risk for a single financier and deepening the m arket. 45 A CII - KPMG Report

India can establish itself as an important global film-making hub The seeds of corporatisation have been sown and early forms of vertical integrat ion between content producers, distributors, exhibitors, broadcasters and music companies can be observed in the industry. The stakeholders, especially the new generation of producers, directors and performers, are now much more receptive t o international best practices to redefine the way of doing business. Better dis cipline has resulted in a slow turnaround in the industry, which recovered from an unsuccessful 2002 to record better profitability in the last two years. The f ilm industry has entered a new phase of growth First wave of growth Second wave of growth Institutional financing Limited IPOs Golden era for studios Bonds, Low insurance s corporate governance Integration of value chain Entry of MNCs Evolution of the Indian film industry J F Madan monopoly on exhibition Prabhat Studios High cost private New Theatres Bombay Talkies financing Gradual rise of Dubious ‘banners’ channels of finance Venture capital, private equity Corporatisation Early distribution networks Individual film makers 1910 1920 1930 1940 1950 1960 1990s 2001 2004 2005 onwards Source: KPMG Research Integration and rightsizing of all functions across the value chain is expected to lead to a consolidation among the fragmented players in the industry. This wo uld result in increased market power, better economies of scale (through sharing of common resources across different areas of the value chain) and initiatives to mitigate risks as against transferring risks on to the next player. This will lead to a more efficient film-making process, where relevant content will be de veloped, distributed and exhibited in a more synergistic manner and on a larger canvas. Aided by investments in technology (like networking the last-mile throug h digital distribution) and the right measure of governmental intervention, Indi a could establish itself as an important global film-making hub outside of Holly wood. 46 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The changing paradigm The opening up of new markets overseas, with viewership of Indian films spreading beyond the Indian diaspora into Asian, and eventually no n-Asian audiences. ! Nationwide distribution of well-made, big-budget regional f ilms, some of which could cross over into countries like Japan and China. ! Risi ng penetration of home video and greater demand for pay-per-view content with th e advent of alternate delivery platforms like DTH and IP-TV. ! Increased theatri cal attendance consequent to right-sizing and upgradation of theatres and introd uction of multiplexes to enhance the viewing experience ! Reduced leakages and p iracy, with greater investments in digital distribution technology and network f or: eliminating/ reducing the time lag between releases in mainstream and other centres more effective monitoring and recording of revenues ! Components of the Indian film industry The Indian film industry comprises of a cluster of regional film industries, lik e Hindi, Telugu, Tamil, Kannada, Malayalam, Bengali, etc. This makes it one of t he most complex and fragmented national film industries in the world. These regi onal language films compete with each other in certain market segments and enjoy a virtual monopoly in certain others. The most popular among them is the Hindi film industry located in Mumbai, popularly referred to as “Bollywood” . Indian films certified by the censor board 120 0 Number of films 100 0 800 600 400 200 0 1999 2000 Hindi mainstream Source: Central Board for Film Certification 2001 Other Hindi 20 02 Regional 2003 Bollywood Out of the 200 Hindi films made in India each year, around 150 are mad e in Bollywood. These Bollywood films are released throughout India on both big and small screen formats, with several of them being screened overseas as well. Though there have been sporadic instances of regional films, enjoying a national release or even an overseas release, virtually all films having a national audi ence, 47 A CII - KPMG Report

are made in Bollywood. It accounts for over 40 percent of the total revenues of the overall Indian film industry, which is currently estimated at INR 59 billion . It is estimated that only INR 50 billion finds its way to the industry coffers , with the balance INR 9 billion being cornered by pirates1. Regional films The major regional film industries are Tamil and Telugu, which together earn around INR 15 billion, followed by Malayalam, Bengali and Punjabi. The average cost of production of a regional film, in keeping with its limited market (compared to a Hindi film) and lower revenue potential, are only a fraction of that of a mains tream Bollywood film. With increased viewer exposure to a plethora of entertainm ent options on satellite television, the number of regional films produced annua lly has fallen from around 800, three years ago, to around 650 currently. Howeve r, in terms of discipline and cost control, the level of professionalism prevale nt in certain regional film industries (like Tamil) is higher than that observed in Bollywood. For instance, the average time frame for completion of a relative ly big-budget Tamil film is 4-9 months, as opposed to 15-18 months in Bollywood. Some key reasons for this are: ! Appropriate importance given to script develop ment and pre-production, ! Leading actors working on limited number (usually one or two) of assignments at a time and ! Large scale of operations of studios giv ing them: flexibility to amortise and spread costs and risks over a larger portf olio greater degree of integration In terms of discipline and cost control, certain regional film industries are mo re professional than Bollywood Market Share by R even u es Hind i Mainstre am 4 3% Cross-o ve r Hindi 2% Fore ign 2% O the rs 8% Malayalam 10 % Other Hind i 2% Be ngali 1% Telug u 15 % Tam il 1 7% Source: Industry I n d u s t r y e s t i m a t e s t h e t o t a l r e v e n u e l o s s d u e t o p i r a c y a n d l e a k a g e s i n t h e a t r e c o l l e c t i o n s a t I N R 15 - 2 0 b i l l i o n . S i n c e t h e p r i c e p a i d b y t h e e n d c o n s u m e r f o r s u ch i l l e g i t i m a t e p r o d u c t s i s s i g n i f i c a n t l y l o w e r t h a n t h e n o r m a l p r i c e , w e h a v e c o n s i d e r e d t h e r e t a i l v a l u e o f s u ch i l l e g i t i m a t e i n c o m e a t I N R 9 b i l l i o n 48 Fo c u s 2 010 : D r e a m s t o r e a l i t y 1

English films Big budget Hollywood films are beginning to make a mark, with thei r dubbed versions making inroads into the semi-urban and rural markets. A recent case in point is 'Spiderman 2', which along with its dubbed version, grossed a whopping INR 342 million, higher than 'Murder' and 'Hum Tum' - two mainstream Bo llywood hits of 2004. On a cumulative basis, box office collections of foreign f ilms grew in both revenues and number of releases, from INR 1.5 billion from 60 films in 2003 to INR 1.8 billion for 72 films in 2004. Enthused by the internati onal success of India-themed English films made in UK and US (like ‘Monsoon Weddin g’, ‘Bend it like Beckham’, and ‘American Desi’), there is now a growing trend among young er film-makers to make English language films in India for the overseas viewers. Though the market share of such English language films made in India is still i nsignificant, both by volume as well as by revenues, there exists a niche audien ce for them, which is growing. Arthouse films, short films and documentaries Par allel film-makers like Satyajit Ray and Shyam Benegal have won plaudits internat ionally for adapting the neo-realistic style of film-making to an Indian milieu. Even in commercial Indian cinema, during the 50s and the 60s, filmmakers like B imal Roy, Guru Dutt, V. Shantaram and Mehboob Khan made films with powerful soci al messages that were box office hits, successfully walking the tightrope betwee n critical acclaim and commercial success. Interaction between art and commercial film arenas is expected to raise the qual ity of cinematic content Gradually, from the 60s, a distinction started developing between the so-called 'commercial' and 'art' films. The art film-makers could not compete at the box o ffice due to the lack of commercial viability of the subjects they attempted. Th e mainstream films kept growing in terms of budgets and star cast. From the 70s onwards, there was a clear divide between commercial and art films. In the last few years, the tide seems to have turned again with barriers between art and com mercial films beginning to wither away. Noted art house film-makers like Shyam B enegal, Govind Nihalani and Ketan Mehta are foraying into big budget, star-studd ed films while commercial actors are increasing performing in art films. Such in teraction between art and commercial film arenas is expected to bring about an o verall improvement in the quality of content. In addition, India also produces a round 1300 short films, documentaries and nonfeature films, several of which hav e won critical acclaim and international awards. However, there has been no orga nised attempt at commercial exploitation of the non-feature genre. 49 A CII - KPMG Report

Emerging genres Till date, categories like tele-films and special-effects driven films, which drive film revenues internationally, were virtually absent in Indi a. Efforts in producing telefilms have been few and far between. However, with t he advent of additional distribution platforms like DTH and IP-TV, this could be come a considerable revenue-earner for the industry in the future, with establis hed film producers, directors and actors helping in realising its potential. The recent success of films like ‘Koi Mil Gaya’ and ‘Bhoot’ and the domestic success of Hol lywood films like ‘Spiderman-2’ and the Harry Potter movies indicates a growing tast e for special-effects driven films in India. Indian visual effects houses have a cquired the sophistication and skill-sets to handle the special effects requirem ents of Indian mainstream films, though they may still have some distance to tra vel before they bag any large Hollywood contracts. Increased demand coupled with a supply push (post-production and visual effects houses investing in films) co uld increase revenues from this genre. Sequels of very successful commercial fil ms, another genre hitherto non-existent in India, are being attempted for the fi rst time. It remains to be seen how effectively the new generation of film maker s leverage these genres to generate revenues. Current revenue distribution Distribution of film revenues Leakages/ pir acy 14% I n ci nema ads 2% Music 2% Satel l i te/ DTH/ I P -TV 9% DVD/ VCD/ overseas cable 4% Overseas theatri cal 12 % Domesti c theatrical 57% Source: Industry The industry realises almost 70 percent of its total revenues (around 80 percent of legitimate revenues) of INR 59 billion from domestic and overseas theatre vi ewership, unlike in countries like the US which earn only 35 percent of revenues from theatre viewership while the remaining 65 percent is derived from other re venue sources such as DVD/ VHS/ cable, satellite, pay-per-view, etc. 50 Fo c u s 2 010 : D r e a m s t o r e a l i t y

For a brief period which ended in around 2001-02, sales of music rights accounte d for 20-30 percent of the cost of production for a major film, selling for as m uch as INR120-150 million. Such prices were not sustainable and consequently, th e sale of music rights ceased to be a major source of financing of productions. Lately, however, producers have been able to extract high prices from television channels by selling the satellite rights of major films in advance. Established producers have also been able to tap in-films advertisements as another source of revenue, their clients mostly being consumer goods companies. Along with an overall reduction in costs, each of the revenue components can gro w. With the deepening of the home video market, sale of DVD/ VCD rights have now em erged as a considerable source of revenue, though at present, such rights are mo stly bundled along with overseas theatrical rights and sold at lump sum prices. Overseas income from sale of theatrical and home video rights have been increasi ng from INR 2 billion in 1998 to INR 4 billion in 2000 to INR 9 billion now, acc ounting for 16 percent of total revenues. Size and growth With an overall reduction in costs, there is a potential for each of the revenue components to grow, albeit in varying degrees. Domestic theatrical revenues are estimated to grow at 17 percent, aided largely by multiplicity of ticket rates and higher occupancy due to rightsizing of screens from INR 34 billion to INR 86 billion in 2010. Satellite rights, including pay-per-view and broadband rights, could take off in 2007 when DTH, IP-TV and broadband , cable networks are expec ted to be rolled out on a large scale. Satellite revenues are expected to grow a t 22 percent from INR 5 billion to INR 17 billion in 2010. Growth in other incom e from in-film promotions and merchandising is anticipated to flatten out after the initial spurt, while growth in revenues from the sale of music rights could be minimal. The combined forces of digital technology and more stringent regulat ions should be able to reduce the menace of piracy, though in absolute terms, it may still continue to account for around INR 6 billion in revenues in 2010. The current realisation on overseas theatrical and home video at retail value, i.e. the amount that the overseas end-consumer pays on Indian filmed entertainment i s believed to be around USD 360 million a significant 90-100 percent over the US D 190 million (INR 9 billion) at which these rights are sold. The end-user consu mer revenues of USD 360 million are projected to grow at 13 percent annually to reach USD 750 million in six years (some optimistic projections put it at over U SD 1 billion), while the realisation for the Indian IPR owners will be better, n arrowing down the margin from 100 percent to around 40 percent by 2010. Conseque ntly, overseas theatrical and home video are expected to grow at 22 percent annu ally from INR 9 billion to INR 30.5 billion in 2010. This would still 51 A CII - KPMG Report

be well below the true export potential of Indian content and the appropriate ma rketing focus, synergistic alliances and co-productions could push this number u p significantly. Growth of the Indian film industry 160 140 120 100 80 60 40 20 0 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Leakages / piracy In cinema ads Music Satellite/DTH/IPTV DVD/VCD/overseas cable Overseas - theatrical Domestic theatrical (INR billion) Source: KPMG Research Overall, the industry is expected to grow annually at 16 percent to cross the IN R 100 billion mark by 2007 and reach INR 143 billion in 2010. , If the combined efforts of the various stakeholders and the government create the desired impact in terms of charting a structured roadmap for the future, this growth rate coul d even exceed 30 percent in the next 4-5 years. The later part of this section f ocusses on the need for such collaboration. Segment-wise growth of film revenues 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% -60% 2003 2004 2005E 2006E 2007E 200 8E 2009E Domestic theatrical DVD/VCD/overseas cable Music Leakages / piracy (In percentage) Overseas - theatrical Satellite/DTH/IPTV In cinema ads Total 2010E Source: KPMG Research Setting an industry agenda for accelerated growth Though the growth prospects for the Indian film industry are quite strong, it is still performing below its underlying potential. It is a fact that India's per capita monthly spend on films is less than INR 4, which is extremely low for an entertainment-crazy country like ours. 52 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Concerted efforts undertaken by the industry participants can launch the industr y on an accelerated growth path, so that it can beat the forecasts. Some of the key drivers that can enable such accelerated growth could be: ! ! ! ! ! ! ! ! ! ! Corporatisation Developing economies of scale Organised film financing Value cha in integration Last mile consolidation in distribution and exhibition Piracy and its control Expanding the international market Outsourcing to India Training an d education and Government incentives. Corporatisation In the 1990s, the Indian film industry was completely fragmented , with no individual entity - content producer, financier, distributor, exhibito r, music company and satellite broadcaster - commanding any considerable presenc e across the value chain. As a result, the revenue earning capacity of any given film became a function of the relative bargaining power of the concerned partie s. Consequently, creative freedom and quality of content suffered. Risk mitigati on, contracts and insurance were alien terms, while time and cost overruns were commonplace. A corporatised approach to production implies and includes the foll owing mix of initiatives or actions: ! Intelligent selection of scripts which fa ctors in an understanding of consumer preferences and market trends ! Project fe asibility analysis for target audience preferences, box office results talent po pularity and story viability in domestic and international markets ! Active part icipation and consent of each activity head at the green-lighting stage ! Invest ing in equipment, technology and management information systems to bring down co sts and build in flexibility in shooting schedules ! Control over production tim elines, budgets and quality with periodic monitoring ! Outsourcing non-critical functions to focus on the core aspects of filmmaking ! Introducing a profit shar ing system thereby reducing initial risk on full upfront payment etc. 53 A CII - KPMG Report

In the last few years, the industry has taken a few steps towards corporatisatio n. However, it is currently in the first stage of corporatisation, without a cle ar delineation of creative and management functions. More often than not, the pr omoter/ CEO doubles up as the chief creative person, getting involved in every s tage from script selection to casting, while creative people also function as op erational managers. In the industry, there are six or seven large production hou ses which have built a formidable track record and capabilities over the years a nd possess rich experience in managing practically all the elements of the value chain. This experience enables them to operate with greater efficiency compared to the rest of the industry. In a way, they have also corporatised themselves. Corporatisation can greatly aid this industry in the following ways: Imposing tr ansparency and discipline in the film-making process Higher emphasis on scriptin g, planning and documentation Very high focus on cost-control Developing an inst itutional memory of best practices ! ! ! ! There are only six or seven large production houses that have the experi ence of managing all elements of the value chain In these ways, it could help make the film-production process much more efficien t. The Indian film industry is far behind Hollywood in terms of its efficiency i n the myriad aspects of film production, as illustrated below. Component Scripti ng and development Pre-production Above-the-line cost control Below-the-line cos t control Risk reward sharing and mitigation Contracts and documentation Product marketing Merchandising Source: KPMG Research India Hollywood 54 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The film producers will have to change their mantra from ‘make the costliest film of the year’ to ‘make a portfolio of cost-effective films in a year’ While the Indian film industry has advanced to a significant extent in controlli ng direct costs, the below-the-line costs are rather poorly managed. This affect s the film's budget adversely through time and cost over-runs. Scripting and dev elopment is another vital part of film production that is largely neglected in I ndia. Contracts and documentation and merchandising are a few other elements of film-making where India lags far behind Hollywood. On a brighter note, India has made some basic progress in pre-production and product marketing, in recent tim es. Corporatisation, with its accompanying emphasis on transparency, accountabil ity and consolidation in the various elements of film-making and distribution, c an bring about an overall improvement in enhancing the profitability of the sect or. Developing economies of scale The film producers will have to change their m antra from 'make the costliest film of the year' to 'make a portfolio of cost-ef fective films in a year'. They will have to blend films of different genres and budget segments aimed at different markets and different audiences to dissipate their risk profile. It is estimated that the producers can reduce their costs by 10-12 percent by: ! owning studio infrastructure and equipment ! signing long-t erm contracts with creative talent ! signing multiple contracts with distributor s and exhibitors. They can also raise their revenues by signing long-term contra cts with distributors and exhibitors. This will enable them to get a higher shar e of the domestic theatrical revenues and also help in plugging leakages. On a s imple estimate, a 10 percent reduction in costs in the medium term, coupled with a 15 percent increase in revenues can more than double the industry profits. It is expected that the combination of key drivers at play could bring the industr y closer to its optimal level of profit generation in the near future. Portfolio approach: a simulation Reduced costs and expanded revenue streams go towards reducing return volatility and project risk substantially Cost reductions Pre production Artists’ costs Post production costs Equipment Prod uction expenses Distribution costs (print + publicity) Total Existing costs (%) 2 30 7 4 35 22 100 Possible cost increase (reduction) (%) 2 (3) (2) (1) (4) (3) (11) Revised costs (%) 4 27 5 3 31 19 89 Existing revenues (%) 65 11 14 6 4 Tota l 100 Revenue Increase/ (decrease) 9 5 14 Revised revenues (%) 74 11 14 6 4 5 11 4 Cost mitigation / planned strategies can typically bring down production costs b y approximately 10-12 percent Revenue enhancement strategies can boost income by around 10-15 percent Revenue enhancements Domestic theatrical Overseas theatrical Satellite Music Oth ers Leakages Source: KPMG Research Resulting in favourably altering the risk reward profile by 20-25% 55 A CII - KPMG Report

It is estimated that by developing a portfolio of films, it is possible to shave 10 percent off the artist's costs, reducing it from 30 percent to around 27 per cent of the overall filming cost. The distribution costs (print and publicity) c an be cut by approximately 14 percent, reducing it to 19 percent of the overall cost. The production expenses can also be similarly reduced to 30 percent of the overall filming costs, from 35 percent, while a higher budget could be allocate d for preproduction. In all, it is estimated that corporatisation and economies of scale slash film production costs by over 10 percent. Side by side, it is als o expected to increase revenues by 14 percent, by raising domestic theatrical re venues by 9 percent and plugging leakages of 5 percent. This can significantly i mprove the risk-reward ratio by almost 25 percent. Even at the current revenue n umbers, cost reduction undertaken in this manner could lead to a complete turnar ound in the risk perception of the industry, by improving the risk-reward ratio. By creating a portfolio of films in various genres and stages of production and the attendant cost-amortising and revenue-enhancing methods, the returns could go up to even 40 percent. Organised film financing Till 2000, films were mostly financed through private sources, since commercial lending agencies considered the industry to be a risky and low-priority sector. The two major sources for finance were: ! Distributors and music companies, who would pay advances to established film-makers and films with reputed star casts to acquire the theatrical/ music rights. ! High-net worth individuals Due to the unorganised nature of this funding and its perceived riskiness, the interest ra tes charged were usurious. Curiously, despite several downturns and the apparent riskiness, private financing continued unabated, even during lean periods. For instance, even in 2002, annus horribilis for the industry, fresh capital continu ed to enter. This indicates that the industry was able to generate sufficient re turns, despite the high financing cost. This also implies that it is quite likel y that in the absence of proper accounting and reliable data on costing, coupled with the continuous game of one-upmanship among large producers/distributors (p rompting them to make exaggerated statements about their expenditure), the costs of production may have been grossly overstated in the past. In other words, it is possible that the bottom-line for the industry may actually have been much he althier over the last few years than what it was believed to be. 56 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The availability of organised financing from commercial banks and lending instit utions, primarily IDBI, triggered the entry of private equity funds and large co rporate houses in this space. It is believed that the general experience of the organised sector has been satisfactory, which should lead to the entry of more p layers in the near future. Organised funding has significantly reduced the avera ge financing cost in this sector. However, institutional lending rates are still high compared to other sectors, since film financing is perceived to be riskier . Limited or non-recourse financing, akin to project financing, is not common. I t is believed that institutional financing could bring in stipulations like comp letion bonds, insurance, well-defined contracts, etc. The production houses' wil lingness to accept these conditions will determine the comfort level of the fina nciers. Once financiers earn reasonable returns for a sustained period, the risk -perception could change. Then one may even see sophisticated financial structur es like securitisation, credit enhanced bonds, etc being introduced into the mar ket. In the existing model of funding, financing is done on a project-wise basis . The bank finances upto 50 percent of the cost of a project and retains the neg ative rights as collateral. The producer brings in the rest of the money from hi s own sources. The bank also insists on a completion guarantee from the producer and insurance against delay. Institutional lending rates are high compared to other sectors, since film finan cing is perceived to be riskier Corporatised financing structures - First generation (existing) Full recourse Bank Guarantee / Collateral Producer Loan up to 50% 1. Negative rights 2. Completion guarantee 3. Insurance Equity 50% + Film Project Source: KPMG Research In the emerging financing structure, credit enhancers like evaluation by a ratin g agency and specialised guarantee funds are used to mitigate the risks to the f inancing agency. These enhancers help the bank take a larger share of the risk, say upto 70 percent of the project budget. The interest rates for such finance c ould be lower because the risk to the bank is reduced significantly. 57 A CII - KPMG Report

Corporatised financing structures - Second generation (evolving) Limited recours e financing (illustrative) Interest Loan guarantee (say 50% of the bank loan) Bank Film production company Specialized guarantee funds Understand risks, does detailed appraisal Takes a no nfund exposure Equity 30% + Film project Loan upto 70% Credit enhancers Rating agency Source: KPMG Research In the futuristic scenario of funding films, the financing will not be project s pecific, rather a working capital loan could be given to the integrated entity w hich owns the entire value chain. It will be securitised using the exhibition re ceivables. Such a scenario will allow the bank to spread its risk across a portf olio of projects of the film production company. Corporatised financing structur es - Third generation (futuristic) Receivables based financing (illustrative) Film library Home video Television Exhibition Music Digital distribution, last mile integration and higher transparencies could allo w for direct securitisation of exhibition receivables Receivables securitisation Bank Working capital Film production company Film project Complete cash entrapment Source: KPMG Research 58 Fo c u s 2 010 : D r e a m s t o r e a l i t y

With cheaper sources of financing becoming available from legitimate sources and the industry becoming more disciplined, the quantum of unorganised financing is expected to shrink. In an increasingly professional environment, unviable produ cts with weak scripts could find it difficult to garner funding. Consequently, t he average number of films produced annually in India is expected to be reduce t o around 600 over the next five years, while the average cost of production per film will increase. This will include an increased spend on script development, pre-production, visual effects and marketing. The changing pattern of film finan cing 1200 250 1000 200 800 Number of films 150 INR million 600 100 400 50 200 0 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Corporatised films Other f ilms Average cost of a mainstream film Source: KPMG Research The percentage of films produced through organised funding in the industry is ex pected to grow. Though corporate and institutional funding is currently limited largely to Bollywood films, it may not be long before regional films begin to qu alify for such financing.

59 A CII - KPMG Report

Have mid-budget films eroded overall industry profitability? Around 30 percent of the films generate 90 percent of the industry revenues. Thi s is not surprising considering that out of around 150 mainstream films produced annually, 40-50 percent would not be considered financially viable in a corpora tised environment. These laggards include ! Very low budget (Category D) films w ith weak scripts, completely unknown cast and inexperienced producers and direct ors ! Certain category AA (super budget) films that suffer due to cost overruns and a higher risk quotient and ! Several B Grade (mid-budget) films that suffer due to a serious mismatch between the products' cost and revenue potential. In a n increasingly corporatised environment, films that are motivated more by passio n than commerce are unlikely to get past the approval stage, unless there is a v ery strong justification for financing such products. In order to better underst and the risk return profile of mainstream (Bollywood used as a proxy) films, we have classified films from 2003 and 2004 into the following four categories base d on cost, production value, artists and technicians, and content. In an increasingly corporatised environment, films that are motivated more by pa ssion than commerce are unlikely to get past the approval stage Categories AA A B C Lowest Cost (INR) 150,000,000 80,000,000 30,000,000 10,000,000 Highest Cost (INR) 300,000,000 150,000,000 80,000,000 30,000,000 Gross collections include domestic and overseas theatrical receipts, domestic an d overseas satellite and video rights, music rights and in-film advertising and merchandising revenues. Category AA films are typically ‘big banner’ films. These films have a strong star c ast, high level of technological sophistication and typically, socially acceptab le themes. The key factor in an AA category film is that the producer and the di rector have a very strong track record and have the ability and the experience t o complete the film on time. Category 'AA' costs are assumed to range from INR 1 50 to 300 million. Apart from domestic theatrical and other revenues, these film s have an overseas potential as well, depending on the presence of certain lead actors. Category A films have costs that are assumed to range from INR 80-150 mi llion. The costs cover variables like type of shoot, locations, number of shifts , the type of agreements with artists, post-production costs, capitalised intere st, and so on. At the same time, they enjoy multiple cash flows on the sale of s atellite rights, music rights, cable rights, internet rights and sponsorships. G enerally, these films recover their costs in the first four weeks after release, unless they have been 60 Fo c u s 2 010 : D r e a m s t o r e a l i t y

made at a disproportionately high cost. Category B films are typically made by r elatively financially weaker producers. In many cases, the completion of the fil m gets delayed due to the lack of last-mile finance. The producer also does not have his own sources of finance and usually taps the market for funds. Sometimes , the directors of these films have a mediocre track record with negligible past box office success to their credit. The star cast here may not be top grade and may include actors who have not been completely accepted by the mainstream audi ence. Often, these films are not completed due to lack of funds. Their costs are assumed to range from INR 30-80 million. Category C films comprise of a heterog eneous mix of low budget, high quality content films at one end with a high prof it potential, to still-born projects characterised by a lack of quality, content , and good artists fashioned on run-ofthe-mill subjects, espousing mediocre musi c and virtually no market. Their costs are assumed to be between INR 10-30 milli on. Category D films, which comprise of virtual non-starters in terms of finance , content, and technical quality, have not been included in the sample examined due to their inability to get past the approval stage in a more corporatised env ironment. Ranking films by risk and return Categories Rank by returns 2 AA 2 A 3 B 1 C Rank by risk 3 2 4 1 Combined rank 2 1 3 1 The overall sample consisted of over 150 films released in the years 2003 and 20 04 It should be noted that the above analysis is indicative and not comprehensiv e. It is intended to serve just as an illustration. It is nevertheless observed that B and AA category films have proved to be relatively more risky investments for production houses, followed by A and C category which show lesser variation in their respective returns. B category films also perform poorly in their over all returns ranking, followed by AA and A category films that share the same ret urn characteristics, with category C films finishing on top once again. The comb ined ranking for both the years shows that category A and C films are better inv estment prospects in terms of the balance between their risk-return 61 A CII - KPMG Report

characteristics, followed by category AA (super budget) films and, finally, cate gory B (mid budget) films which appear to be the riskiest. Significantly, catego ry B films represent an average of 40 percent of the Bollywood film industry's i nvestments, compared to only 16.5 percent investments in category C and 26 perce nt in category A films. Thus, the performance of the overall film industry could be largely affected by overinvestment in unprofitable segments like category B and under investment in profitable segments like categories A and C. By strategi cally investing in a balanced portfolio, film companies and production houses ca n increase their overall returns considerably, while reducing their overall risk . This is not to imply that mid-budget films should not be produced or financed; however, it is imperative that the risks with respect to such films are well mi tigated, costs and schedules adhered to and a proper assessment of the content a nd the creative team carried out at the developmental stage before any financing decisions are taken. 62 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Value chain integration The production phase A comparison of the stages of film production in the Indian film industry (using Bollywood as a proxy) with that of Hollywood reveals that the Indian film industry tends to ignore the most important stage of production - the development stage. During the development stage, typically, the story is d eveloped from a concept or an idea into a complete script with a provisional scr eenplay. The commercial viability of a creative concept is evaluated carefully b y way of market segmentation, market research and use of sophisticated revenue f orecasting models. In Hollywood, on an average, this stage takes anywhere betwee n 2-4 years and only 20 percent of the stories developed at this stage move on t o the next stage of pre-production. The film production process Conception of idea Development of idea Market research Obtaining rights Signing tentative cast, crew Raising capital Screenplay breakdown Shooting schedule Loca tion scouting Budgeting Casting and unions Equipment rentals Permits, etc. Princ ipal photography Blocking Lighting Final rehearsals Shooting Editing Sound effec ts Music production Special effects Mixing Development Pre-production Production Post-production Source: Film Production Management, Baston Cleve The general tendency is to transfer the risk to the next link in the value chain In Hollywood, the studio is an integrated entity that oversees all aspects of th e value chain (from production to distribution and at times, even exhibition) an d hence has an incentive to make sure that the product is marketable right from the conceptual stage, since there are not many opportunities for risk transfer w ithin the value chain. In the Indian context, due to the unorganised and fragmen ted nature of the film industry, the tendency is to transfer the risk to the nex t link in the value chain rather than to manage the overall risk effectively. Th e lack of allocation of time and budget towards script development and market re search clearly manifests itself in the relative unprofitability of the industry in India, despite its increasing revenues every year. 63 A CII - KPMG Report

Time allocated to various stages of production 3 .5 3 2 .5 2 1.5 1 0 .5 0 Development Pre-production Hollywood Production Bolly wood (Years) Post-production Source: KPMG Research Bollywood spends significantly more time in the production stage compared to Hol lywood. Some possible reasons are: ! Cost overruns due to inadequate planning in the development stage itself and ! Lack of smooth funding during various stages of production (especially in the case of mid and low budget films) In the postproduction stage, too, Bollywood tends to spend relatively lesser time compared to its US counterparts. Some probable causes are: ! Unavailability of funding (d ue to the film being over-budget at the production stage itself) ! Lack of impor tance given to post production ! Haste in releasing the film in order to recover the money. Allocation of expenditure across film industries Bollywood Hollywood 0% 20% 40% Marketing 60% 80% 10 0 % Development and Production Source: KPMG Research Another important difference between Bollywood and Hollywood is that the latter attaches considerable significant attention and funds to marketing of films. In India, however, it is the distributors who virtually carry the entire burden of marketing the film. This leads to the following problems: ! Distributors often g o through a working capital crunch due to the failure of one film, leading to in sufficient availability of funds for marketing the next. ! Each distributor uses his discretion in marketing a film. This can lead to the promotional effort con veying a message completely different from what the producer intended. This may be another area where the cost distribution and resource allocation structure of Indian films can be made more efficient. 64 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Last-mile consolidation in distribution and exhibition With around 12,900 active screens (down from 13,000 in 1990), out of which over 95 percent are standalone, single screens, India's screen density is very low. I n contrast, China, which produces far less films than India, has 65,000 screens, while US has 36,000. With many more avenues of entertainment available to the y outh (an important target population), it is imperative to create an enhanced th eatre viewing experience. India is under-screened (Screens per million population) 117 77 43 30 45 46 52 53 61 There is a need for at least 20,000 screens in India as against the current 12,9 00. 12 UK Germany Denmark Spain France Italy US Belgium Ireland India Source: UNESCO The multiplex revolution The conversion of standalone, poorly maintained singlescreen theatres to sophisticated multi screen theatres, in addition to the new m ultiplexes within or around shopping malls and family entertainment centres, is an emerging trend in urban India today. Multiplexes, though a recent urban pheno menon, have shown the way forward in increasing domestic theatrical revenues. Th e reasons for their success are: ! They enjoy an average of 50-60 percent occupa ncy per screen as opposed to 30-35 percent of standalone theatres, ! The custome r is willing to pay more for the enhanced viewing experience, ! The government h as accorded various tax rebates for multiplexes, ! States like Maharashtra and D elhi have permitted dynamic ticket pricing, allowing them to change ticket price s according to demand and supply. ! They increase footfalls in shopping malls by 40-50 percent. As a result, several major malls have multiplexes in or near the m. The present retail boom has led to a significant rise in the number of multip lexes. 65 A CII - KPMG Report

Increasingly innovative promos for Hollywood films and alliances that now involv e a wide spectrum of players - multiplexes, television channels, internet portal s, cellular operators, hotels, cafes and consumers goods - are expected to perco late to Indian film releases as well. Multiplexes are ushering in a new era in exhibition of films The advent of multiplex chains is expected to usher in a new era of film exhibit ion, apart from just an enhanced viewing experience. Some of the expected change s are: ! Dedicated marketing teams to leverage state-of-the-art technology to ad dress the programming needs of exhibitors ! Marketing team to work out content-t o-customer matches on the basis of consumer surveys and other metrics. ! Develop ing synergistic marketing strategies in conjunction with content producers, broa dcasters, music companies, etc. ! Offering better terms to producers based on Pr esence across multiple locations Significantly higher transparency The strength of their balance sheet These activities of the multiplexes could to lead to a po ssible shakeout and consolidation among the standalone theatres. Changing distri bution model Currently, theatrical rights for films are bid out to distributors on a per-territory basis, against minimum guarantees. Distributors in turn work out flat fee, lease rental and/or revenue sharing arrangements with exhibitors. However, this model 66 Fo c u s 2 010 : D r e a m s t o r e a l i t y

is highly unstable and is not expected to survive in the long term because of th e following: ! Established producers command very high minimum guarantees, leadi ng to disproportionate risk-reward sharing if the film is not successful. ! The distribution model of the future could become an infrastructure play, run by uti lity providers. ! There is lack of reliable information on theatre collection, d ue to the fragmented last-mile, which perpetrates under-reporting. ! Many screen s/ theatres are expected to be wired up, with the entry of utility companies in the distribution sector. ! A spiralling demand for content, a considerable porti on of which is expected to be film content, is expected to be sparked off by the digital home revolution (discussed in detail in the Television section of this report). The industry could see alliances between producers and exhibitors on one hand an d broadcasters and utility players on the other In the future, the industry could see alliances between producers and exhibitors on the one hand, and broadcasters and utility players on the other. Traditional distributors could increasingly seek to re-invent their business model by gaini ng control over the last mile in select theatres and seeking to enhance the thea trical value proposition by investing in theatre upgrades and multiplexes. Aggre gation of different parts of the value chain can eventually lead to greater reve nue capture and enhanced bottomlines. Revenue aggregation for an integrated film producer Revenue 75 Distributors and exhibitors Additional marketing costs 8 Revenue 8 Overseas rights Revenue 16 Additional marketing costs 2 Home video rights Ticket sales Revenue 100 Producer Revenue 4 Non ticket sales Revenue 6 Revenue 20 Television rights Revenue 13 Revenue 10 Revenue 3 Music rights Revenue 3 Revenue at retail value 138 Leakages Revenue 30 Revenue to producer 100 Incremental revenue 38 Incremental revenue 88 Untapped revenue 50 Source: Industry 67 A CII - KPMG Report

Piracy and its control Initiatives to reduce piracy in the years to come, either due to digital encoding mechanisms or better enforcement of the law, can also l ead to an increase in domestic theatre viewership revenues. In the US, a typical theatrical window spans six months, where collection amounts to 25 percent of t he total gross. In India typically 70 percent is collected over three months, af ter which piracy catches up and virtually nullifies any further theatre revenue potential. There are a large number of video rental shops across the country, ma ny of which thrive on pirated videos. It is difficult to estimate the combined r evenues of these rental shops but the impact it has on eroding theatrical revenu es is significant. Issues relating to piracy have been discussed in detail later in this report. Expanding the international market While the initiatives mentioned above can expand the domestic market, a better e xploitation of Indian products in other markets can provide another avenue of gr owth. These markets include: ! The Indian diaspora ! Neighbouring markets like P akistan, Sri Lanka and Bangladesh which are now opening up, ! Non-traditional / new markets like Greece and the CIS countries, where Indian films were extremely popular 30-40 years ago, through sub-titled or dubbed content. The global progr ess of Indian films New western countries Asian countries with common languages: Pakistan, Bangladesh, Sri Lanka, Malaysia Revisit CIS, Greece, other once popular markets Indian Diaspora 1995 2000 2005 2007 2010 Source: KPMG Research 68 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The Indian diaspora is estimated to be 20 million strong and growing. The combin ed wealth of the global Indian diaspora is an estimated USD 300 billion. Apart f rom being a community binder for Indians across the world, Indian films in the p ast few years have contributed in a significant way in promoting culture and tou rism. The Indian diaspora 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Myanmar Malaysia Saudi Arabia (In million) South Africa Source: KPMG Research Over the last ten years, overseas theatrical revenues have grown continuously an d are now a major influence in determining the way mainstream films are made. Mo re Indian films are now distributed and released in mainstream international the atres, owing to the growing demand from the Indian diaspora. Most of these reven ues accrue from US, UK and Canada owing to their high concentration in these cou ntries. However, the success of mainstream films overseas seems to be driven by the popularity of a few leading performers. To earn sustainable export revenues, it is imperative that this success extends beyond a few blockbusters to a wider portfolio. It is now a challenge for mainstream producers to create content tha t is universal enough to cater to the Indian abroad and to the man in rural Indi a, while being technically comparable to a Hollywood film, in order to woo the d iscerning audience. Looking beyond the Diaspora Another key area of market expan sion from an international perspective, is the export of Indian films to foreign audiences, both to culturally similar countries (e.g. Pakistan, Bangladesh, Sri Lanka, etc.), as well as to countries where cultural barriers are considerable. Currently, the non-Indian viewers of Indian films are largely restricted to Asi an expatriates, as opposed to say Americans or Europeans. Trinidad & Tobago USA UK UAE Canada Mauritius 69 A CII - KPMG Report

Pakistan, for example, has a 155 million strong population that has a keen inter est in Bollywood films. Similarly, countries like Bangladesh (136 million strong Bengali speaking population), Sri Lanka (3.5 million Tamils), Malaysia (1.5 mil lion Tamil speakers), Singapore, UAE, and Fiji also have good potential for diff erent regional Indian films, as has been proven by the popularity of Indian regi onal television channels in these countries. It is important for Indian producers to tie-up with agents who have the right re lationships and an understanding of different markets Agents and marketing Most foreign distributors have a limited understanding of B ollywood's international potential. Therefore, it is difficult for them to commi t considerable investments in marketing the same. Also, there are not many exist ing overseas distributors of Indian films. Going forward, it is important that I ndian film producers get into distribution tie-ups with global majors to enable mainstream releases of their films, as opposed to releases only in India-centric theatres as was the practice previously. These alliances can also be facilitate d by marketing agents. Internationally, most independent producers do not have r elationships with distributors across countries. So, the representatives or agen ts form the critical bridge between the (independent) producer and distributor. It is important for Indian producers to tie-up with agents who have the right re lationships with major distributors along with an understanding of different mar kets and theatrical revenue streams. Similar alliances and a more focussed appro ach to distribution and marketing of DVDs, VCDs, etc. Are required to tap the po tential of the overseas home video segment. In general, a more comprehensive and concerted distribution effort is the key to maximising the revenue potential of Indian films from international audiences. 70 Fo c u s 2 010 : D r e a m s t o r e a l i t y

A Possible Segmentation of Markets Primary Market Secondary Market Hindi speakin g Indian Diaspora 20 million strong. Tertiary Market Domestic regions within Ind ia where the films have to be dubbed or sub-titled. The Bollywood (Hindi) Regional Film 60 percent of the population in India. Pakistan 155 million 8 percent Urdu speaking. Countries where the films have to be dubbed or sub-titled (Pakistan, Sri Lanka, Bangladesh, Singapore, Malaysia, Fiji, UAE, etc.) + Russian, Indian Diaspora in Pakistan. French, Spanish, Arabic, etc. Countries where the films have to be dub bed or sub-titled (Pakistan, Sri Lanka, Bangladesh, Singapore, Malaysia, Fiji, U AE, etc.) and Russian, French, Spanish, Arabic, etc. The Bollywood Urban Film a la “Jhankar Beats” “Dil Chahta Hai” etc. , , The English Regi onal Film a la English August (can include Indian Diaspora and Joint Ventures ma de for the Indian market) Urban City population Metro and Multiplex Phenomenon Indian Diaspora and other countries like Pakistan, etc. Cine-going urban English Speaking Indian population (around 1.50 percent) Countries where the films have to be dubbed or sub-titled. (all English speaking countries of English Speaking Pakistan, the world huge tertiary audience) Bangl adesh, Sri Lanka etc population and Indian Diaspora in these countries Tamil spe aking Indian Diaspora Domestic regions within India where the films have to be d ubbed or sub-titled Countries where the films have to be dubbed or sub-titled Eg , Japan for films starring the leading Tamil film actor Rajnikanth. English speaking Indian Diaspora. The Tamil Regional Film 11 percent of the population in India. 18 percent of Sri Lanka, Malaysia, Singapore, etc and the Indian Diaspora in the se countries The Bengali Regional Film 2.50 percent of the population in India. Bangladesh and its diaspora Domestic regions within India where the films have to be dubbed or sub-titled Co untries where the films have to be dubbed or sub-titled Domestic regions within India where the films have to be dubbed or sub-titled Countries where the films have to be dubbed or sub-titled Domestic regions within India where the films ha ve to be dubbed or sub-titled Countries where the films have to be dubbed or sub -titled The Punjabi Regional Film Punjabi Speaking Population in India Pakistan - 48 percent of 155 million speak Punjabi. Punjabi (Indian and Pakistan

i) Diaspora. The Telugu Regional Film 10.50 percent of the population in India. Telugu speaking Indian Diaspora. India, Pakistan, etc.closer cultural match (fil ms may have to be dubbed or sub-titled) Indian Diaspora and Joint Ventures a la “Elizabeth” “Bend it , Like Beckham” , “Monsoon We dding” Global (where the language of the film is the first language of the country) Mal ayalam (3.90 percent), Kannada (4.40 percent), Marathi (1.80 percent), Gujarati (1.20), Oriya (1.0 percent) Countries where the films have to be dubbed or sub-titled Domestic regions withi n India where the films have to be dubbed or sub-titled Countries where the film s have to be dubbed or sub-titled Other Regional Industries Key points: ! These markets experience a strong overlap in the primary markets, relatively lower overlap in the secondary markets and practically no overlap in the tertiary market (where the market becomes more heterogeneous with different countries). ! Audiences would tend to see these films in the theatrical release “w indow” more in the primary market than in the secondary market (relative to the pr imary market) and least in the tertiary markets (consisting mainly of satellite, cable and DVD/ video viewing) 71 A CII - KPMG Report

Can the Indian film industry become a global powerhouse? Wooing the international viewer India is one of the few markets globally where H ollywood has not been able to dominate. Hollywood only has a 4 percent market sh are in India, arguably the lowest amongst all other exporting countries. The Ind ian film industry boasts of a repertoire of 67 ,000 plus feature films and a few thousand documentaries made over the years in 30 different languages and dialec ts. This kind of body of content is only second to the US and the UK and therefo re, can be a considerable source of export revenue due to its potential of distr ibution via multiple formats globally. In contrast, most countries that had vibr ant film-making industries earlier have seen a decline in their domestic product ion due to the local dominance of Hollywood films coupled with lack of competent local language content. Even countries like France, UK and China have felt the need to institute state initiatives and control mechanisms like limiting the exh ibition of foreign films to help their local film industries compete with Hollyw ood. India is one the few markets globally where Hollywood has not been able to domin ate Since these countries are not producing significant content locally, they could be looked at as an attractive alternative market for all types of dubbed and sub -titled Indian films. This provides the Indian industry with a new opportunity t o exploit in the international film landscape. CIS countries and the Middle East are the most appealing markets for India within this niche segment. Global box office revenues 0 .9 0 0 .7 1 0 .4 7 3 .0 6 4 .0 2 4 .0 9 0 .8 0 0 .5 2 3 .1 4 4 .9 5 5 .5 8 0 . 6 0 3 .7 9 0 .8 0 (USD billion) 0 .6 9 3 .7 9 7.6 6 8 .4 1 9 .5 2 9 .4 9 2000 US A EMEA 2 0 01 A s ia-P ac ific 2002 L atin A m e ric a C anad a 2003 Source: MPAA Penetrating these markets, however, will require significant upgradation in many aspects of production, like the quality of subtitles, dubbing, production value s, universality of content, the ability to tell a story keeping an international audience in mind and, most importantly, the ability to handle a large canvas. I t is not surprising, therefore, that internationally successful films based on I ndian themes have been made by celebrated non-Indian directors, like James Ivory (several 72 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Merchant-Ivory) films, Richard Attenborough (’Gandhi’), David Lean (’Passage to India’) and Roland Joffe (’City of Joy’), or by Indian expatriates like Shekhar Kapur and Mi ra Nair who are familiar with the pulse of the western audience. New generation Indian directors are becoming increasingly aware of the fact that a different ki nd of story telling style and skill is required for an international audience; t his is an encouraging development. Cross pollination of talent and resources Som e of Hollywood's greatest directors and producers have originally hailed from no n-English speaking nations, for instance Fred Zinnemann, Milos Forman, Billy Wil der, Roman Polanski and Elia Kazan. This confirms the fact that individual talen t and story-telling ability is not constrained by geographies - capable film-mak ers will always find their way through to appreciative audiences. With Indian fi lms becoming more sophisticated and its talent gaining global recognition, new o pportunities for collaboration between the two industries are constantly evolvin g. For example, Indian directors like Shekhar Kapur (’Elizabeth’), Gurinder Chadha (’B ride and Prejudice’) and Mira Nair (’Vanity Fair’) are reinforcing their credentials i n English film-making. Individual talent and story-telling ability is not constrained by geographies ca pable film-makers always find their way to appreciative audiences Apart from these individual forays, Hollywood is increasingly importing talent a nd concepts generated by Indian film industry. Recent examples are A.R.Rahman's collaboration with Andrew Lloyd Webber in ‘Bombay Dreams’ and ‘Moulin Rouge’ which featu red a popular Bollywood film song. International assignments being bagged by act ors like Om Puri, Nasiruddin Shah, Aishwarya Rai, etc are on the rise. The globa lisation of the Indian film industry has started - with many more actors, direct ors, producers, composers and technicians getting new opportunities creating a g reater visibility and acceptability for Brand India. Co-productions and collabor ations The next considerable step in the interaction between the Indian film ind ustry and the world could be co-production, with established Indian film-makers collaborating with international majors to create global products. Elsewhere in the region, involvement by major studios in local film-making and distribution h as brought about a completely new dimension to the end-product. Columbia produce d the landmark crossover film ‘Crouching Tiger, Hidden Dragon’ (which reportedly gro ssed an estimated USD 140 million at the box office worldwide) and few other Hon g Kong based films, while Warner Bros has started distributing films produced in the Philippines. The Miramax-produced Chinese film, ‘Hero’ opened to a USD 18 milli on collection in August 2004, surpassing any other Hollywood film that week and reportedly ended with well over USD 100 73 A CII - KPMG Report

million in box office receipts. Korea's ‘Taegukgi’ has done brisk business in US and Japan. Film exports from Korea were negligible till 1997 and have increased man ifold to USD 37 million in the first half of 2004. It is important to note how a focussed approach and thrust on marketing helped Korea achieve such a significa nt growth in exports in the last 4-5 years. Indian history, mythology and litera ture too have their fair repertoire of compelling stories that can be adapted fo r a global audience. For instance, an epic like 'Mahabharata' can be recreated o n the screen with the same grandeur as 'Troy', or the story of Hanuman, can be r etold with the same technical finesse as 'Spiderman'. Increased collaborations c an permit the scaling up of budgets and technical capabilities that are necessar y to create such magnum opuses on a global scale. Indian mythology, literature and history can be a vast source for compelling sto ries that can be adapted for global audiences. English remakes of interesting Indian films can be another potential option for such collaboration. At least one such initiative is reported to be underway alre ady (Mira Nair's proposed remake of the successful Bollywood film 'Munnabhai MBB S' in English).Remaking films in a different language and setting is quite a suc cessful and well-established model globally. 'The Ring', a recent Hollywood rema ke of the Japanese horror film 'Ringu' grossed around USD 130 million in the box office. Outsourcing to India Apart from monetising the direct potential of Indian filmed content globally, th ere are several applications where India, due to its inherent cost advantage, ca n emerge as a major competitor to other countries as a preferred outsourced dest ination for films. Some of these are:Digital content creation The convergence of computer technology with film-making technology is revolutionising the way film s are made. Digital content is an integral part in Hollywood films such as 'Matr ix', 'Twister', and 'Jurassic Park'. Given the fact that India has a talent pool of world-class software professionals which is available at much lower cost com pared to the West, India could have been at the forefront of film related softwa re and graphics production. Already, a beginning has been made by organisations like the Hyderabad-based Ramoji Rao Studios which has provided equipment, crew, sets, and post-production facilities to at least seven Hollywood productions inc luding the Oscar-winning 'Gladiator'. India is steadily growing into a major hub for cost-effective outsourcing for animation and special effects. According to industry experts the size of the Indian visual effects industry is currently est imated at around INR 30 billion and has 74 Fo c u s 2 010 : D r e a m s t o r e a l i t y

grown at around 30 percent over the last few years. According to NASSCOM, the si ze of the animation industry itself is INR 25 billion, while special effects and other services account for the remaining INR 5 billion. However, India still fo rms an insignificant part of the global visual effects value chain. Over the las t couple of years, many new post-production studios have been set up in India, a ided by the fact that the infrastructure requirements for a medium sized visual effects studio are not very high. Most of these establishments operate well belo w their true capabilities and at a relatively low end of the value chain. They a re yet to take appropriate initiatives in terms of quality control and building the requisite skill sets to move up the value curve. Also, no Indian studio has yet been able to integrate all the segments to be able to offer large-scale endto-end services for discerning clients. As a result, India has continued to rema in a mere low end outsourcing destination for developed countries with very few notable instances of creative collaboration and origination. India forms an insignificant part of the global visual effects value chain With prospects of increasing domestic and overseas business in the future, it is imperative that the Indian post production and animation houses make the necess ary investment in technical and human capital to be globally competitive in term s of quality and creativity and not merely on costs alone. Locations A large num ber of Hollywood films are presently shot outside the United States in countries like Australia, South Africa, Canada and even Spain. For example, ‘Matrix’ was shot in Australia, ‘Shanghai Knights’ was shot in the Czech Republic, ‘Anacondas’ in Indones ia, while large parts of ‘Kill Bill’ and ‘The Entrapment’ were shot in Beijing and Malay sia respectively. The Indian subcontinent extends right from the snow capped Him alayas in the north to the warm coastal regions in the south, with forests and d eserts in between - a range of locales for film shoots covering nearly every con ceivable climate and location. However, despite this, the trend of using Indian locations has not really caught on internationally. This may be attributed to th e commonly held perception in Hollywood about political and regulatory impedimen ts. Ironically, on the other hand, several countries like South Africa and New Z ealand have been wooing Indian producers with sops and incentives. No Indian studio has yet been able to integrate all the segments to offer end-to -end services for global clients A facilitative regulatory environment and a focussed promotion drive by the gove rnment and industry associations could help create the right visibility and awar eness for India as a shooting destination. Outsourcing: A word of caution India is now maturing as a outsourcing destination in terms of its ability to offer en d-to-end services of the desired quality to discerning international customers. 75 A CII - KPMG Report

More than 50 percent of the Fortune 500 companies have some form of offshore out sourcing operations in India. With current revenues of USD 12.5 billion and a st eady growth rate of 30 percent, the business process outsourcing industry in Ind ia is likely to continue to grow. Traditionally, the back-end post production wo rk has shifted from one country to another to take advantage of the low-cost, hi gh-quality output. The back-end hub for films shifted from US to UK and now resi des in Australia. The cost differential for post-production activities between U S and India could be as high as 1000 percent. India, with a 2.5 million strong e xperienced work force, could be a formidable outsourcing player if it were to in vest in appropriate world class equipment for post production. However, India's cost advantage is not enough to create a large outsourcing industry. For Hollywo od, quality is a more important factor compared to mere cost reduction, as has b een made clear by its preference for other countries (like Singapore) vis-a-vis India. Training and education Training and education is an area within the India n film milieu that needs urgent attention, especially from the perspective of th e industry's bid to increase its market size by going global. Although an estima ted 2.5 million people currently work in the film industry in India, there is a glaring dearth of institutions and learning centres that impart professional tra ining in creative, technical, and functional areas of film-making. As a result, most of the current breed of artists and technicians that make up the Indian fil m industry are self-taught craftsmen who have mastered their craft by assisting veteran film-makers, who in turn have also learnt their art through years of exp erience rather than any sort of formal training. Apart from FTII Pune, there are hardly any other film-making school of repute in India. For the industry to rea ch global standards of film-making, there is an urgent need to develop and align film education to the requirements and opportunities of mainstream cinema. Indi a needs to develop creative and technical courses which are focussed and simulta neously, responsive to the current market environment. For example, computer gra phics, animation and special effects courses designed to match global industry s tandards are needed in order to take advantage of the outsourcing potential of t he market. A professional approach will also go a long way in providing the righ t balance of classroom instruction, hands-on workshops (learning-by-doing), and academic interaction with like minded peers, further driving the more knowledgeoriented and systematic approach to film-making. Apart from being under-trained and under-educated in global production and 76 Fo c u s 2 010 : D r e a m s t o r e a l i t y

management processes, a lack of nationally recognised formal training institutes also gives the Indian film industry and its participants a certain lack of resp ectability as compared to conventional professions like engineering, law and med icine where one cannot enter without formal training. This acts as a disincentiv e to many prospective creative talents towards entering the industry. With a for mal degree requirement as one of the qualifiers for entering the industry, the l ess talented would ideally be decanted by the system, and raise the bar for such specialised services. This would eventually lead to better alignment with globa l standards of film-making and an improvement in quality of the product due to s uperior quality and standards of its creators. A lack of nationally recognised formal training institutes gives the industry a certain lack of respectability compared to conventional professions where one ca nnot enter without formal training However, it is important to note that training and education in films is complet ely unlike training and education in more conventional fields like business and law, where employment is practically guaranteed after the completion of the cour se. Due to the intermittent and project-based nature of film-making and the fact that there are many more people interested in taking it up as a vocation than w hat the industry can support, there is expected to be severe competition on grad uation. For example, in USA, out of the thousands of film school graduates produ ced annually at their 125+ film schools throughout the country, only a few stude nts actually end up 'practicing' film-making while others take up other vocation s as a means of sustenance. A good way to tackle this problem in India could be to have MFA programs in film instead of BFA, which would allow students to get t heir Bachelors degree in a vocation they can fall back on, apart from providing them with a well rounded education. Government incentives The role of the govern ment as an enabler and a facilitator has been discussed at length later in this report. Specifically in the context of films, there are several areas where the government could act as a catalyst, through direct or indirect support. Certain countries like Canada, Iceland etc. offer tax incentives for shifting the produc tion to a local site in that country from a country where the film is primarily intended to be exhibited (’runaway film production’). Tax incentives are also grante d by certain countries on co-productions, involving two or more production compa nies from different countries jointly financing and producing a film. Coproducti on can enable the production houses to avail the benefits that are available to national films in other countries with which co-production treaties have been en tered into. These tax incentives are by way of special tax credits or deduction of eligible profits from income subject to tax. Entertainment tax levied by vari ous states/ municipal bodies on the value of film 77 A CII - KPMG Report

tickets, live stage-shows etc. adversely affects the entertainment industry. Thi s results in a large portion of theatre ticket receipts diverted towards tax, in stead of being channelled into development of theatre exhibition facilities. At an average of 60 percent, the entertainment tax levy in India is one of the high est in Asia. A wishlist of concessions: Complete amortisation of production cost s in the year of completion of the film ! Amortisation of costs of incomplete fi lms, subject to furnishing adequate documentation ! Extending tax-incentives for multiplexes in metro cities ! Tax incentives for newly set-up film ventures, wi th a corporate set-up and sizeable amount of investment ! Providing facilities a nd indirect tax incentives on film production, studios, etc. ! Tax incentives fo r film-financing activities ! Rationalisation of entertainment tax ! Concessions on customs duty on import of studio and other equipments and software to promot e use of superior technology in film-making. ! Government could play a meaningful, facilitative role in the areas of education and foreign trade In addition to fiscal incentives, the government could play a meaningful role in the areas of education and foreign trade, not necessarily through grants or inv estments but through facilitation (of say, land allotment and clearances), by co mplementing the private sector's initiatives in this regard. Areas of possible g overnment involvement Government incentives u u Piracy control Legal and regulatory Incentives u u Tax breaks Import and export Subsidies u u Training and education Film development u u Investments in education infrastructure Setting up professional training Institu tes for professionals u u u Film funding assistance Strengthening ailing film assistance bodies Film appreci ation courses for increasing audiences’ awareness of ainema Source: KPMG Research The initiatives and ideas suggested above have the potential to play the necessa ry assisting role in restructuring the industry and ensuring that it takes off o n the path of sustained growth. What is needed now is a firm dedication to carry out deep-seated transformational modification including strategic and structura l alterations, implementation of new technologies, superior understanding of the consumer pulse and better organisational effectiveness to ensure that the secto

r realises its true potential. 78 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The industry is making its leap from a fragmented, unorganised framework to an o rganised, commercially focussed structure. It will need to adapt and imbibe the business processes that would aid this metamorphosis. Simultaneously, it needs t o tap alternate revenue streams by utilising the right technologies and followin g the right processes to optimise resource utilisation. The key to success in su ch a dynamic scenario will be the ability of the players to adopt global practic es with the necessary degree of customisation and localisation. When it succeeds in making this transformation, it will compare favourably with the world's most developed film industry, viz. Hollywood, in terms of functioning and earning po tential. Slowly but surely, the Indian film industry is moving Back to the Future In conclusion, it may be pertinent to observe that most of the initiatives discu ssed above - like the integration of the value chain (akin to the studio model o f the 30s and 40s), the emergence of new genres, the merging of barriers between mainstream and parallel films and the exploration of new markets like Eastern E urope and Greece, cross over films and co-production - have all been attempted b y the industry during the 30s through to the 70s, with varying degrees of succes s. In a way, therefore, it can be said that slowly but surely, the Indian film i ndustry is now moving ‘Back to the Future’. 79 A CII - KPMG Report

Music The times they are a changin’

Music The times they are a changin’ The Indian music industry is over a century old. However, the past few years hav e been dismal for the industry. It has shrunk to INR 10 billion from INR 13.5 bi llion in the last four years, as the onslaught of piracy, the high cost of acqui sition of film music and the low priority accorded to the sectoral issues by the authorities have somewhat upset its business viability. The situation in India is not unique. Globally, the music industry has been in recession for about four years and is now making a slow recovery. A series of revenue enhancing and cost -cutting measures have been undertaken by global music majors, which are expecte d to bring about a turnaround soon. In India, the pattern of music consumption a nd distribution has shifted radically in recent times. Music buying has reduced and, despite the popularity of the new Hindi films, which make up for 40 percent of total music sales, the number of units being sold is falling. On the other h and, piracy has ensured that the average retail price of music cassettes remains stagnant over the years, while that of CDs fall. This has led to a spiralling d ecline in revenues, since such falling prices have not been compensated through rising volumes. In recent times, the pattern of music consumption and distribution has shifted r adically. Over the last few years, the industry also witnessed the rapid rise of remixes, or cover versions and music videos of original soundtrack, which have attained m ass popularity and received more airplay than the originals, on television and o n FM radio, but did not significantly increase the sales of the original music c ompanies. Future growth is likely to come from non-physical formats like digital downloads, royalty income and ringtones, among others. The Indian music industr y needs to adapt to this swing in audience preferences by leveraging appropriate technology in a facilitating regulatory environment. Going forward, the industr y will need to focus on controlling its distribution and manufacturing costs. Th is is likely to enhance the industry's bottomline and result in more capital bei ng freed for investment in technology and infrastructure. The recovery process f or the industry will be slow and a moderate growth is expected from hereon. Ther e is an immediate need for the various stakeholders, viz. film producers, music companies and user-segments to come together and evolve solutions from within, a nd adopt a collaborative approach as discussed later. A unique industry structur e The Indian music industry has a unique structure compared to most global marke ts. Till 1990, it was completely dominated by film and devotional music. With th e advent of satellite television and increasing consumer exposure to nonfilm mus ic channels, non-film albums and remixes have gained popularity recently. In the non-film category, devotional music produced by smaller and local 81 A CII - KPMG Report

companies is the most popular. A few late entrants to this category have decided to stay away from the vagaries of film music and have focussed on high end clas sical, devotional and other niche genres instead. Genre-wise distribution of music sales in India Others International 8% Devotional 10% 8% New film music 40% Popular music 8% Regional film music 5% Old film music 21% Source: Industry estimates Genre-wise distribution of music sales in USA Classical 3% Jazz 4% Religious 7% Others 12% Rock 27% Country 11% R&B urban 11% Rap / hip hop 12% Pop 13% Source: IFPI Piracy - A growing affliction Though the problem of piracy has been in existence for the last twenty odd years, it has emerged as an all-engulfing menace in the last five years or so. The volume of pirated units has been rising consistently despite the falling prices of legitimate music. Piracy, which is currently esti mated at INR 4.3 billion, accounts for as much as 42 percent of the industry's t otal revenues. Unless stringent measures are taken now, this is expected to rise further. A look at the Indian audio-video market shows that the VCD/ DVD/ MP3 s egment is growing at an explosive pace of almost 300 percent. However, this grow th has 82 Fo c u s 2 010 : D r e a m s t o r e a l i t y

not been reflected in a corresponding growth in the legitimate sale of CDs, VCDs and DVDs. On the other hand, there has been an alarming rise in the production and sales of CDs and DVDs, far in excess of demand, in India and certain countri es. Evidently, such growth has only resulted in increased piracy. While local CD -R burning is assuming a larger percentage of the piracy revenues (replacing VCD s and manufactured CDs), import of pirated CDs and DVDs from neighbouring countr ies continues unabated. Piracy trends Estimated capacity 8 7 6 5 4 3 2 1 (All disc formats, billion units) Total legitimate demand Excess capacity 120% 100% 80% 60% 40% 20% 0% In di a Si ng ap or e Th ai la nd Po la nd Alarming rise in capacity despite falling demand indicates growing piracy Source : IFPI, industry estimates Apart from physical piracy, another increasing problem is digital piracy. It is powered by the rising popularity of MP3 technology and rising PC penetration, ma king free downloads a convenient option for the consumer. While India has a larg e, indigenous copyright industry and a reasonably sound copyright law, there are several obstacles to reducing piracy. These are: ! Reluctance by law enforcers to accord due attention to the issue, ! Lack of resources and training (to track sophisticated MP3 piracy), ! Lack of an optical disc law and ! Lenient punishme nts. However, there is some light at the end of the tunnel. Indian Music Industr y (IMI), an industry body comprising over 50 member companies, has stepped up it s efforts to curb piracy through regulation as well as through technology. The m embers have decided to contribute 1 percent of their annual turnover, which work s out to approximately INR 40 million, towards this cause, though this amount is considered rather inadequate. The recent strengthening of the Civil Procedure C ode and the proposed Optical Disc Law are steps in the right direction. Strict v igil at the customs check-points and more stringent implementation of the law by the police will go a long way in reducing physical piracy in the near future. si a In do Cz ne ec si a h Re pu bl ic Ta iw an Ko ng Ch in a M al ay si a H on g Ru s 83 A CII - KPMG Report

Side by side, it is expected that digital piracy too will be brought under contr ol, eventually, through: ! Technology push: a wide repertoire of legitimate digi tal music becoming available through a variety of convenient platforms and optio ns ! Demand pull: increased internet penetration and the advent of broadband ! E fforts by authorities to educate and deter the free downloader Global efforts to curb digital piracy Concerned by the growing trend of free downloads and peer-t o-peer networks, and the inability to control mounting losses due to home piracy , music companies worldwide have decided to adopt a carrot-and-stick policy. Rea lising that there is a significant section of listeners with access to free and convenient downloads, they are adapting to the same channels of distribution to provide the convenience of digital downloads. They are also backing this up with a strong regulatory push, public announcements, litigation warnings and legal c ases against users distributing large volumes of music files over the system. Th e results have been positive and for the first time since its origin, music down loads on peer-to-peer file sharing networks have started reducing. Also, new glo bal developments have seen better acceptability of new service offerings. Apple Computer's iTunes Music Store, launched in April 2003, that sells individual son g downloads for 99 cents, has reportedly sold more than 200 million songs till e nd 2004. The availability of a wide repertoire of more than one million songs fr om all four major labels and over 600 independent labels has contributed to its success. The new digital age is likely to see the rapid growth of service provid ers like iTunes, Napster, Rhapsody, MusicMatch etc. who have been able to enhanc e the music companies' revenues through innovative offerings like: ! Audio books ! Exclusive tracks, in-studio performances, customised playlists and ondemand v ideo ! Portability - the freedom of accessing the account from any PC ! Flexible payment options, like pay-per-song, monthly subscription, one-off charge, pre-p aid cards and music allowance accounts. ! Tie-ups with retail stores and PC manu facturers. 84 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Composition of revenues Currently, the music industry derives annual revenues of INR 10.2 billion, of which music sales contributes around 92 percent and the no n physical formats contribute the balance. Ring-tones now contribute around 5 pe rcent, and royalty revenues 2.5 percent. It appears that the negative trend in r evenues, seen in the earlier years, has been reversed. Sales in 2004 have increa sed at a very modest 1.2 percent vis-à-vis a 4 percent decline in 2003 and 14.5 pe rcent drop in 2002), while the bottomlines have significantly improved. Music re venues 15 10 5 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E Pirated CDs and c assettes Royalty Revenues 2010E (INR billion) Original CDs and cassettes Ringtones Digital formats Source: KPMG Research Recovery and growth From a perspective of pure financial returns, and looking at other alternative and more attractive avenues available to the entertainment se ctor, the music industry will need to completely reinvent its business model in order to attract significant investments. In the future, it is hoped that the fi lm and the music industries will work collaboratively, aided by digital infrastr ucture, effective distribution formats and a more conducive and effective regula tory regime, to combat piracy and get the listener back into the buying mode. Gr owth in sales 140% 120% 100% 80% 60% 40% 20% 0% 2001 -20% -40% 2002 2003 2004 2005E 2006E 2007 E 2008E 2009E 2010E Original CDs and cassettes Digital formats Pirated CDs and cassettes Royalty Revenues Ringtones Total industry Source: KPMG Research 85 A CII - KPMG Report

In the future, the industry is likely to see changes in its distribution and con sumption patterns, aided by technology and more stringent regulations to curb lo sses and leakages. The industry is expected to recover and post moderate growth to reach INR 13.2 billion by 2010, a CAGR of less than 5 percent. However, as no n-physical formats gather momentum, the bottomlines of the music companies are e xpected to increase more than proportionately as a result of improved efficiency and lower delivery costs. With mobile phone penetration already over 50 million and expected to double in the next two years, revenues from ringtones are expec ted to become a significant contributor to the toplines of music companies. Also , as additional endusers like pubs and discotheques, hotels and restaurants are brought under the royalty payers' net, publishing (royalty) income is expected t o grow significantly, from INR 254 million currently to INR 747 million in 2010. This number can increase significantly with investments in technology to track and record online usage and a more cooperative approach from the royalty payers. A firm regulatory push, together with investment in Digital Rights Management, w ill eventually bring down losses of original IPR holders A firm regulatory push, together with investment in Digital Rights Management, w ill eventually bring down losses currently suffered by the original IPR holders. Split of revenues Original music sales Loss through cover versions 16 14 12 10 8 6 4 2 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E 10% 0% 40% 30% 20% (INR billion) Pirated music sales Loss to original IPR owners 60% 50% Source: KPMG Research In the future, music will increasingly be sold through non-physical digital form ats, as technology makes new products and services available and affordable. By end2005 digital sales are expected to account for around 6 percent of global mus ic sales. It is expected that digital distribution of music will become popular in India by 2007 when large telecom, cable and DTH players roll out their networ k. In , keeping with the global phenomenon of the emergence of service providers , there will be a gradual proliferation of such providers in India too. These pr oviders will sell bundled offerings of digital music, television broadcast and p ay-per-view films and events to their consumers through different delivery platf orms like digital cable, IP-TV and satellite. 86 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The journey from here... Though piracy remains a major global issue globally, the solution for the Indian music industry, because of its inherent nature, will need to be quite different and will have to come from within the entertainment industry. A few steps that could rejuvenate this industry are suggested below: Film industry as a partner T he Indian music industry is quite unique compared to those in other countries, a s it is virtually dependent on new Hindi films for the lion's share (40 percent) of its revenues. Regional and old Hindi films add another 25 percent to the ind ustry revenues. The film industry needs to look at the music industry as partner s rather than buyers - the current risk-reward distribution among them is lopsid ed and needs to be made more equitable. The film's performance at the box office and the music company's cost of rights acquisition determine the profitability of a music album. However, the music creates the curiosity factor for a film. It is the first phase of promotion that initiates the entire brand building for a film. Music companies do not have any say in the way the music is conceived or p roduced, yet they are expected to market it. Here, a collaborative approach with the producer of the film, and a revenue sharing based understanding, could resu lt in improved content and better risk sharing. In the future, there could be co llective efforts where the music companies are involved at the content-creation stage and also in the marketing of the film. Over the last three years, there ha s been a unified effort in the industry to correct the price paid for purchasing music rights. In the last few years, while the film industry went through a pha se of rationalisation, the music industry made certain overvalued acquisitions. One fall-out of this market correction has been that the sale of music rights ha s dried up as a significant revenue stream for producers. Moreover, a new trend of producers setting up their own music companies has emerged. In the near futur e, there could be an increased number of alliances, and even acquisitions, with film production houses taking over music companies, to avail of their distributi on network and operating expertise. The FM factor It is believed among certain s ections of the music industry that the proliferation of FM radio stations across the country has led to a decline in the sale of audio cassettes and compact dis cs. Globally, FM stations help promote albums and labels by playing their songs. However, in India, FM is considered more of a threat than a promotional medium for the music industry the reason once again being the unique genre-preference o f the Indian listener, which is heavily skewed towards new film music. 87 A CII - KPMG Report

However, since FM radio is limited to a handful of large cities, its impact in a ccelerating the downfall of the music industry may be overstated. In the future, though, there is a need for the music and radio industries to work together rat her than at loggerheads, to work out a common growth path within the given envir onment. The possibilities and synergies of co-branding of music products and pro perties between radio stations and music companies can be explored. For example, Radio X could promote a collection of Y Music's songs or artists resulting in i ncreasing the demand for these songs. On the other hand, Y could release a 'Radi o X Top 10' album consisting of such songs and programmes promoted on air. Again , on several occasions, good quality, non-film albums produced by music companie s do not get reasonable airtime. Such experimental or offbeat music can be effec tively promoted on radio and the channel can be incentivised to take certain ris ks through intelligent revenue-sharing arrangements. Strategic thrust on marketi ng non-film music Music is not a necessary item on the consumer's shopping list. In the film-centric Indian music industry, there is virtually no loyalty for th e label among the segment that buys only film music. However, the marketing mode ls developed by FMCG companies to launch and sell lifestyle and aspirational pro ducts can be implemented by companies to boost the sale of non-film albums. This is possible by developing brands and charging premium prices once brand loyalty is built among the target audience. Once a strong brand recall is created throu gh successful marketing of non-film albums, the same can be extended to film alb ums to create a differentiating factor over competing pirated products. Interest ingly, the growing sale of video remixes of old classics has actually opened up a window of opportunities for the music companies that hold the original rights. The future could see these (original) music companies themselves getting into t he remix act in a big way. This same move could see them getting into the casset te segment of non-film devotional songs recorded by unknown artists, hitherto a stronghold of the lesser music companies. Online marketing With increasing PC pe netration, the internet is expected to become a significant influencer in the pu rchase of music. Online sales involve lower distribution costs and eliminate the retail margin of 15-20 percent. Part of these savings can be utilised for innov ative net-marketing that offers consumers detailed information and reviews, and also the flexibility of customised and unbundled offerings. 88 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Artist and repertoire One of the strategies adopted by the music industry for th e growth of non-film music segment involves identifying new talent, nurturing it and creating strong brands around it. Such artist and repertoire (A&R) manageme nt will assume greater brand-building increases. One effective way to build bran ds with differentiated content is to create a talent pool of artists who are gro omed, promoted and retained by the label. Notable experiments in recent years ha ve been 'Band of Boys' and 'Viva', music groups promoted by Universal and Channe l V respectively, which managed to generate significant awareness and popularity amongst their target segments. Sony Entertainment Television's 'Indian Idol' is another similar exercise in which people vote for their favourite contestant. T hrough this show, Sony aims to identify talent which is popular with the audienc e and simultaneously connect with the audience, which is an effective way of pre -selling what would have otherwise been albums by unknown artists. Similar exper iments have proven to be fairly successful in other countries like Australia and USA. The most successful example of such a strategy is the ‘Spice Girls’ band that enjoyed global popularity. Music companies could benefit from the Indian experie nces in this arena and further refine this strategy. The benefit of such a strat egy is that apart from generating music sales, the creation of brands can be lev eraged for multiple sources of revenue like brand merchandise and memorabilia am ong other things. At the same time, the cost of such talent acquisition is also relatively low, compared to the fees and royalties that are paid out to leading singers. A&R in India can prosper in an environment that is more transparent and artist-f riendly Internationally, A&R forms a significant and steady revenue stream for music com panies. Though in India, the film soundtrack is more important than the singer, there is no reason why A&R cannot prosper in a more transparent and artist-frien dly environment. Currently, there is a certain lack of trust between the artists and the music companies. A fair and transparent business model could provide th e platform for a healthy artist-recording company relationship. At the same time , a more serious effort needs to be put into the content that is churned out, to increase the shelf life of the artist and the music property, so as to create a sustainable long-term value proposition. This can be possible if the music comp anies consider allocating budgets and setting up dedicated divisions manned by e xperienced people. Royalty collections Currently, Phonographic Performance Ltd. (PPL) and Indian Performing Rights Society (IPRS) are the two administering bodi es for royalty collection for all music that is publicly played over radio, rest aurants, clubs, discotheques, etc. The scope and the awareness for such royalty collections has increased manifold over the last few years. It is expected that in the near future, the music companies will be able to collect substantial reve nues through royalties from a vast cachement of 89 A CII - KPMG Report

users. The increasing user base can also enable PPL and IPRS to reduce the per u ser royalties collectible from other industry stakeholders like radio. However, PPL and IPRS do not the have the manpower, funds and the infrastructure to monit or and collect royalties on a nation-wide scale. One solution to increase collec tions and bring more users into the royalty net could be to introduce a point of sale tax - an indirect tax collected from all customers of pubs, discos, etc. I t could be coupled with a share of the revenues from the sales of these establis hments. This collection can be allocated among various music companies depending on certain mutually agreed criteria. A part of the money collected could be ret ained towards a development fund that will, among other things, invest in piracy control. Judicial leniency While existing laws have punishments for a term not less than six months and a fine not less than INR 50,000, offenders for copyrigh t violation often get away with a single day imprisonment and fines between INR 500 and INR 1000. The fine too, goes to the government and not to the music comp any. Such lenient clauses do not serve any purpose as a deterrent to offenders. Again, due to lenient copyright laws related to music [like Section 52 (1)(j)], and the opaqueness of the system, the original rights holders stand to lose ever y time a remix of a popular song is made by a second recording company. Smaller recording companies and new entrants without significant archival content have s uccessfully exploited this clause to the detriment of the original rights holder s. Coupled with this, the lack of optical disc laws and ineffective implementati on of controlling physical piracy, discussed earlier, have led to huge losses to the exchequer by way of non-payment of income tax, sales tax, excise duty and e ntertainment tax. A tighter regulatory regime and a more stringent enforcement o f law is the need of the hour. Digital distribution With the rapid rollout of en abling digital technologies and rising PC penetration, music companies will need to embrace new technologies. The future will mean making more sales to more peo ple in more ways but at a lower average price. Music companies need to re-engage innovatively with the consumer. The future demands a new consumer-inspired busi ness model that incorporates everything that modern technology can offer, which is balanced with enhanced retail delivery. Also, there is a need to monetise acc ess to music on the Internet, a difficult but not impossible challenge, as Apple’s iTunes experiment has proved. This requires significant investments in time and money, and a buy-in of all major music labels 90 Fo c u s 2 010 : D r e a m s t o r e a l i t y

to agree to come together and put up their repertoire on downloadable platforms. However, the music companies alone do not have the wherewithal to make the nece ssary upfront investment, and they may therefore need to work together with a di gital access provider to home through cable, fibre or satellite on a revenue sha ring basis. Collaborative efforts between access providers and music companies i n this regard are reported to be underway. Convergent distribution Aided by enab ling technology and a reasonable subscriber take-up, the music industry also has the potential of participating in convergent distribution, at least in the majo r metros when such services are rolled out. It means simultaneous availability o f content to the public (via radio, television, internet, retail), real-time mar keting, promotion and distribution. Convergent distribution will also enhance th e value proposition of the access providers and improve subscriber take-up. Orga nised retail Globally, bundled offerings like books, music and coffee in stores located near hypermarkets, multiplexes and other entertainment destinations have significantly increased footfalls. Though hypermarkets alone account for 40 per cent of sales in developed countries like France, Japan, etc., organised retail accounts for less than 2 percent of the total sale of music in India. With the g rowing acceptance and availability of large format retail stores, this ratio is expected to increase to around 5-6 percent in the next 4-5 years, which will sti ll be rather low by international standards. Since the purchase of most media pr oducts is instinctive and preference based, their points of sale have to be spre ad across the various options available in the retail arena. Such outlets includ e supermarkets to service stations to specialised electronics shops to record sh ops. If this were to happen, it could help in curbing physical piracy too, since such pirated products are mostly sold through small neighbourhood music stores. Public awareness campaigns Such campaigns against piracy and free downloads hav e been quite effective in the US. The need for the Indian music industry to inve st in public relation cannot be understated. The formation of a development fund , discussed earlier, could be thought of, for channelising investments in this a rea. New business models Emerging home entertainment technologies, the growth of high-end mobile handsets and music's growing role in games, advertising, films, television and corporations will result in music companies re-inventing their t raditional business models significantly to be able to fully capture these emerg ing streams. Every Convergent distribution will enhance the value proposition for access providers 91 A CII - KPMG Report

new technological innovation will also give rise to a new form of piracy, so con tinuous investments in digital security will need to be made. Conclusion The Ind ian music industry needs to undertake several strategic shifts going forward in order to retain its lost glory. It needs to revamp its operating model with supp ort from key stakeholders and evolve new revenue streams for various delivery pl atforms. The last decade saw a spurt in the number of players who were attracted by the profits seen during the boom years. The next few years could see a conso lidation and shake-out. The corporatisation in the film industry would have a be neficial effect on the music industry, as they jointly move towards a more equit able revenue and risk sharing model. Music is a creative industry, which needs s upport in trying times. How willingly and effectively the various stakeholders c ome together to adopt a partnering approach will determine the pace at which the industry re-invents itself to stay competitive. 92 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Radio Tuning in

Radio Tuning in Radio is a mass medium and therefore ideally suited for India - leveraging its t win advantages of wide coverage and cost effectiveness. It is dominated by the s tateowned All India Radio (AIR), which covers 91 percent of India's area and rea ches 99 percent of the population, through a wide network of broadcasting centre s and transmitters. Apart from AIR, there are 21 privately-owned FM stations in 12 major cities, all of whom have been granted licences over the past 3-4 years. Advertising is the sole source of revenue for radio in India. Currently, the se ctor generates annual revenues of INR 2.2 billion and is growing at around 20 pe rcent annually. This implies a marginal rise in radio's share in the advertising pie to around 1.9 percent. Given that commercialisation of radio is still in a nascent stage in India, this growth rate is far from flattering. As a result of unsustainably high licence fees, the sector has been reeling under heavy losses. A few FM stations have been forced to shut down, as they could not afford to pa y the annual license fees, set at levels significantly above their earning capac ity. If one considers the private sector FM market in Mumbai, four players cumul atively generate annual revenues around INR 250-300 million, against total opera ting costs of around INR 550-600 million. Given that a significant portion of th e operating costs is the licence fee, which is set to increase at 15 percent per annum, revenues would need to grow at over 40 percent annually to break even in the next three years. The global scenario Globally, radio is enjoying a renaiss ance based on the support of the youth. They seem to prefer it since, unlike tel evision, it is more compatible with their lifestyle. Research trends in Australi a indicate that radio enjoys a higher level of popularity among the 15-29 age gr oup. Today's busy teenagers love radio because it complements a faster-paced lif estyle - they can listen to music and get information on the move. Younger audie nces, particularly those below the age of 25, also have access to new technology like mobile phones. They have taken very quickly to interacting with their favo urite radio stations and RJs via email and SMS for song requests and competition s. Globally radio is enjoying a renaissance based on the support of the youth. 93 A CII - KPMG Report

FM listeners across age groups 41% 35% 34% 28% 20% 40% 12-14 15-19 20-29 30-39 40-49 50+ Source: - MRUC and AC Nielsen ORG Marg's Indian Listenership Track 2004 The Indian potential India has an estimated 180 million radio sets, reaching ove r 99 percent of its one billion inhabitants - a clear indication of the vast com mercial potential in India for this medium. Plainly, the radio sector cannot and should not be satisfied with a growth rate in the low 20s. In India too, it is the younger generation that is the key target audience vis-à-vis radio. While cons umption in India is still largely at home, 'the radio on the move' trend is catc hing on in urban and semi-urban areas. The easy availability of FM radio sets at affordable price points (ranging from INR 40-INR 150) is fuelling its mass pene tration. FM listening habits 100 80 60 40 20 0 8 7 7 1 5 8 2 4 1 5 72 72 Delhi At home In Car Commuting Mumbai Neighbour/Friend’s place At office ( incl. Shops) Others Source: - MRUC and AC Nielsen ORG Marg's Indian Listenership Track 2004 According to market research, in Mumbai and Delhi, FM penetration is the highest in the SEC A segment and least in SEC D. Further, 70 percent of radio listeners in these cities listen to FM radio all seven days of the week. However, this se ctor has not been able to monetise its hold on the listener’s eardrums. In spite o f such attractive statistics, in terms of its advertising spend, radio remains a 94 Fo c u s 2 010 : D r e a m s t o r e a l i t y

laggard. It has less than 2 percent share of the total advertising pie in India, compared to a global average of 8 percent. In the US, radio has a 13 percent sh are, in Spain 9 percent and closer to home, in Sri Lanka, radio has a 21 percent share of the advertising spend. Global ad spend on radio Share of total ad spend 25% 20% 15% 10% 5% 0% Fr an ce Sp ai n Au st ra lia Ja pa n La nk a Br az il Source: - KPMG Research Universally, media categories in the growth stage have a share of around 5 per c ent and mature categories average around 10-12 percent of the total advertising expenditure across various media. We estimate that if its real potential is unlo cked in India, commercial radio could account for approximately 8 percent of med ia spends in the short to medium term and up to 10-12 percent in the long term. Radio revenues 25.0 G er Sr i m (INR billion) 20.0 Current growth path Potential growth path 15.0 10.0 Includes only ad revenues Future subscription revenues (pay radio) included sepa rately under ‘Digital Revenues’ of TV industry 5.0 0.0 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E Source: - KPMG Research In di a

95 U SA Ita ly A CII - KPMG Report an y U K

Bridging the gap Due to the public-broadcaster nature of AIR and its socio-economic rather than a commercial focus, its ad revenues are expected to grow at a moderate pace. Sinc e the private FM channels need to survive in a commercial and competitive enviro nment, they have focussed on mass entertainment to gather listeners. Hence, it i s expected that the private FM channels will drive the future growth of the sect or. FM radio needs to grow from the current 21 stations in 12 cities to atleast 300 stations in 100 cities To exploit the true potential of this sector, FM radio needs to grow from the cu rrent 21 stations in 12 cities to at least 300 stations in 100 cities. At an inv estment of INR 40 million per radio station frequency, the total additional inve stment required will be INR 11 billion. In its current form and structure, the r adio industry will not be able to attract the necessary funding. TRAI, the desig nated regulatory body for radio, has proposed a transition from the existing lic ense fee regime to a revenue sharing one, to help the radio industry curb it los ses. It is hoped that clarity on revenue-sharing emerges, soon. Apart from ratio nalising the licence fees, the government will need to promote and facilitate th e growth of private FM radio by: ! Relaxing the entry barriers on foreign invest ment ! Providing a level playing field in programming for private players For ex ample, opening up news and current affairs ! Enabling multi-city broadcasting of common programming content for radio companies ! Fostering the growth of niche channels by: Lifting restrictions on the same player owning multiple stations in the same city Relaxing licence fees for niche channels Incentivising existing p layers to set up additional channels with niche content The industry, on its par t, needs to develop strategies to expand across the country and enhance business performance, thereby turning India's promise into reality. In other words, the challenge confronting radio is to bridge the gap between the current growth tren d and potential growth expectations. It is expected that increasingly, FM radio stations will concentrate on: ! Focussing on local and smaller advertisers ! Exp loiting future value of programming content ! Making niche and differentiated pr ogramming a viable option ! Managing costs of operation in line with its busines s model ! Managing brand association ! Selling radio as part of the multi-media strategy 96 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Local mantra The sales and marketing efforts of the major FM radio stations have focussed on the large advertising clients. This may be partly attributed to the FMCG-marketing background of some of the managers and partly due to the sales s trategy of the multi-media groups that own most radio stations. However, radio i s a unique medium and the focus on large advertisers seems to be at the cost of its largest potential benefactor - the local retailer. The retail segment global ly constitutes a large part of radio's clients and sales, but currently in India accounts for a small portion of the radio revenue pie. For example, in USA, 70 percent of all radio revenues come from local retailers, and only 30 percent com es from either national or international advertisers or from the network of adve rtisers. In contrast, in India, retail comprises only 8 percent of radio adverti sing. Profile of advertisers on Indian radio Telecom 8% Others 26% Retail 8% Finance 10% Durables 12% FMCG 14% Media 22% Source: Industry Radio, by its very nature, is a localised medium, due to it’s ability to transmit a particular message over a small geographical area. The retailer, with city/ lo calityspecific target groups, can be a major beneficiary of radio advertising. C learly, there is a need to unlock the advertising potential in the retail segmen t. Radio stations offer high frequency ‘opportunity to hear’ for the advertiser. Int ernational research indicates that radio has 60 percent of television’s effectiven ess at increasing campaign awareness amongst an audience of 16-44 year old radio listeners. However, advertising on radio costs just 15 percent that of televisi on. While the price relativity for other audiences will vary, the achievement of 60 percent of the result at 15 percent of the cost makes radio significantly mo re cost effective than television. 97 A CII - KPMG Report

Revenue composition 11% 11 percent of clients contribute 60 percent of revenue 60% 89% 40% % Clients % Revenue Source: KPMG Research The price differential between radio and television will vary depending on the a rea and the audience. In India, where the cost of television advertising is more than seven times that of radio advertising, the cost effectiveness of radio adv ertising will be even more acute, which can be a great proposition for local ret ailers. A high frequency combined with a moderate card rate (effective rates ave rage between INR 500 to INR 900 per 10 seconds) provides an opportunity for reta il players to promote their products and services cost effectively without fragm entation as in the case of national or even regional media. Presently, the adver tiser base of FM radio is highly skewed, with around 11 percent of advertisers c ontributing 60 percent of their revenues. This should not be the case in a local ised, mass-medium like radio. Ideally, the advertiser base should be broad-based with a large number of local advertisers promoting their products. While some r adio stations are waking up to this reality, this potential is largely untapped. It is important for the radio stations to highlight the effectiveness of using radio for local level promotions and region-specific ad campaigns. Moreover, sin ce many FM players are associated with larger, vertically integrated media corpo rations, cross media promotions could be an added incentive for the potential ad vertiser. 98 Fo c u s 2 010 : D r e a m s t o r e a l i t y

FM licensing - The story so far In 1999, the government decided to allow fully owned Indian companies to set up private FM stations on a licence fee basis. Bids were called for allotting licen ces for 108 FM frequencies in 40 cities for a ten-year period. However, the gove rnment imposed a few conditions like: ! Broadcasts will be for education/enterta inment only, with a ban on news and public affairs programming ! No foreign equi ty was allowed, although foreign institutional investors may have portfolio inve stments of up to 30 percent ! Licence fee will be determined by auction for each market. Subsequent annual license fee renewals will be based on bid price plus a fixed percentage. In May 2000, as part of Phase I of radio broadcast licensing , the auction was conducted and 37 licenses were issued, out of which 21 are ope rational in 14 cities. The results were not very encouraging, given that only 25 percent of the available licences were operational. Even the existing licensees claimed to be making heavy losses in their operations. The main reason for this was that the licence fees were based on highly optimistic projections. A commit tee was established under the chairmanship of Dr. Amit Mitra to make recommendat ions for Phase II of radio broadcast licensing. This committee found that the in dustry appeared unviable under the existing licensing regime and suggested a shi ft towards a one-time entry fee coupled with a revenue-sharing agreement. In Feb ruary 2004, as the designated regulatory authority, TRAI was asked to give its r ecommendations for the Phase II licensing of FM radio. In April 2004, TRAI came up with a consultation paper that listed the following issues: ! Service area: S hould it be city-wise or regional or national? ! Duration of licenses: Is there a need to change the present license period? ! Fund for rural roll out and niche programming: Should it be created? What should be its quantum? ! Licensing proc ess: What approach should be adopted to award the FM radio licenses? ! Quantum o f entry and license fees: How should entry and licence fees be set? Should it be a revenue-sharing model? ! Multiple licenses: Should multiple licences at the s ame centre be restricted? If yes, then to what extent? ! Networking: Should it b e allowed between broadcasters in the same city? ! News and current affairs: Sho uld the restriction on news and current affairs be maintained? ! FDI limit: Shou ld FDI be permitted in this sector and what should be the limit of FDI? 99 A CII - KPMG Report

! ! Non commercial licenses: Should certain frequencies be reserved for niche channe ls? Migration related issues: Should migration of existing licensees to revenue share regime be permitted? If yes, under what terms and conditions? In August 2004, TRAI presented its recommendations on the regulatory framework f or private FM stations. The main recommendations are: ! Licences should continue to be allotted on a city-by-city basis. ! The licence period should be ten year s, extendable for additional five years. ! A portion of the revenue received by the government to create a fund for public service broadcasting. ! Change the li censing process from open bid auction to tendering, without any reserve entry fe e. ! Bids for the next phase of licensing should be based on entry fee plus reve nue sharing model (4 percent of gross revenues). ! The winners should be selecte d in descending order of their entry fees. The entry fee for a player should be equal to the amount bid by him. ! Multiple licences to the same player in the sa me city should be permitted, subject to monopoly restrictions. ! Networking shou ld be permitted across broadcast stations of the same entity in different cities . ! FM channels should be allowed to broadcast news and current affairs programs , subject to AIR code of conduct. ! 26 percent FDI should be permitted in FM bro adcasting (news and entertainment) subject to some safeguards. ! Existing player s should be allowed to migrate from a licence fee regime to the model adopted fo r new FM licence bidders. ! Co-location of transmission towers should be encoura ged by suitable incentives. The Information and Broadcasting Ministry disagreed with some of TRAI recommendations. The objections and TRAI's rejoinders to them are listed below: ! The government's stand was that adopting a closed bid tender system without a reserve entry fee would leave the process vulnerable to cartel isation. According to TRAI, a reserve price has meaning only when there is a par ticular value to an asset, which won't be sold below reserve price. Here, it is just a mechanism of selection among the bidders. The government also thought tha t withdrawal penalties to deter non-serious bidders were not stringent enough. T RAI suggested a modified proposal to deter speculative bidders, while protecting smaller players. ! The government opposed TRAI's recommendation to move to a re venue sharing model because it would be difficult to monitor, cumbersome to impl ement and would cause revenue loss to the government. TRAI reiterated 100 Fo c u s 2 010 : D r e a m s t o r e a l i t y

! ! the fact that the current fees were too high and would kill the industry prematu rely. Instead, it suggested some accounting safeguards to ensure ease of monitor ing. It also indicated that administrative convenience cannot be a major factor in deciding the licence fee model and that the government undertakes much more c omplex tasks like scrutinising over 30 million assesses annually for income tax. It also pointed out that the current revenues received by the central governmen t were unsustainable. Shifting to a revenue sharing model would ensure that the industry is able to thrive and could even lead to higher government revenues in the future, as in the case of cellular telecom industry. The government opposed the TRAI suggestion on allotting multiple licences to the same player in the sam e city, saying that it would create a monopoly. It cited a Supreme Court (SC) ca se in defence of its stand. TRAI explained that the SC judgement sought to preve nt the monopolies in the broadcasting arena under the garb of the right to free speech. TRAI is of the opinion that it has built in enough safeguards to prevent monopolisation. The government was of the viewpoint that the networking permitt ed by TRAI in its recommendations was unfettered and would lead to minimisation of local content and emergence of virtual national networks. TRAI mentioned that networking is permitted in a restricted manner. Competition and monopoly restri ctions would also limit the extent of networking. 101 A CII - KPMG Report

Creation of value packs Most of the programming currently being aired, whether m usic or not, has little or no library value. Very little programming is develope d to create any strategic intellectual property. Creating specific IP whether in the form of RJs, programme formats or around content areas could have the dual advantage of being re-usable in the future and being syndicated across other cha nnels. Interactivity is a major content driver within the radio programming stra tegy. However, if the topics discussed are not affected by the 'recency' factor, there is enough potential to create a library of recordings that can be used be yond a single show. Such content, when re-broadcast, saves the cost of producing new content and generates newer revenues by offering brand association with suc h a property at reasonably low rates. Besides, such content can be exported for broadcast in other countries where the demand for Indian content is considerable . Creation of a good software library can become a source of competitive advanta ge for a radio player. Niche programming Internationally, content specialisation has been a distinct trend in the evolution of radio, especially FM radio. Radio stations have traditionally grown by attracting specialised audiences. These st ations address specific audiences based on geographic, socio-economic or ethnic or combination of factors, like a radio station that caters to the African-Ameri can population of New York or a Malayalam channel with Indian content for expatr iate Indians in the Middle-East. Being localised, these channels also meet the d emands of local advertisers. Initially, most radio stations in India started off with a defined niche as well. Between them, they provided the listener with a c hoice of English, Hindi and mixed content. However, the pressure to sell airtime forced them to resort to the lowest common denominator - Hindi film music. Very few have held on to the English format or even non-film content. Channels that started out with English programming as a key differentiator have drastically re duced the total airtime dedicated to it. Since there is very little to different iate between the various channels, the resultant effect is constant channel swap ping by listeners. Radio stations have not been able to generate any significant channel loyalty. In fact, a closer look reveals that even programme loyalty doe s not exist, with listeners simply switching from song to song. This me-too appr oach towards content has a direct implication on the marketing of the radio chan nels as any message or campaign carried by it runs the risk of being lost in the clutter. Hence, there is an urgent need to evolve programming towards different iated content. It may also require a shift from mass marketing of the radio chan nels to marketing programmes targeted at specific market Radio stations need to start establishing their own identity through differentia ted content 102 Fo c u s 2 010 : D r e a m s t o r e a l i t y

segments. Validation of niche audiences would enable differentiated client targe ting with unique value propositions. With limited sponsored market research done in this area, radio stations find it difficult to market their USP However, the se radio stations need not look beyond . their walls to get valuable listener da ta. The innumerable contests and interactive sessions on air bring in close to 3 0,000 callers every day for a single channel in a city like Mumbai - a valuable database that is currently under leveraged. Radio stations will need to start fi nding their own niche. Channels that address specialist listener groups need to emerge. Correction in the cost structures Most radio stations in the country are offshoots of larger, vertically integrated media organisations. The other media units of such organisations work on a much larger scale. Being a part of such l arge media houses, radio too seems to have expense items not necessarily justifi ed by its scale of operations. Manpower The most conspicuous item on the expense list is 'salaries'. The salary structure in radio is comparable to that of othe r larger media units. This is driven by the fact that radio stations hire people from high wage industries like television, FMCG marketing or advertising. This has led to the creation of a people-cost structure that is incompatible with the current size and revenue earning capacity of the radio industry. While it is ne cessary to incur reasonable manpower costs in order to stay competitive and attr act the best talent, innovative cost management solutions such as the right mix between live and recorded music could reduce production and salary costs. Brandi ng Branding plays an important role in establishing a strong channel and program me association amongst listeners. The key word is 'association'. What the listen er associates with is the quality of content. Brands that have spent more on mar keting have a higher recall, but that does not necessarily translate into higher listenership, particularly in a market where lack of niche programming has resu lted in constant surfing for songs of choice. Some private FM stations have incu rred large costs on building merely 'Top of Mind Recall' for all listeners, irre spective of their preference or affinity to the station. But as the market matur es and niche channels develop with defined target groups and unique value propos itions, branding exercises will become more meaningful. Channel brands and progr ammes will be associated with niche content and specific listener profiles that can be sold to potential advertisers. 103 A CII - KPMG Report

There is no doubt about the effectiveness of radio when it comes to building bra nds for its clients. For example, brands like Binaca / Cibaca and Bournvita were built on radio. These programmes rode on extremely successful content formats. Branding is expensive and therefore, radio stations with limited budgets need to make a choice between channel branding and programme branding. What could work better for them would be a combination of two. Programmes that are aligned to ch annel positioning can ride on the channel branding, while other programmes shoul d develop their individual brands, without diluting the channel positioning. The multi - media story Although most radio stations in India are part of larger me dia outfits, they do not necessarily leverage their strengths across multiple me dia. Business units within media groups tend to have their own sales teams worki ng in isolation, not fully selling their integrated media story to prospective c lients. While it is necessary to maintain and operate separate profit centres, g oing forward, radio stations could look at a greater degree of integration of sa les efforts to fully exploit the multimedia strategies. This way, the media grou ps, rather than just being owners of media assets, will be able to offer an inte grated value proposition to the advertiser. Conclusion India's radio industry ha s a strong growth potential if mechanisms and policies are put in place to provi de it with appropriate support. India, with its diverse regional influences, is in a prime position to take advantage of the growth potential of this segment. W ith privatisation gathering momentum, the increased number of private radio chan nels across the country is likely to transform commercial radio from an urban ph enomenon to a national one, as has been the case with satellite television. 104 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Digital radio broadcasting Two digital radio distribution technologies have emerged recently - Internet rad io and digital radio broadcasting (DRB). Internet radio streams audio through th e Internet. DRB involves the broadcast of digitally encoded audio and data to a receiver through either terrestrial radio frequencies or through satellite trans mission. DRB offers a number of advantages over the existing analog system: Bett er quality reception compared to analog AM and FM broadcasts to fixed, portable and mobile receivers ! Ability to carry a range of additional data, usually prog ramme associated data, including graphics and text, such as station name, song t itle, artist's name and record label, news, weather, time, traffic and promotion al information ! Dynamic reconfiguration enabling services to easily change from , say, a high quality music programme in one time slot to two talk programmes of lesser technical quality in another ! Internet radio and DRB have different modes of transmission, one via cables and the other terrestrial transmitters and satellite; however, they share some simil ar digital concerns. DRB technology comes at a cost - consumers need new recepti on equipment and broadcasters require new infrastructure. As with the conversion to digital television, the speed with which audiences adopt new technology will depend on the cost of the new equipment. Different technologies are being devel oped to deliver DRB services. Those expected to achieve some success in the next 5-10 years include: ! Eureka 147 ! Worldspace ! The USA's IBOC systems ! The US A's S-Band satellite services ! Japan's ISDB system ! Digital AM, both medium an d shortwave ! Various cable and satellite technologies (to fixed receivers). A c onsortium of broadcasters in Europe developed the Eureka 147 system. The system converts an audio signal to a digital signal, which is then compressed. A multip lex can bring together several audio channels and encode them into a single data stream. Data and other services can then be added to form an ensemble. Digital receivers separate and decode the ensemble for the listener. Each multiplex is a ble to carry five 'compact disc quality' programmes: around six 'FM quality' ser vices; around 12 'AM quality' services; almost 30 voice channels; or any combina tion of these. The signal can be dynamically reconfigured so that a 105 A CII - KPMG Report

high quality service can be readily switched to a number of lesser quality servi ces or vice versa. To date, UK has the most advanced use of DRB technology. DRB has commenced there using Eureka 147 A legislative framework is in place, in whi ch . broadcasters and multiplex managers are licensed separately. The government has allocated the spectrum to allow seven digital 'ensembles'. The BBC National Radio and Independent National Radio were each allocated an 'ensemble'. The rem aining five 'ensembles' will carry BBC along with independent local and regional radio. The BBC launched its national service in 1995. The first commercial digi tal radio network was launched in November 1999. Over the past few years, Intern et radio has been making inroads into the Indian broadcast scenario. It can easi ly incorporate text, images, even video clips into the broadcast, which makes it attractive for certain sectors like training, etc. However, while conventional radio is heavily regulated, there is no regulation at all for the Internet versi on. Like the cable television industry, this lack of regulation can prove to be a double edged sword. On one hand, it makes the process of starting a radio stat ion easier, thus driving growth. On the other hand, it raises a number of issues such as content regulation and copyright violations, format rights, revenue mod els, etc. Currently, internet radio stations such as www.indiafm.com and AIR's o wn www.allindiaradio.com are available to Indian audiences at no cost. 106 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Bridging the gap What will it take?

Bridging the gap What will it take? The Indian entertainment industry maintained very healthy growth rates through t he nineties as it exploited a favourable economic environment and lack of regula tory controls. This, however,created a very skewed industry structure, character ised by opaqueness and rampant loss of revenues to rightful recipients. Today, i n television, India is believed to have the worst skew in the distribution of su bscription revenue between broadcasters and distributors. The film and music sec tors suffer revenue losses of over INR 20 billion due to piracy. A closer analys is of the film industry shows that the extent of value destruction in mid-budget films (INR 20-100 million) could be as high as 80-90 percent; in many cases, du e to a pronounced lack of process orientation and discipline. Such industry real ities, resulting from structural anomalies and regressive practices, could hampe r any intervention to make a positive change. Linear growth projections often ig nore the underlying potential and carry the danger of being based on a limited u nderstanding of the potential of the sector. Consider this: ! India's annual per capita adult spend on films is less than two rupees. At a projected Compounded Annual Growth Rate (CAGR) of 20 percent this could at best grow to three rupees in the next five years. This, however, does not represent the true potential of the film industry in this country of one billion people, for many of whom cinema tic entertainment is the only or primary leisure activity. ! With 200 channels a nd 48 million cable homes, India is the third-largest cable economy in the world after US and China. But India also has the second lowest (after China's) per ca pita cable spend at INR150 per home per month. The hourly price realisation from a family of five with an average television viewing of one hour per day per per son, is just one rupee. Read with the fact that cable is still not reaching even one fourth of India's 200 million households, it is clear that the CAGR of 20 p ercent grossly understates the real potential of television. What is required to day is an urgent commitment to undertake fundamental transformational change inc luding strategic and structural corrections, adoption of new technologies, impro ved consumer connect and organisational effectiveness in order to ensure realisa tion of the sector's true potential. The evolutionary process followed by differ ent segments of the industry defines the need, nature and rationale for such cha nges. The older and relatively conservative segments of the industry, such as fi lm production and distribution, have evolved slowly through reluctant experiment s in corporatisation, while relatively new and dynamic sectors like television h ave experienced accelerated growth and investor confidence. Consequently, the ty pe and scale of the issues faced differ within industry segments. The nature of interventions required range from corrective Required today is an urgent commitment to undertake fundamental transformational change including strategic and structural corrections 107 A CII - KPMG Report

measures to facilitative regulation and institutionalisation. Such interventions differ from each other on the scale of the initiative, degree of difficulty, re lative importance, complexity and level of risk. Following chart depicts the ext ent of maturity exhibited by various subsectors of Indian entertainment industry . Sub-sector Maturity Factor Television Film Music Radio Industry history Regulatory maturity Adoption of technology Extent of competition in content Extent of competition in distribution Maturity of internal processes Ability to attract & retain talent Ability to attract investments Extent of piracy Other revenue leakages Demand growth projections Note: The extent of shadow in the circle indicates the degree of maturity for ea ch of the subsectors. 108 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Based on a comprehensive understanding of the industry, the interplay between it s drivers and our interactions with various stakeholders, the following initiati ves are recommended to be undertaken by industry and the regulatory authorities. A stakeholder charter for concerted action will trigger thinking and meaningful interaction in this sector, which would lead to clarity of direction and urgenc y of action. The KPMG-CII 10/10 Charter Industry initiatives 1 Improve organisational effectiveness through focussed pro jects Improve yield Develop alternative revenue streams Improve consumer connect Develop new markets through aggressive market making Increase market activity i n newer genres Improve governance standards Improve organisational ability to at tract and retain talent Explore consolidation options Leverage technology strate gically Regulatory initiatives Implement addressability for broadcasting distrib ution in a phased manner Review programming code and censorship laws Define serv ice obligations and grievance redressal mechanisms Rationalise last mile licensi ng Evolve a framework for regulating cross media / value chain holdings Allow th e freedom to choose the business model Constitute a national anti-piracy force P rovide investment and operational incentives Constitute a unified regulator Deve lop national media and entertainment policy 2 3 4 5 6 7 8 9 10 109 A CII - KPMG Report

Getting the house in order – The industry charter The Indian entertainment industry has the opportunity to enter an exciting phase of growth driven by favourable socio-economic changes and smarter distribution technologies. The realisation of such opportunities would depend on the aggressi veness of the industry players and the pragmatism of policy makers and regulator s. To unlock value, the Indian entertainment industry would need to: ! develop m arketable products keeping in mind the socio-economic realities of the Indian ma rket ! improve operational effectiveness through global benchmarking, adoption o f best practices, technology and strategic innovation ! leverage the capabilitie s thus developed in international markets This requires a fundamental mindset sh ift from complacency which breeds inefficiencies, to an insatiable quest for exc ellence. This section, focusses on the specific steps that the industry needs to undertake for such a transition to take place. Such initiatives need to address : ! structural issues that have contributed to destroying value and inhibiting g rowth; and ! strategy and operational issues across the value chain. Markets An analysis of industry structure and value chain reveals a need for corrective mea sures for ensuring profitable growth across market segments.Regulatory changes c an enable and facilitate the introduction of new distribution platforms, thereby bringing in much-needed competition and consumer choice. However, to leverage a n enhanced market opportunity, the industry needs to manage costs better, reduce revenue leakages, improve operational effectiveness and develop and leverage de eper consumer insights. In the past an environment of 'convenience alliances' cr eated skewed market structures without effective competition which bred ineffici encies. This resulted in an inability to meet performance expectations and an in dustry that is characterised by: ! most segments being resource starved, consist ing of smaller entities with limited potential to scale. Television is probably the only segment, which has adequately funded scalable players. ! Lack of manage ment depth, especially in the film industry, has been the outcome of a lack of p rocess rigour and measurement, the reluctance to invest in systems and procedure s and in technology adoption. ! Inadequate organisational capabilities and lack of governance transparency impair the industry's ability to attract resources li ke investments and talent at reasonable costs. That, in many ways, also defines the fundamental premise of corporatisation in the entertainment industry. Industry requires a fundamental mindset shift from complacency to an insatiable quest for excellence 110 Fo c u s 2 010 : D r e a m s t o r e a l i t y

In order to effectively manage the 'growing up' process, the industry needs to q uestion and review its current structure and several aspects of the operating st rategy. The schematic below segments the industry based on its level of maturity with respect to governance standards and process orientation. Low High High DTH Operators Alternative Platform Vendors ‘Maturing segments' consists of segments with reasonable process orientation and g overnance standards, comprising largely corporatised entities. Due to the compar atively recent evolution of sectors like broadcasting, digital distribution, FM radio, and the licensing and investment requirements, organised players had an o pportunity to enter these spaces on equitable terms. This facilitated a certain level of organisational maturity in these sectors. However, an assessment of con stituent players of these segments point to large spaces which are yet to evolve . As the extent and intensity of competition increases with more resourceful pla yers entering the market, players in the maturing segments should move swiftly t o plug such gaps and ensure profitable survival. 'Aspirants' comprise players wh o recognise the importance of effective corporatisation but, either due to lack of adequate expansion capital or an “if-itain't-broke,-we-won't-fix-it” attitude, ha ve been able to achieve very little in that direction. Multi-system operators, o rganised content producers, music publishers, etc fall in this category. nCorporate Governance Theatre owners Unorganized Content producers nMature segments MSOs Radio Stations Broadcasters Movie Distributors Corporatised Content producers Low Music retailers LCOs Music distributors nOperational effectiveness nAspirants n nLaggards 111 A CII - KPMG Report

With the entry of organised, resourceful players the incumbents need to understa nd their strategic vulnerability and take immediate corrective measures Most players in these sub-segments either started as offshoots of corporate enti ties or took steps to transform themselves to corporatised entities, when such p ositioning became 'fashionable' in the last few years. However, in most cases th e initiative was confined to incorporating companies, constituting boards, creat ing formal structures and inducting professionals in a very limited manner. A po wer shift to professional, process driven organisations is yet to be seen. The t hird segment, 'Laggards', consists of players yet to wake up to the demands of t he emerging business environment. These elements of the value chain made a signi ficant contribution towards accelerating the growth of entertainment industry. F or instance, the Local Cable Operators (LCOs) demonstrated an enterprising appro ach that contributed to the aggressive growth of cable television in India. Most other sub-segments of this cluster like theatre owners, music distributors, etc ., also made similar contributions to the overall industry growth. For the overa ll sustainability of a profitable growth of the sector, the opaque practices, ra mpant piracy and inherent inefficiencies in these subsegments are issues that ne ed to be addressed immediately. This should be seen in the context of the changi ng competitive environment. With the entry of organised, resourceful players wit h alternative technologies offering attractive value propositions, the constitue nt players need to understand their strategic vulnerability and take immediate c orrective measures. While these clusters throw up some unique, sector specific i ssues depending on the nature and extent of evolution, most industry issues cut across such clusters. These issues fall under the following four categories: ! S tructural issues, including issues relating to distribution of value amongst val ue chain participants, extent of competition and level playing field. ! Revenue related issues emanate from the industry's inability to achieve and sustain grow th rates commensurate with the industry potential. ! Profitability related issue s resulting from a combination of the first two issues along with an inability t o manage costs. ! Resource related issues with regards to the industry's difficu lties in attracting resources like investment, talent, etc. Any corrective actio n should therefore focus on correcting structural anomalies and improving sector performance. Even though structural corrections need to be addressed largely th rough regulatory interventions, there are several aspects which lend itself to a n industry led correction. The analysis of such aspects highlighted seventeen ke y issues that demand urgent steps from Indian entertainment industry. 112 Fo c u s 2 010 : D r e a m s t o r e a l i t y

These initiatives have been prioritised in the table below to identify high-impa ct initiatives using a weighted average with the 'Ability to drive value' as the most influential factor. Weightages Ranking 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Possible industry initiatives Improve operational effectiveness Improve yield Develop alternative revenue stre ams Develop consumer connect Aggressive market making Enhanced activity in newer genres Improve governance standards Create an environment to attract and retain talent Industry consolidation Adoption of technology Support the evolution of a meaningful regulatory regime Improve process orientation Improve quality of con tent Financial innovation Remove value chain frictions Performance measurement A ggressive benchmarking 50% 30% 20% Weighted score 4.3 4 3.9 3.5 3.3 3.3 3.25 3.25 3.15 3 3 2.8 2.8 2.7 2.4 2.3 2.2 Ability to Ease of Drive implement Extent of inaction value ation 5 5 5 4 4 4 2. 5 2.5 3.5 3 3 3 3 3 2 1 1 4 3 2 3 3 3 4 4 2 3 3 3 3 2 2 4 3 3 3 4 3 2 2 4 4 4 3 3 2 2 3 4 3 4 From the above, the top ten initiatives were selected for closer scrutiny with a view to focus the spotlight on select high value opportunities the industry can pursue for each one of them. 1. Improve operational effectiveness Margin pressu res will induce the entertainment sector to focus their attention on costs. To a chieve sustainable efficiencies, the priority should be on enhancing organisatio nal effectiveness in delivering strategy and addressing the following key aspect s of effectiveness: ! Organisation structure and its alignment to operational st rategy ! Streamlined processes, including measurement mechanisms ! Inculcating g lobal entertainment industry best practices to enhance the process delivery qual ity ! Consistent global benchmarking to facilitate continuous improvement ! Stra tegic use of technology. The entertainment businesses need to assimilate experiences of pathfinders in ot her sectors 113 A CII - KPMG Report

The entertainment businesses need to assimilate experiences of pathfinders in ot her sectors. A holistic approach towards operational effectiveness, along with t he adoption of best practices and learning from other regions and industries wil l not only facilitate the desired performance turnaround but also ensure sustain ability of benefits. Recommended steps (A) Develop organisational understanding on the need for effectiveness improvement (B) Conduct a diagnostic to identify i mprovement opportunities (C) Form dedicated teams for the identified projects (D ) Measure the improvement 2. Improve yield The compulsions outlined in the earli er section will drive entertainment businesses to endeavour to maximise revenue yield from their products. Such an initiative could have the following dimension s: ! Maximising revenue from traditional revenue sources. For example the tradit ional revenue streams from television include airtime sales and subscription rev enues ! Ensuring yield from the traditional revenue sources involves the followi ng: Effective marketing to communicate the proposition of the product to generat e awareness and trial Efficient distribution to ensure availability of the produ ct to an interested consumer Ensuring utilisation at optimum price levels ! Deve loping and encashing alternative revenue streams like merchandising, events, sup plementary content, export, etc While all the three are important to all genres of entertainment, some considerations are more important in the context of certa in genres. For example the first two considerations are very important for the f ilm industry which is trying to maximise the opening weekend yield. The last is particularly pertinent in the context of airtime sales in television, considerin g the perishable nature of airtime. Indian entertainment businesses must focus o n developing systemic maturity and process orientation required to ensure yield maximisation. The absence of a facilitating environment that provides reliable d ata and other services required for yield management initiatives underlines the need to put in place the required internal processes and systems for enhanced da ta quality. The relevant internal processes cover the following functions: ! Mar ket research and demographic profiling to understand consumer expectations and c onsumption patterns ! Marketing communication planning in terms of content, chan nels, etc and campaign execution 114 Fo c u s 2 010 : D r e a m s t o r e a l i t y

A disciplined process supported by adequate systems, and prior planning will hel p improve yield and minimise risks ! ! ! ! ! Distribution planning for cost effective coverage and yield maximisation Airtime inventory management and dynamic pricing Tiering and pricing of programmes Stra tegic product innovation Monitoring sales and taking corrective measures, etc Often decisions on the revenue side across genres are taken on an intuitive unde rstanding of the market and depend on the judgement of a few key individuals. A disciplined process supported by adequate systems, and prior planning will help improve yield and minimise risks. Global organisations follow mature processes i n managing yield and use systems evolved in other industries with similarly peri shable products like airline seats, hotel rooms, etc. The Indian entertainment b usiness should inculcate global best practices, not just from the entertainment space but also from similar industries. For such initiatives to be impactful, in dustry-wide efforts to develop a mature infrastructure for reliable data gatheri ng from the last mile points need to be coordinated. The Industry needs to put i n place the following systems to be able to improve the quality of data: ! A dat a gathering and warehousing system to collate and analyse theatrical revenues of films. Such a system can be front ended by remote ticketing to enhance the reli ability of data. ! Cable television subscriber information system centrally admi nistered and funded by the industry. A subscriber card issued by the system shou ld be made mandatory for all cable subscribers. A subscriber card should be prod uced for inspection by the licensing authority or by agencies authorised by indu stry bodies. A consensus on such a process for the subscriber validation can sig nificantly reduce the extent of revenue leakage in the system. ! The current sys tem of audience tracking, which largely determines media buying on television co uld be enhanced through broadbasing the existing sample size; enhanced automatio n of the tracking mechanism and the entry of more research agencies. Recommended steps (A) Develop and implement revenue assurance processes and syst ems (B) Improved process orientation in other customer facing functions (C) Put in place shared systems to collect and analsze last mile consumption information 3. Develop alternative revenue streams Global experiences in developing and enca shing alternative revenue streams in sectors like films, television, etc provide compelling evidence for the commercial attractiveness of such products. 115 A CII - KPMG Report

Some examples are: Taking the products to newer geographic territories; crossove r of Tamil films to the Japanese market illustrates such territorial extensions ! Product innovation, such as un-film advertising and strategic use of brands in side mainstream content, resulting in improved revenue opportunities. ! Developm ent of new products leveraging key assets of the core product category. Merchand ise options or supplementary programming like the 'The making of Lagaan' are exa mples of developing new categories. ! In order to develop alternative streams of revenues, the industry needs to have a vision for an enlarged revenue model. Alternative revenue opportunities should be identified at the product planning stage itself. Planning for alternative re venues should be undertaken with a view to establishing definitive targets and a ssigning clear organisational ownership for achieving revenue objectives. Altern ative streams will become significant revenue contributors as the entertainment industry stabilises and entertainment consumption becomes more sophisticated. Recommended steps (A) Identify possible alternative revenue streams for each pro duct category (B) Target for 10-20 percent revenues from such sources (C) Create dedicated teams focused on alternative revenue stream 4. Develop consumer conne ct The entertainment industry value chain across genres needs to connect more cl osely to the voice of the consumer, employ the feedback to enhance consumer expe rience and thereby enhance value. For this, the content producers / content owne rs need to establish formal channels for consumer connect. While the need for cr eative space is well appreciated, creative professionals and content producers n eed to work together to also balance consumer needs and commercial realities whe n developing products. The high uncertainties and failure rates of individual en tertainment products like films, television serials, etc highlights the viabilit y issue of a majority of the ideas getting funded. The industry needs to take no te of the gap in systemic research and feedback in the new product development p rocess. Some initiatives that can be undertaken to increase the viability of pro ducts at the conception stage include: ! Market research to develop consumer ins ight for new product development, evaluate acceptability of product ideas and pl an distribution ! Customer segmentation and profiling of target segments ! Devel oping points for brand experience and consumer dialogue ! Continuous consumer in teraction and customer satisfaction surveys to gather feedback on consumption ex perience The industry needs to take note of the gap in systemic research and feedback in the new product development process 116 Fo c u s 2 010 : D r e a m s t o r e a l i t y

! ! ! Formalised mechanisms to inculcate such feedback into organisational processes a nd future projects Employee training to develop consumer orientation, especially in last mile distribution Consumer support and complaint management processes i n last mile distribution The transition to a consumer focussed business has to be well thought through as it involves fundamental shifts in business models and operational strategy. Recommended steps (A) Redesign the customer facing processes to enhance the qual ity of experience (B) Ensure consumer feedback flow through to product design, m arketing and distribution (C) Establish consumer satisfaction measurement and li nkages of such measures with remuneration Increasing intensity of market activity in the last mile distribution will spur demand for quality content, triggering action across the value chain 5. Aggressive market making The entertainment industry will see increased market activity across genres and across the entire value chain. A combination of new technologies, regulatory changes and a growing awareness of a professional busin ess and market oriented approach can make the difference. Consider the following developments: ! Three Direct To Home (DTH) players are expected to be fully ope rational by end-2005, providing the much needed consumer choice in broadcasting last mile ! Telecommunication majors are introducing broadcast distributions ser vices. An IP-TV based service is currently undergoing advanced trials and is exp ected to enter the market in the near future ! Several MSOs may consider investi ng in CAS enabling equipment and digitising the last mile, even without a regula tory directive, to effectively compete with DTH/ IP-TV players ! Digital distrib ution of films is finally off the ground in 2004. Though the initial experiments lack scale, the emergence of multiple scale players in digital film distributio n is expected in the next couple of years. DTH players and IP-TV players may als o extend their services to cover digital cinema ! Large corporate houses are dem onstrating serious interest in the entertainment industry either by setting up o wn experimental outfits or through investments ! Indian Music Industry (IMI) is exploring options to partner to digitise and electronically distribute music acr oss India 117 A CII - KPMG Report

Increasing intensity of market activity in the last mile distribution will spur demand for quality content, triggering action across the value chain. However, t his assumption is premised on middle class India's enormous appetite for enterta inment. We believe that such demand is a function of the following: ! Quality an d diversity of content ! Compelling value proposition in terms of quality of ser vice, pricing, etc ! Low initial investments While the market developments menti oned above are capable of bringing about a quality shift in entertainment delive ry, businesses need to develop models with: ! Focus on content quality ! Attract ive price propositions, often based on subsidising the consumer acquisition cost s or consumer premises equipment costs ! Imaginative re-engineering of the cost structure through redistribution of risks and rewards ! Aggressive marketing, br anding and distribution to ensure market visibility and coverage As these initia tives require significant investments and increase the risk profile, entertainme nt businesses that are adopting an approach to enlarge the market, need to asses s the viability of such a plan through a careful examination of market potential , competition, costs, potential risks and mitigants. Such an assessment should a lso take into consideration the learning from other developed markets, as they o ffer key signposts on the road ahead. Companies need to constantly define new/ changing genres based on the demographi c profile of the market Recommended steps (A) Rethink growth targets in the light of emerging distributi on scenario (B) Develop 'low entry barrier, low cost' business models (C) Establ ish the viability of such models through quantitative business cases 6. Enhanced activity in newer genres Media and entertainment content, like any o ther product, needs constant evolution to meet changing consumer needs. Media co mpanies need to blend artist creativity with consumer tastes and preferences. In this pursuit they need to constantly define new/ changing genres based on the d emographic profile of the market and a surveyed understanding of consumer likes. Creativity needs to be channelised in the right direction so that its commercia l attractiveness can be exploited. To its credit, the Indian music industry has constantly looked at new genres to keep it afloat. Indi-pop, Sufi, fusion, re-mi x, folk, etc. are all successful genre 118 Fo c u s 2 010 : D r e a m s t o r e a l i t y

creations in the popular Indian music space over the last ten years. The music i ndustry's foray into devotional music partly revolutionised its fortunes. In a s imilar manner, television saw an era being dominated by Mahabharat and Ramayan, where the protagonists achieved 'a demi-God 'status in India. Religious programm ing continues to have its share of success in the television space, through inde pendent channels on Christianity, Hindu mythology and devotional music - 'bhajja ns'. This genre is relatively unexploited in films. The “tried and tested formula” i n Indian film making is being challenged. The industry has witnessed how new gen re creations have set new trends and reaped rich rewards. However, any new genre success 'formula' is quickly replicated and often the weak treatment of the 'me -too' results in failures. In the television space, potentially lucrative genres such as lifestyle, education and health are still under-leveraged. An assessmen t of the Indian demographic profile, as well as increased programming on these g enres on mass entertainment, and even news channels, indicates a potential to ex ploit each of these genres separately, and targeted marketing to advertisers cou ld result in unlocking this potential to some extent. Themes need to be consumer centric and contemporary. Entry into new genres may include rekindling genres o f the past, if that is what the consumer demands. Success hinges on a good under standing of consumer behaviour, likes and dislikes, sampling of content, creativ e programming, effective marketing and distribution. Recommended steps (A) Explore and innovate - develop new genres (B) Consumer res earch to be undertaken continuously to be in sync with changing consumer prefere nces (C) Redirect creative resources towards genres in line with consumer intere sts The investor community tends to display limited conviction towards the entertain ment industry, citing issues of corporate governance 7. Improve governance standards The investor community tends to display limited conviction towards the entertainment industry, citing issues such as: family run enterprises, lack of transparency, lack of professional management, inadequate financial discipline and reporting. As large industrial houses, financial instit utions and private savings evince interest in this sector, the industry players need to institutionalise processes that will lay the foundation for good corpora te governance. 119 A CII - KPMG Report

Typically, an effective corporate governance framework is based on the following principles [drawn from the OECD (Organisation for Economic Co-operation and Dev elopment) Principles of Corporate Governance]: ! It should promote a transparent and efficient market and be consistent with the law. It should protect and faci litate the exercise of shareholders' rights and ensure the equitable treatment o f all shareholders, including minority shareholders. ! It should recognise the r ights of stakeholders established by law or through mutual agreements and encour age active co-operation between corporations and stakeholders in creation of wea lth and the sustainability of financially sound enterprises. ! It should ensure that timely and accurate disclosure is made on all material matters regarding th e corporation, including the financial situation, performance, ownership, and go vernance of the company. ! It should ensure the availability of appropriate stra tegic guidance to the management of the company; effective monitoring of the man agement by the board and the board's accountability to the company and its share holders. While the responsibility to actualise corporate governance rests with i ndividual organisations, industry associations can play a crucial role in develo ping corporate governance standards that should reflect both the maturity of the industry as well as the practical constraints faced by participants. Recommended steps (A) Industry association to create a corporate governance cell (B) Cell to set up processes in line with corporate governance principles (C) C ell to define reporting requirements (D) Cell to set up an audit committee to au dit governance procedures among members 8. Create an environment to attract and retain talent The attractiveness of the entertainment industry as a professional option needs to be re-established in a challenging talent market (both on the creative and the business management side ) against stiff competition from sunrise sectors such as BPO, software, aviation , etc. If the industry seeks to continue attracting talent against stiff competition, i t would need to undertake a number of measures With the intensity of market activity and the extent of competition rising, the need for attracting and retaining top talent assumes greater significance. If th e industry seeks to continue attracting talent, it would need to undertake a num ber of measures that are infrastructure building in nature and also lead to a ch ange in mind-set. 120 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Some of these include: Developing an educational infrastructure catering to the sector by creating world-class institutes in India, on the lines of the IITs and IIMs for attracting young talent, providing training in both the creative and b usiness aspects of the entertainment business private-public partnership models should be encouraged to develop the required infrastructure ! Improving the attr activeness of the sector by benchmarking itself with competing sunrise sectors i n terms of remuneration and career growth to make the sector attractive for pros pective employees establishing an exciting and professional working environment by instituting appropriate systems, process and organisational practices establi shing a quantitative performance management system which sets measurable perform ance targets, measures and rewards performance in a fair manner establishing mer itocracies founded on sound principles of organisation building ! Establishing a brand in the talent market by articulating its value proposition to professiona ls in terms of growth potential, development, compensation and lifestyle adoptin g consistent communication of its value proposition at the talent market this wo uld need to be actioned through media campaigns and presence at college campuses as well as career fairs ! Recommended steps (A) Benchmark compensation, employee policies and working envi ronment and take measures to plug the gaps (B) Implement quantitative performanc e management systems (C) Aggressive branding in the talent market 9. Industry consolidation The Indian entertainment industry is fragmented. There is a vast disparity between a few large players and multiple small players, all of whom are competing for a finite market with a finite set of resources. Certa in elements like the last mile distribution, content production, etc are far mor e fragmented than other parts of the value chain. For example, there are a large number of small independent film producers, who typically operate in the mid-bu dget range of INR 20-100 million. An analysis of the profitability of such proje cts reveals that this segment of the industry has been the least attractive. Whi le the contribution of this segment to the industry in 121 A CII - KPMG Report

The inability of fragmented players to be more efficient is a consequence of the greater cost of resources that they bear due to their inefficient scale of oper ations terms of investments and the platform it provides for talent development are not to be underestimated, there does exist a case for a more efficient utilisation of resources that will not only add greater value to the industry but will also raise the profitability of these small players. The large production houses can realise efficiencies at three different levels: Financial - Having larger budget s and established names, the level of risk that financial investors perceive is far lesser, resulting in lower interest costs ! Risk management - With multiple projects, the production house can spread its risk across projects of varied the mes and financial sizes. This enables the management of risk at a portfolio leve l ! Utilisation of resources - Apart from financial resources, these production houses have shared resources in terms of infrastructure that can be more effecti vely utilised across various productions to bring down the project costs. Additi onally, the availability of multiple projects makes possible the setting up of a repository of talent to be recruited and effectively employed within the produc tion house ! Inefficiencies across genres and across the value chain result in the following detrimental effects: ! Lower profitability of small players Independent players with inefficient mechanisms and low resources suffer from an inability to realis e profits. ! Reduced attractiveness of the industry Lower profitability and loss es reduce the attractiveness of the industry, because of the increased level of risk and lower return on investment The repercussions of this are felt when play ers need to attract investment, evident from the unwillingness of investors or h igh rates of interest demanded for the perceived level of risk ! Quality of serv ices Lack of resources (a key issue faced by small players) means that the quali ty of services to the end consumer could be affected The inability of small loca l / independent cable operators to upgrade their service offering by investing i n better infrastructure illustrates the point The inability of fragmented player s to be more efficient is a consequence of the greater cost of resources that th ey bear due to their inefficient scale of operations. Therefore industry partici pants need to explore consolidation options to build up scale efficiencies. Reco mmended steps (A) Review the long term growth strategy to evaluate the desirabil ity and practicality of inorganic growth (B) Explore inorganic growth opportunit ies. 122 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Lack of sophistication is not just a limiting constraint to organisational effec tiveness, but also a significant risk from a business continuity perspective 10. Strategic adoption of technology Technology can play the dual role of a dema nd driver and process enabler. Technology adoption in last mile distribution has the potential to revolutionise the entertainment sector in the country. The ini tial adoption is expected to see the launch of DTH/ IP-TV/ DSL services, digital cinema, digital radio, etc. This will set the stage for an exciting phase of te chnology led growth. The ability of operators to leverage exciting new technolog ies like Interactive Television, broadcasting to mobile devices, etc will drive growth as the digital entertainment matures into digital commerce. In addition, such strategic technology adoption will also emanate from the need to improve pr ocess efficiencies dramatically. The entertainment sector remains relatively les ser technology-enabled with respect to process delivery. It is interesting to no te that sophisticated operators with technologically well developed core process es in production, broadcasting, etc continue to have business functions using le gacy spreadsheets and primitive applications. The entertainment industry should learn from the large strides made by traditional sectors like manufacturing in t echnology adoption in the last decade and the consequent gains in productivity a nd competitiveness. Such lack of sophistication is not just a limiting constrain t to organisational effectiveness, but also a significant risk from a business c ontinuity perspective. Entertainment businesses should take immediate steps to a ddress both these dimensions, vis-à-vis the strategic use of technology as a compe titive tool and as a process enabler and aim to evolve a medium-to-long term str ategy to leverage technology. Recommended steps (A) Identify opportunities for strategic use of technology (B) Develop a long term blue print for technology adoption with quantitative busine ss justifications (C) Increase the technology spend 123 A CII - KPMG Report

Stakeholder charter It is hoped that the industry should undertake the following initiatives to participate in the industry's next phase of growth and set a pro gressive long-term direction. Degree of impact on # Action points Industry Consumer Resistance to change Complexity of implementation 1 Improve organisational effectiveness through focused projects Improve yield Deve lop alternative revenue streams Improve consumer connect Develop new markets thr ough aggressive market making Increase market activity in newer genres Improve g overnance standards Improve organisational ability to attract and retain talent Explore consolidation options Leverage technology strategically High Medium Medium Medium 2 High High Medium Medium Low Low High Medium 3 4 High High High High 5 High High Medium Medium 6

High High Low Medium 7 High Medium High High 8 High Medium High High 9 High High High High 10 High High Medium Medium 124 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Getting the house in order – The regulatory charter The objective of regulation Most modern economies use selective multi-dimensiona l regulatory / policy interventions to ensure growth and consumer choice. While the nature and extent of such interventions typically depend on the industry con text involving specific issues to be addressed, there are several common objecti ves which define such initiatives. Each of these objectives acquires a different level of importance depending on where the industry lies on its evolutionary cu rve and the prevalent market dynamics. Some of the primary objectives that regul atory interventions seek to achieve include: ! Protecting stakeholder interests with consumer interests being the priority ! Ensuring adequacy of competition ! Ensuring sustainable industry growth ! Facilitating the adoption of new technolo gies ! Protecting investments ! Ensuring business viability ! Protecting intelle ctual property rights ! Regulatory oversight A large part of the growth of India n entertainment industry has taken place in a regulatory vacuum. This has given rise to distorted structures to develop and protect monopolistic positions and o paque distribution chains facilitating revenue leakages. At the same time, as me ntioned earlier the industry is at the threshold of a potentially steep growth c urve if the stakeholder groups meet expectations. Given this context, the govern ment and industry regulators must lay out a clear agenda and set off initiatives to bring about the desired transformation. The desired initiatives are analysed below from the perspective of the three key objectives of government / regulato ry intervention, viz: ! Protecting stakeholder interests ! Ensuring adequacy of competition ! Fostering growth Protecting stakeholder interests The stakeholder universe of the entertainment industry includes the following groups: ! Industry players Content producers / owners Distributors Last mile access providers ! Co nsumers ! Government The government and regulators must lay out a clear agenda and set of initiatives to bring about the desired transformation 125 A CII - KPMG Report

Industry players Regulatory direction to ensure stakeholder interests should ori ginate from an analysis of the extent and adequacy of competition in the enterta inment value chain. A high level scan of the value chain reveals three clusters with varying levels of competition and opaqueness. This necessitates the need fo r differentiated treatment at the regulatory level. These three clusters of indu stry participants are: ! Mature segment ! Laggards ! Growth engines Alternative Platform Vendors Radio Stations DTH Operators Broadcasters Radio Carriers The sections below discuss the constituents of each cluster and their regulatory needs. Mature segments This segment consists of players operating in a highly c ompetitive market with a reasonable level of transparency. Television broadcaste rs and corporatised content producers can be considered mature as compared to ot her segments. As in the case of broadcasters, most genres offer the choice of mo re than three players. Popular genres like general entertainment, sports, news, etc offer much more choice today. This cluster, with higher overall levels of co rporate ownership, operates under a relatively more transparent environment. The free play of market forces that has fostered competition and value creation in this cluster, should not be tampered with. nExtent of transparency nExtent of transparency LCOs nMature segments Corporatised Content producers Movie Distributors MSOs Music distributors Theatre owners Music retailers Unorganized Content producers nIntensity of competition nLaggards nGrowth engines 126 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Illustrative list General Entertainment News English Entertainment Sports Music Infotainment Kids Films Star Plus, Sony, SET MAX, Zee, Sahara One, SAB, DD CNN, BBC, NDTV India, N DTV 24X7 NDTV Profit, CNBC, Zee News, Star News, , Headlines Today, Aaj Tak, Sah ara Samay, DD News etc Star World, Zee English, AXN, Adventure, FTV, Trendz etc. ESPN, Star Sports, Ten Sports, DD Sports etc. V, MTV, B4U, etc National Geograp hic Channel, Discovery, The History Channel, Animal Planet etc. Hungama TV, Cart oon Network, Pogo, Nickelodeon, Animax etc. Star Movies, HBO, Hallmark, Zee Cine ma, Zee MGM, Star Gold, CVO, etc. Any intervention that ignores the evolutionary context and forces driving it is likely to fail and can also be counter-productive Laggards These are characterised by relatively lower levels of competition and t ransparency. Significant sections of the conventional last mile of the entertain ment sector fall under this category, along with the unorganised sector in conte nt production. They account for over 50 percent of the value created by the indu stry. They need to be seen in the context of a peculiar industry dynamic, which is simultaneously the cause and the effect of a unique set of evolutionary proce sses. Therefore, any intervention that ignores the evolutionary context and forc es driving it is likely to fail and can also be counter-productive. The followin g factors need to be considered before formulating regulatory position vis-à-vis l aggards. ! Socio-economic distribution of Indian consumers and affordability of entertainment products: A large majority of Indian consumers are in the low inco me brackets. As many as 75 percent of Indian cable homes have incomes lower than INR 8,000 per month. When an industry services large low-income segments of the society, it will be forced to adopt 'innovative' methods to re-engineer the cos t structure, which may not be always legitimate, equitable and fair. ! Revenue l eakages through piracy and under declaration: Such re-engineering (as mentioned above) typically takes the familiar route of piracy and under declaration. Leaka ges stretch from the under-declaration of the number of cable subscribers and th eatrical revenues to the unauthorised reproduction and distribution of copy-righ ted content. ! Unviable tax structures: Most state governments view the entertai nment sector as an easy revenue target and hence, tax it heavily. ! Existence of last mile monopolies: While adequate competition exists in several parts of the entertainment last mile, some significant segments demonstrate monopolistic beh aviour. The problem is acute in the last mile of cable services where operators have managed to develop a monopolistic environment through informal arrangements on the ground. Such arrangements impact the consumers the right to select their operators. 127 A CII - KPMG Report

! Lack of transparency: The distribution chain of the entertainment industry is ch aracterised by a lack of transparency across genres. The resulting lack of visib ility of the consumer and his consumption pattern causes inequitable distributio n of value, influences investor perceptions negatively and protects vested inter ests. Innovative, practical solutions as well as efficient implementation to resolve t hese issues are imperative today. Impractical solutions are unlikely to work, as they often do not address the complex equilibrium of cause-effect relationships effectively, triggering overall discontent. Our experience with conditional acc ess implementation or investment subsidies for films have proved that isolated e fforts will not have the appropriate impact. Growth engines These comprise emerg ing media like FM radio and alternative distribution platforms like DTH, IP-TV, digital movie distributors and exhibitors, etc. This cluster represents the futu re of Indian entertainment industry not only because of the increasing share of these media and platforms in the overall entertainment activity, but also becaus e of their ability to be a positive change agent for the entire sector. However, the operating environment is skewed against them because of the disparities in license conditions and cost structures. Governments and regulators need to recog nise the relevance and significance of alternative platforms and facilitate a co nducive environment. Having discussed the regulatory need of industry participan ts, let us look at the regulatory needs of the most important participant in the industry value chain – the consumer. Consumers Protection of consumer interests s hould be high on the agenda of the government and regulators. Consumer interests can be defined along the following lines: ! Consumer choice: Consumer's right t o choose a content-quality-price combination ! Access to customer service: Right to receive prompt and effective service and avoidance of any discrepancy betwee n original product promise and functionality delivered In most segments of the e ntertainment industry freedom of choice is either nonexistent as in the last-mil e of television cable services or limited as in the case of sectors like film/ m usic distribution etc. The scenario with respect to customer service and grievan ce redressal mechanisms is not very different. Governments, regulators and indus try players should devise specific measurable actions aimed at improving consume r choice and service levels. Impractical solutions are unlikely to work, as they often do not address the com plex equilibrium of cause-effect relationships 128 Fo c u s 2 010 : D r e a m s t o r e a l i t y

governments, regulators and industry players should devise specific measurable a ctions aimed at improving consumer choice and service levels. Government The gov ernment's engagement with the sector should be guided by its interest in expandi ng the economic activity in the entertainment sector in a sustainable manner wit h a view to: ! expand the direct and indirect tax base of the sector ! increase the employment potential of the sector ! increase the foreign exchange earnings of the sector The government should play a role in promoting art and culture in our society and should own the tools/ channels for disseminating information, pr oviding recreational content to communities not accessible in a commercially via ble manner and making social interventions to facilitate positive change, like i n the case of literacy or family planning. Government should also safeguard nati onal interests like security or national assets like spectrum. Ensuring adequacy of competition The best way to safeguard stakeholder interests is to ensure the free play of market forces in a market environment where adequate competition e xists. Such conditions minimise the need for corrective regulatory interventions . As analysed in earlier sections of the report, adequate level of competition d oes not exist in several clusters in the entertainment value chain. As a result, the corrective interventions are often far less effective and decisive than req uired. For instance, in the case of the broadcasting last mile segment where nea r monopolistic conditions exist in most parts of the country, government and reg ulatory bodies agree that the entry of alternative platform operators like DTH , IP-TV or xDSL operators will be able to increase the extent of competition sign ificantly. However there are certain aspects that need to be kept in considerati on: ! In the absence of effective regulatory provisions and enforcement measures to ensure transparency, cable operators enjoy an unreal cost structure built on the premise of cost avoidance and under-declaration. Alternative platforms oper ating in an open, addressable manner will not be able to compete effectively ! F urther, alternative platforms do not enjoy a level playing field vis-à-vis cable s ervices in the current regulatory environment: ! For example, DTH operators need to pay an INR 100 million license fee and a 10 percent revenue share on adjuste d gross revenues. Cable operators only need a registration from the local post o ffice. It is also pertinent in this context to note that cable services are an e stablished business and the infrastructure is already amortised, while for DTH, which is a new business, the 10 percent gross revenue share will push back the b reak even point by a Best way to safeguard stakeholder interests is to ensure the free play of market forces in a market environment where adequate competition exists 129 A CII - KPMG Report

! ! few years. In the initial years this share will effectively have to be paid out of capital, there being no positive cash flow or profits, and this will have a l ong term cascading effect on project costs and cash flows. The extent of Foreign Direct Investment (FDI), which could be a significant source of funding, is lim ited to 20 percent for DTH, while in cable services FDI can be up to 49 percent; DTH set-top boxes currently need to be interoperable across various DTH platfor ms, while no such restrictions are imposed on cable operators, where there exist s a virtual monopoly at the last mile. Last mile corporatised entities across the sector face similar disadvantages in cost structures because of rampant piracy. To ensure adequate competition to pro tect stakeholder interests, the government and regulators need to take forceful policy/ regulatory positions and follow it up with effective implementation. Fos tering growth It is clear that most sub-sectors in the entertainment industry ar e performing suboptimally and unable to tap the opportunity and potential availa ble. The eventual realisation of such potential is a function of focussed and co ordinated stakeholder action. The government and regulators have to make conside rable contributions to make such coordinated action happen. An analysis of sub-s ector performance clearly shows that television is the prime mover for the indus try so far. Through the nineties, the television sector has emerged as both the largest and the fastest growing cluster in the entertainment industry. Moreover, several positive steps like the introduction of alternative platforms (DTH and IP-TV) have been taken to accelerate the rate of growth. Given such a context, g overnment should consider proactive interventions for other sub-sectors like fil ms, music, radio, etc with a view to: ! facilitate an investment friendly enviro nment ! provide policy/ regulatory clarity and ! ensure a level playing field fo r competition In summary, as the industry goes through an evolutionary process t o realise its actual potential, the government and regulatory bodies should play the role of a change agent. With a view to protecting stakeholder interests, en suring adequate competition and sustainable growth, a charter for governmental/ regulatory intervention, needs to be identified. The government and regulatory bodies should play the role of a change agent 130 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Key issue Protecting stakeholder interests Consumer n Television Films Radio Music Choice of content Platform - operator quality-price combination Customer service and grievance redressal Addressability Transparency Free play of market forces Non access n Choice in pricequality combinations Diversity of content n n Diversity of content Alternative access points n Choice of price quality combinations Alternative access points n n n Industry players n n n n n Transparency Free play of market forces Investment and operational incentives St ringent anti-piracy regime n Rationalisation of licensing regime Freedom in choosing the technical architectu re for Broadcasting Credible measure for listenership of stations Investment and operational incentives n Stringent anti-piracy regime Investments and operational incentives n n n n

n n Investment and operational incentives n n Governments n Policy/ regulatory clarity Transparency Enhanced tax compliance n n n Policy clarity Transparency Enhanced tax compliance n Policy/ regulatory clarity Enhanced licensing fees Continued control of select g enres Adequate competition exists n n Transparency Enhanced tax compliance n n n n Ensuring adequate competition n Ensure level playing field Stringent anti regime Policy / regulatory clarity Inv estments and operational incentives n Stringent anti-piracy regime n n Stringent anti-piracy regime n Ensuring growth n n Policy / regulatory clarity Investments and operational incentives

n Policy/ regulatory clarity n Stringent anti-piracy regime n n n Establish a credible n Investments and measure of listenership operational incen tives of stations A high level analysis of the key issues highlights the following priorities acro ss sub-sectors: ! Ensure consumer choice ! Improve customer service and redressa l mechanisms ! Improve last mile transparency ! Ensure non-discriminated access to content and platforms ! Rationalise licensing conditions ! Allow operators th e freedom to select the business model ! Develop stringent anti-piracy regime ! Provide investment and operational incentives ! Provide policy / regulatory cons istency and clarity Clearly, to address these priorities, governmental/ regulato ry interventions with varying degree of complexity, and close coordination betwe en stakeholder groups is essential. We have attempted to prepare a short list of high impact interventions from a larger set of possible interventions identifie d against the above listed compulsions, through extensive industry interaction. 131 A CII - KPMG Report

The following criteria were developed after extensive industry interactions and were applied to prepare the shortlist: ! The nature of impact the intervention c an make on fostering growth and competition and protecting stakeholder interests ! Complexity of implementation including possible stakeholder resistance Below, we profile our top ten governmental/ regulatory interventions with a view to in itiate an industry dialogue to evolve a consensus on sector priorities 1. Implem ent addressability for broadcasting distribution in a phased manner Most industr y analysts agree that mandatory addressability is the best possible solution for the issues plaguing the broadcasting and cable services industry. The governmen t has initiated steps in line with this thought process to implement conditional access systems (CAS). However, several factors specific to CAS implementation i n the Indian context need to be given sufficient consideration before devising a strategy for implementing addressability. As mentioned earlier in this section, more than 75 percent of Indian cable homes earn less than INR 8,000 in a month. Currently, an average cable home pays around INR 150 per month for around 100 c hannels. ! ! ! Impact on broadcaster revenues Mandatory implementation of addressability may in crease the cable prices significantly as pay channel revenue models will be impa cted significantly by a falling subscriber base and resultant negative impact on advertising revenues Infrastructural investments required by the cable operator s get factored into the price. At 30 percent penetration, the cost of conditiona l access implementation in four metros with secure digital STBs, will work out t o be about INR 11 billion. (Source: Media Partners Asia). MSOs will have no opti on but to carry forward this cost to consumers Increased consumer cost In order to maintain the current set of channels, a consumer needs to spend around INR 35 0 without providing for the STBs (FTA with taxes at around INR 100 and five prom inent bouquets at current prices at INR 250). With a provision for STBs, the mon thly bill can easily cross INR 400, putting most popular entertainment channels beyond the reach of a majority of consumers, triggering a spiral of reduced adve rtising revenues and rising channel prices. For the consumer, this would be a ca se of 'paying more and watching less'. 132 Fo c u s 2 010 : D r e a m s t o r e a l i t y

! ! Market-driven conditional access No other country mandates the use of conditiona l access systems for accessing pay content. The decision to distribute the signa ls in an encrypted fashion and therefore force the use of conditional access dev ices is purely a business model decision of the cable operator. In that sense, a consumer transitioning to a conditional access system takes a conscious decisio n based on the attractiveness of the services on offer. Keeping in mind the digi tal transition Most countries consider migration to an addressable environment a s part of a larger transition to a fully digital environment. Industry players a nd regulators in several advanced countries like USA, UK, Australia, etc are com mitted to effect such a transition as soon as a majority of the cable homes are in a position to migrate and realistic timelines are set. An example of planned migration: China's digital upgrade timeline 2002 2002 2003 2003 2005 2008 2008 2015 Finish testing the technical standards for terrestrial transmission Publicise na tional standards for digital cable television transmission Adoption of national digital television standards Publicise national digital television standards Lau nch digital television broadcasts in selected cities Transmit Beijing Olympic Ga mes on HDTV Launch digital television commercial broadcasts in major cities Swit ch-off analogue system nationwide Source: www.china.org.cn In summary, whatever be the mode of implementation, addressability, if not imple mented keeping in mind practical compulsions, it may deny a majority of consumer s access to quality entertainment and slow down the growth of the industry consi derably. The government also needs to develop a phased, long-term plan to migrat e to a fully digital environment and set a realistic date for analogue transmiss ion. Whatever be the mechanism of implementing addressability, the government ne eds to evolve a framework for the classification of channels, which will then en able the industry (through consumer choice) to determine what is valued and what is not. International experience suggests the following three tiers of programm ing: 133 A CII - KPMG Report

Government needs to develop a phased, long-term plan to migrate to a fully digit al environment A. Free to air channels: Most elementary tier of programming consists of free to ai r channels only. Every cable operator should dedicate a 'stipulated share' of ca pacity to carry the FTA tier. Such an FTA tier should consist of: a. Stipulated number of public broadcasting channels b. Most viewed channels in the relevant c ommunity to ensure mandatory carriage of popular free to air channels in a speci fic region. c. Other FTA channels that the cable operator chooses to include in the FTA tier Scores from the existing viewership rating system should be used to pick channels for the class (b) slots. The government/ regulator may need to co nsider regulating the prices of the FTA tier till effective competition and cons umer choice come about in the natural course. B. Basic pay programming: Cable operators should put together a basic tier of pay p rogramming comprising the following: a. Genre leading pay channels in general en tertainment, sports, news, music, etc. Such leadership needs to be established t hrough viewership monitoring mechanisms like TRPs. In such a system a stipulated number of leading channels in each genre should be necessarily included in the basic pay tier. b. Pay or FTA channels that the cable operator chooses to carry. Such a layer should involve niche channels, channels catering to niche ethnic/l inguistic/religious communities and other pay channels not included as part of c lass (a) mandatory carriage. The choice of channels in these slots should be lef t to the discretion of the operator. In addition, the cable operator should rese rve a specified number of slots for piloting new channels. The pricing for the b asic tier of pay programming could be left to market forces, with government sup ervision of predatory or monopolistic pricing policies. Consumers should be able to watch the FTA tier and the Basic Pay tier without investing in a Conditional Access Device. C. Premium tier of programming: Cable operators should be allowed to offer premium content in a digital addressable environment. Consumers will need Conditional Ac cess Devices for accessing these premium programming channels or pay per view co ntent. Such programming can include premium movie channels, high end sports prog ramming, niche thematic channels, etc. Content providers operating in this tier and cable operators should be allowed to enter exclusive distribution arrangemen ts. Such exclusivity of content is an integral part of digital addressable broad casting in the transition to a fully digital last mile environment. 134 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The government should evolve a framework with clearly defined guidelines for the classification and tiering of channels. Such a framework should also stipulate the nature of price regulation in FTA tier and monitoring mechanisms to protect consumer interests. Such tiering of programming along with a few other initiativ es like licensing of cable operators (discussed below), would enhance consumer c hoice and transparency in the last mile environment. Recommended actions (A) Prepare a long term plan for digitial transition (B) Enc ourage voluntary implementation of addressability (C) Allow addressable operator s exclusive access to premium content (D) Stipulate a system for classifying cha nnels (E) Evolve an acceptable mechanism for FTA price determination (F) Evolve a fair system for sampling new channels 2. Review programming codes and censorsh ip laws Mature content has proven to have large demand globally. This is true of India too. Such content is commonly available over television, film, internet a nd print, without any checks and balances across the country. Effective legislat ion of such content will help enforce discipline and responsibility to transmit or show such content with adequate precautions and warnings. However, the curren t legislation and mechanisms are ineffective and not completely practical in dea ling with this subject. ! ! For example, the current films' rating system is relatively narrow; there is a c ase for multi-tiering the rating system and revisiting the approval process. Sim ilarly, there is a lack of clear, practical norms for mature content on televisi on. Given the medium it is not practicable to enforce a mechanism on a day-to-da y basis and therefore it is essential to find a solution that is acceptable to a ll stakeholders and involves an element of self-regulation. Any moves could however invite strong reactions from various sections of society . As there exist strong, but divergent points of view on this subject, the gover nment should initiate a process to gather and analyse all such opinions along wi th an understanding of the ground realities before reviewing/developing legislat ion. 3. Define service obligations and grievance redressal mechanisms The last m ile of the service delivery in the entertainment sector in India is largely domi nated by the unorganised sector which lives by its own set of rules resulting in a plethora of rights abuses. This results in a peculiar situation with the cons umer rights being completely ignored. 135 A CII - KPMG Report

For example, disputes between cable operators and broadcasters often result in d enial of consumer access to popular sporting events without notice leaving the c onsumer without any choice. In a monopolistic situation, access has become an in strument of blackmail, without any regard for consumer rights. Most consumers ar e scared to take the fight to consumer courts fearing retaliation from the 'unor ganised' sector. The government should examine such abuses of monopoly power and bring out implementable mechanisms to ensure appropriate service delivery and c ustomer service. Such mechanisms should include clear definitions for quality of service, customer service standards and guidelines for record keeping. Governme nt should also specify grievance redressal mechanisms. The initiatives taken by the telecom regulatory authority to improve customer service in the telecommunic ations space offer a benchmark to emulate. 4. Rationalise last mile licensing Th e discontinuities and unplanned evolution of licensing in the entertainment last mile has resulted in inconsistencies for similar products/ services. In the bro adcasting distribution space no licensing is required for cable operators while unified licensing exists for DTH and IP-TV. The unified licensing regime is a mo vement towards such a system. Film or music distribution, exhibition and retaili ng do not require licenses. However, radio, being a broadcast medium, carries un viable license conditions including a hefty license fee. Licensing has a very po sitive role to play in an industry that hopes to streamline its unorganised play ers. Most part of the entertainment value chain needs external facilitation to a ttain the level of discipline and openness required to operate in an efficient a nd equitable structure. Any attempt to review and rationalise disparate licensin g regimes in the sector should take into account the following important factors : ! License fee should not jeopardise the commercial viability of the sector. 10 percent gross revenue share in DTH broadcasting and flat license fees in radio affects the viability of these genres. ! Within a sub-sector, license conditions should ensure a level playing field. As explained earlier, such level playing f ields do not exist in several parts of the entertainment last mile, most notably in the case of broadcasting distribution. The government should consider the fo llowing to initiate corrective measures: Migrate to a commercially viable revenu e sharing model for radio Review DTH license conditions to ascertain whether INR 100 million one time license fee plus 10 percent of gross revenue share make co mmercial sense ! Consider licensing unorganised distribution and last mile entit ies including cable operators, film distributors, movie hall owners, music distr ibutors and retail outlets. The objective of such licensing should be limited to enhancing The discontinuities and unplanned evolution of licensing in the entertainment la st mile has resulted in inconsistencies ! ! 136 Fo c u s 2 010 : D r e a m s t o r e a l i t y

! ! transparency and order in the last mile entities. As part of such licensing, the government should clearly specify the following: Qualifications for becoming a last mile operator. Such qualifying conditions should not exclude existing opera tors, as it would result in on ground and logistical issues. Record keeping and reporting requirements; Quality of service and customer service requirements Har monise licensing conditions across platforms in a given genre so as to allow a l evel playing field as is indicated in the recommendations for unified licensing brought out by TRAI Introduce strict penal provisions including fines, revocatio n of licenses for non-compliance, wrongful declarations, consumer rights abuses, etc The success of such a licensing system will critically depend on the monitoring and enforcement mechanisms put in place. The government/ regulators need to defi ne the monitoring mechanisms including provisions for surprise audits by the lic ensing authority or agencies authorised by the licensor. Strict penalties should be enforced for non-compliance. Recommended actions (A) Consider licensing last mile entities currently not under licensing (B) Harmonise license conditions in a given genre (C) Introduce strong penal provisions for violation of license co nditions. 5. Evolve a framework for regulating cross-media/ value chain holdings Media integration is used as an important strategic tool by the media industry. Such integration provides significant competitive advantage in the market. The strategic reasons for such integration typically include: ! Horizontal integrati on (cross-media integration) with a view to leverage content and client relation ships. ! A television broadcaster owning a radio station is an example of such i ntegration. In such a case the competitive advantage comes from crossmedia usage of content as well as the ability to offer an integrated marketing solution tar geting multiple consumer segments. ! Vertical integration (value chain integrati on) which significantly enhances the competitive positioning because of the pote ntial to gain preferential/ exclusive access to distribution or content. It is r easonably common to see such strategies in action in most large media markets in the world. For examples in the United States, an analysis of the business inter ests of top ten media companies shows that all of them are integrated media play ers with interests in either multiple media or multiple segments of the value ch ain. 137 A CII - KPMG Report

Company Major Business Interests Disney's interests span theme parks, hotels, and consumer goods, such as toys, a nd broadcasting, in addition to movies. The businesses are organised in the foll owing segments: media networks, studio entertainment, theme parks and resorts an d consumer products. Viacom is a leading global media company, with interests in creation, promotion and distribution of entertainment, news, sports, music and comedy. Viacom's well-known brands include CBS, MTV, Nickelodeon, VH1, BET, Para mount Pictures, Viacom Outdoor, Infinity, UPN, Spike TV, TV Land,CMT: Country Mu sic Television, Comedy Central, Showtime, Blockbuster, and Simon & Schuster, etc . Comcast has interests spanning creation and distribution of content and is one of the leading players in cable. Leading Comcast businesses include Comcast cab le, CN8.TV, E! Online, Comcast spectacor, Comcast sports, Philadelphia Fliers, 7 6ers, Golf Channel, Outdoor Life Network, etc. Newscorp is an integrated media c ompany with interest in publishing, film and television production, broadcasting and distribution, network stations and radio Diversified media business spannin g television, radio, outdoor, leisure, etc The oldest network in the US owned by GE. This group owns assets including NBC, CNBC, MSNBC, Bravo Cable Network and Telemundo. NBC has also invested in History Channel, Value Vision, Praxis Commun ication Corporation, etc. Integrated media and communication company had interes ts in creation and distribution of content. The group businesses include AOL, Ti me Warner Cable, Time, HBO, CNN, etc. Cox is an integrated distribution play off ering voice, data, broadcasting and pay per use services Integrated satellite ba sed distribution player. Owns Dish TV Walt Disney Viacom Comcast Newscorp Clear Channel NBC AOL Time Warner Cox Comm. Echostar Comm. Source: Company annual reports However, vertical integration could lead to anti-competitive behaviour/ unfair d iscrimination. Several countries are currently formulating/ reviewing regulation s regarding cross media holdings and mandatory access obligations. In India also Telecom Regulatory Authority of India (TRAI) has opened up the matter for consu ltation. The following critical factors need to be considered before finalising regulatory positions on the issue: ! Integration restrictions will constrain inv estments and growth. ! Industry needs significant investments to transition to d igital last mile, seed STBs, enhance the programming quality, etc. Such investme nts are most likely to come from large integrated media players. Any restrictive regulation will be detrimental to the long term growth of the sector. ! Safegua rds to manage abuse by integrated operations It is possible to evolve safeguards against abuse of advantages arising out of such integration. 138 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Mandatory access obligations like 'Must Provide' and 'Must Carry' provisions sho uld be judiciously used to restrict such abuse. However, the nature of content / access to be covered under such 'Must Provide' / 'Must Carry' regulation needs to be carefully considered as it critically impacts the ability of the broadcast er/ platform owner to function in a commercially viable manner. The government/ regulator should consider integrated ownership with clearly defi ned safeguards to prevent anti-competitive behaviour. Thus, the regulator can un dertake a supervisory role with the powers to intervene and take decisive action when required. Recommended actions (A) Bring out policy on cross media integration and value ch ain integration in media and entertainment (B) Define mandatory access obligatio ns of broadcasting and distribution players 6. Allow the freedom to choose the b usiness model Indian entertainment industry across genres operates under regulat ory/ policy restrictions imposed over the years. These restrictions have resulte d in locking up value in the sector. Some of the existing or proposed restrictio ns that are hindering growth include: ! Architectural restrictions [uploading re strictions for television, transmission restrictions for radio, etc.] (Existing) ; ! Structural restrictions like FDI limits (Existing); ! Service provisioning r estrictions on television/ distribution/ radio, etc (Existing) ! Price regulatio n (Proposed for television broadcasting) ! Cross holding restrictions and mandat ory access obligations (Proposed) ! Limiting the extent of advertising on televi sion broadcasting (Proposed) Such restrictions seriously impair an operator's ab ility to define the business model in a commercially sustainable manner accordin g to the emerging market conditions. For instance, FM radio players operating in multiple cities are forced to set up transmission stations in each city. As a r esult they are unable to leverage the benefits of scale and a pan Indian presenc e, escalating costs significantly in the process. Most above-mentioned restricti ons result in such cost escalations or revenue losses. Restrictive regulation sh ould be put in place with the objective of safeguarding national security or pro tect consumer interests in markets where sufficient competition does not exist. 139 A CII - KPMG Report

Recommended actions (A) Review restrictive regulation across media and entertain ment to remove value locking restrictions (B) Clearly articulate circumstances / qualifying conditions for imposing such restrictions Piracy is the single largest value destroyer in the media and entertainment busi ness 7. Constitute a national anti-piracy force Piracy is the single largest value de stroyer in the media and entertainment business as it prevents the rightful owne r of content from realising the true value of their content. It raises the costs of officially available content putting content providers and content users in a vicious cycle, creating a parallel unorganised market. Leakages account for ov er INR 20 billion revenue losses annually. The various forms of leakages include : ! Losses to the exchequer through under declaration by last mile cable operato rs, MSOs and theatre operators ! Illegal reproduction of content including illeg al film/ music DVDs, illegal music CDs/cassettes, etc ! Use of copyrighted intel lectual property without compensating the legal owner of such property. Examples of such violations include illegal remixes, illegal use of copyrighted content in advertising, etc. A multi-pronged approach is required to deal with such leak ages and analyse the nature of its real economic impact, which not only addresse s the genuine demand for a product with a lower cost but also thereby expands th e market. Therefore the response to piracy, copyright infringements and last-mil e leakages should be premised on the following: ! Stringent legislation and enfo rcement and ! Introduction of appropriately priced products or low cost variants An analysis of piracy and copyright related laws, enforcement mechanisms and co st structures reveals several areas for possible improvement. Such laws require tightening up in terms of content and enforceability. It is quite difficult for individual businesses to coordinate with state level law enforcement machinery a nd the legal system to fight piracy and infringements. Thus, there is a need to coordinate proactive action, powered by stringent legal provisions. At the same time, government should support the industry in developing attractive price prop ositions to address lower income segments. Given such a context, the following s teps can be initiated: ! Creation of a national force with the specific mandate to crack down on piracy and infringements of all forms The government should con sider constituting a national body with law enforcement powers to fight piracy. The constitution of such a body can 140 Fo c u s 2 010 : D r e a m s t o r e a l i t y

be part-funded through industry contributions. The enforcing entity should condu ct its own surveys, maintain subscription/ retail off-take related data and shou ld have the powers to conduct surprise audits, search and seize operations and i nitiate criminal proceedings. ! Plug the loopholes in piracy and copyright related laws The government should re view current legislation to identify and plug commonly abused loopholes like the one relating to music reproductions and introduce stringent penal provisions. R eview taxation policy in the sector Indirect taxation through entertainment tax, sales tax and service tax is a significant part of the total 'cost to the consu mer' of all products and services in this sector. For the fight against piracy a nd last-mile leakages to be effective, governments should take a more imaginativ e approach to taxation in this sector and enhanced revenues through lower taxes and improved compliance, thereby bringing the price levels to affordable levels. ! Recommended actions (A) Constitute national anti-piracy force (B) Review current piracy related legislation and plug the loopholes (C) Include stringent penal p rovisions to disincentivise piracy (D) Rationalise taxes 8. Provide investment and operational incentives For several segments of the ind ustry, investment and operational incentives are the only mechanism to ensure su rvival in the face of an exorbitant cost structure. Direct to Home broadcasting is a classic case where a DTH operator is expected to pay the following kind of tax/regulatory pay outs: ! Sales tax as high as 25 percent in several states ! S ervice tax at 10 percent ! Entertainment tax which assumes significant proportio ns in certain states. With such a tax structure, DTH can never be competitive wi th local cable operators who also do not declare most of their subscriber base. In contrast, tax exemptions for multiplexes have resulted in a virtual multiplex boom. The story goes beyond tax incentives. This sector requires massive invest ments to upgrade the last mile infrastructure. Unless the sector's attractivenes s is significantly enhanced, such investments are unlikely to happen. The follow ing steps are recommended to improve the sector's attractiveness to investors: Entertainment sector requires massive investments to upgrade the last mile infra structure 141 A CII - KPMG Report

! ! ! ! ! Rationalise the tax regime - transition to a low tax, high compliance model; Int roduce tax slabs with cable FTA subscriptions, Low cost film tickets/ CDs/ casse ttes, etc can either be exempted from tax or be subjected to very low taxes; Con sider deferred tax schemes for new entrants, especially with regard to those inv olved in infrastructure creation; Review and rationalise FDI restrictions; Intro duce transparent processes for the approval and disbursement of investment subsi dies. Recommended actions (A) Review taxation policies (B) Develop schemes to incentiv ise investments 9. Constitute a unified regulator In 2004, the government amende d the definition of telecommunication services in the Telecom Regulatory Authori ty of India (TRAI) Act to include broadcasting and cable services, bringing the broadcasting and cable services industry under the regulatory oversight of TRAI. The move triggered hurried stakeholder consultation to evolve regulatory positi ons on issues including the implementation of conditional access systems, possib le cross-holding restrictions, price regulation, mandatory access obligations, p ossible advertising restrictions and customer service. While this is a laudable initiative to make a meaningful regulatory intervention in the broadcasting and cable services space, it is still a case of 'too little, too late' and is more o f a reaction than a reflection of long-term vision for the sector. As the media and entertainment sector prepares itself to enter another explosive growth phase , it requires a progressive regulatory environment that can facilitate growth wh ile protecting consumer rights and minimising any negative socioeconomic fall-ou t. However, such regulatory action can only evolve from a clarity of vision for the sector taking into account the following key factors: ! Digital distribution platforms (such as DTH, IP-TV, digital distribution of films, etc) will revolut ionise the last mile of the entertainment sector across subsegments. ! Such plat forms will deliver a rich menu having multi-media offerings and interactive serv ices along with other voice and data services like telephony, Internet, video co nferencing, etc. For example, an IP-TV operator will deliver a convergent menu, offering a myriad of information and entertainment services. ! Evolution of acce ss equipments, which are capable of receiving convergent offerings. Such access equipments would include smart digital televisions, mobile devices, intelligent home entertainment systems, etc. 142 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Government, in consultation with the industry, consumer interest groups, investo rs and other stakeholder groups should define the roadmap to realise the actual potential of the sector For the market to mature to a level of reasonable stability, it has to endure a long transition period with the following kind of players co-existing: ! ! ! Full-service convergence players Niche convergence operators offering select ser vices Traditional platform owners like pure play cable operators and movie theat res Clearly, there is an urgent need for a comprehensive regulator who shares an exc iting vision of the emerging telecommunications, media, broadcasting and enterta inment sectors, has the depth of regulatory capabilities and understands the reg ulatory process well enough to perform such a role in a transient economy. TRAI, having effectively anchored the regulatory process in the telecommunications sp ace and conducted the initial round of consultation in the broadcasting and cabl e services industry, is probably best placed to take over the role of a converge nce regulator. The government could consider upgrading TRAI as a National Conver gence Regulator. In this role, it should have the regulatory oversight over all businesses dealing with carriage of voice or data including information, news, e ntertainment related content over cable, fibre, copper, wireless, radio, etc. Su ch a move will ensure consistency and continuity of forward looking regulation d riven by a shared vision. Recommended action (A) Appoint TRAI as the National Convergence Regulator with o versight over all businesses dealing with carriage of voice or data including in formation, news, entertainment related content over cable, fibre, copper, wirele ss, radio, etc. 10. Develop a national media and entertainment policy The effect iveness of a regulatory intervention will critically depend on the clarity of vi sion articulated through a comprehensive policy. The success of telecom regulati on was built on the policy direction set by the NTP 1999 which articulated a vis ion for the telecommunication space. Such clarity is the need of the hour in the media and entertainment industry. The government, in consultation with the indu stry, consumer interest groups, investors and other stakeholder groups should de fine the roadmap to realise the actual potential of the sector. The following co rner stones could define the nature of the national media and entertainment poli cy: ! Sustainable growth orientation ! Increasing choice for consumers ! Elimina ting piracy ! Accelerated adoption of newer technologies 143 A CII - KPMG Report

Such a policy making exercise should combine several legislative initiatives of the past including amended cable television bill, convergence bill, etc. The pro cess adopted to evolve the policy must involve composite stakeholder discussion as it is critical to establish the credibility and therefore the acceptability o f the outcome. The time is ripe to initiate the process to develop a comprehensi ve national media and entertainment policy. Recommended actions (A) Conduct stak eholder discussions to develop a shared vision for the sector (B) Develop a nati onal media and entertainment policy before the end of year 2005 Regulatory charter The following table summarises ten initiatives that the gover nment/ regulators should take to give direction and impetus to the long-term gro wth of the entertainment sector: Degree of impact on Industry High High High High High Consumer High Medium Mediu m High High # Action points Improve organisational effectiveness through focused projects Impr ove yield Develop alternative revenue streams Improve consumer connect Develop n ew markets through aggressive market making Increase market activity in newer ge nres Improve governance standards Improve organisational ability to attract and retain talent Explore consolidation options Leverage technology strategically Resistance to change Complexity of implementation 1 2 3 4 5 High Low Low High Medium High High Medium High Medium 6 7 High High High Medium Low High Medium High 8 High Medium High High 9 10 High High High High High Medium

High Medium Conclusion The twenty initiatives (ten governmental initiatives and ten industry initiatives) presented above have the potential to play the necessary facilitat ing role required to iron out structural distortions and take off on a phase of sustainable growth. While this KPMG-CII 10/10 CHARTER is not intended as a presc riptive intervention, it is a starting point for an intense corrective dialogue within the industry and outside. We hope that such a dialogue will set the stage for ushering in a new and exciting entertainment economy. 144 Fo c u s 2 010 : D r e a m s t o r e a l i t y

The tax perspective In the fine print

The tax perspective In the fine print Exchange control regulations In the course of liberalisation of exchange control regulations, the Government of India has allowed 100 per cent FDI in the film sector under the Automatic Rou te without entry level conditions, with only certain post filing requirements to be complied with. The film sector for FDI purposes broadly covers film producti on, exhibition and distribution related services and products. However, the Auto matic Route is not available for broadcasting sector. The permissible limits for this sector are: Segment TV Software Production Setting up hardware facilities Cable network DTH Up linking of news and current affairs TV channel FM Broadcasting Limit 100 perc ent FDI allowed subject to certain conditions 49 percent FDI allowed 49 percent FDI allowed subject to certain conditions 20 percent FDI allowed within the over all limit of 49 percent of foreign equity 26 percent foreign equity allowed 20 p ercent portfolio investment allowed; direct investment by foreign entities is no t permitted There may be merit in permitting greater foreign equity in DTH, which is extreme ly capital intensive and is, in a sense, akin to a telecom infrastructure projec t. Currently the cable industry is unorganised, fragmented and resorts to large scale under-reporting of revenues which results in revenue leakage for the centr al and state government on account of direct (income) and indirect (service, ent ertainment, etc.) taxes. Therefore an alternative medium such as DTH may be enco uraged fiscally by providing a income-tax holiday benefit (as available to broad band network) and indirect tax benefits (such as excise duty and sales tax exemp tions for set-top boxes) since this access mechanism indirectly benefits the gov ernment by partly protecting it from revenue leakage. The current scenario on th e liberalisation of FM broadcasting is not very encouraging in India. Private ra dio stations generally face a long/ uncertain payback period. Nonetheless, the f oreign investment policy for FM broadcasting is in variance with the FDI policy in other media segments as no direct investment by foreign entities, NRIs and OC Bs is permitted in this segment. 145 A CII - KPMG Report

Income tax and allied laws Film production and distribution cost As per the prescribed rules1, a film produ cer who sells the entire exhibition rights of the film is entitled to a deductio n of the entire cost of production incurred by him in the same year in which the Censor Board certifies the film for release in India. A similar deduction is al so available to a film distributor for outright sale of the film distribution ri ghts acquired. In case of a partial sale and/ or partial exhibition of film righ ts by the film producers/ distributors, it is necessary that the film should be released at least 90 days before the end of the tax-year (the tax year is 1 Apri l to 31 March) to claim a full deduction of specified production costs/ specifie d costs of acquiring distribution rights. Where the film is not released at leas t 90 days before the end of such tax year, then the cost of production, limited to the amount earned from the film, shall be allowed as a deduction in the tax y ear and the remaining cost of production shall be allowed in the following year. Where the feature film is not exhibited by the producer himself or not sold, le ased or transferred on a minimum guarantee basis, no deduction in respect of the cost of production shall be allowed in the tax year. The entire cost of product ion shall be allowed in the succeeding tax year(s) in which the film is exhibite d or the rights are sold. Sale of rights of exhibition also includes the lease o f such rights or their transfer on a minimum guarantee basis. Multiplexes The go vernment has introduced partial tax holidays for income of multiplex theatres. A deduction of 50 percent from profits is allowed for a period of five years from the year of commencement of operations in respect of the business of building, owning and operating a multiplex theatre of prescribed norms. Some of the norms prescribed under the rules are: ! The multiplex theatre should be constructed du ring the period from 1 April 2002 to 31 March 2005. ! The multiplex theatre shou ld comprise of at least three cinema theatres and at least three commercial shop s. ! The total seating capacity of all the cinema theatres comprised in the mult iplex should be at least 900 seats and no cinema theatre should consist of less than 100 seats. ! The multiplex theatre cinema should be centrally air-condition ed. ! The ticketing system employed by the cinema theatres should be fully compu terised. 1 R u l e 9 A a n d 9 B o f t h e I n c o m e - t a x R u l e s , 19 6 2 ( t h e R u l e s ) 146 Fo c u s 2 010 : D r e a m s t o r e a l i t y

! The multiplex in order to be eligible for tax holiday should be located in a pla ce other than New Delhi, Chennai, Kolkata and Mumbai. There are no specific/ separate provisions in respect of the taxation of film ar tists, technicians, etc. They are entitled to a deduction of the income derived from foreign sources, subject to the satisfaction of certain prescribed conditio ns. In the case of overseas performance, taxation in the host country needs to b e examined in the context of the applicable Double Tax Avoidance Agreement (DTAA ) and availability of foreign tax credits against Indian tax on such income. Liv e shows and stage performances being held in India are taxed as per the general principles of personal taxation, applicable DTAA provisions and the special circ ular1 issued by the Central Board of Direct Taxes (CBDT)2. As per these provisio ns, income arising from such live shows is generally taxable in India. However, certain exclusions have been provided in case of: ! ! ! Gratuitous performance without any consideration; Performance in India for promo ting sale of records, without any consideration; and Acquisition of copyrights o f performance in India for subsequent sale abroad. In other cases, the amounts are taxable in India, depending upon the facts of ea ch case and the applicable provisions of the DTAA. Foreign television channels/ telecasting companies (FTCs) The two primary sources of revenue for FTCs, amongs t others, is income from sale of advertising airtime on the TV channel and subsc ription revenues. Under the domestic tax law, income of the FTCs would be taxed in India in case they constitute a business connection in India. In case an FTC operates from a country with which India has a tax treaty, it would be taxable i n India only if it constitutes a Permanent Establishment (PE) in India. The prov isions of the DTAA would apply to the FTC to the extent they are more beneficial as compared to the provisions of the domestic law. The term “business connection” i s widely interpreted and based on case law. The definition of PE is generally na rrower as compared to the term business connection. In case the FTC has a busine ss connection/ PE in India, the profits attributable to such presence in India w ould need to be computed. In case the FTCs do not maintain country wise accounts , then this could pose considerable difficulty in computing the profits which wo uld be taxed in India. 1 2 C i r c u l a r N o 7 8 7 d a t e d 10 Fe b r u a r y 2 0 0 0 The Apex Income-t ax administering authorit y in India 147 A CII - KPMG Report

Subscription revenues are collected by Indian distributors and subsequently paid to the FTCs. The Indian tax authorities are contending that the payments of sub scription fees repatriated to the FTCs are liable to tax withholding considering the same to be royalties. Some other issues which the FTCs need to consider is withholding taxes on the payments made to foreign satellite owner for transponde r lease and up-linking charges. The tax authorities contend that the charges are in the nature of royalties/ fees for technical services which are deemed to acc rue or arise in India. There have been conflicting tax rulings on this matter an d the matters are currently pending before the appellate authorities. General tax provisions Withholding tax Certain payments to non-residents (e.g. interest, royalties, fee s for technical services) would not be tax deductible if withholding tax provisi ons are not complied with. Effective 1 April 2003, even certain payments to resi dents (on account of interest, commission or brokerage, fees for technical servi ces or fees for professional services etc) are non tax deductible if withholding tax provisions are not complied with. Set off of accumulated loss and unabsorbe d depreciation In case of a business combination (e.g. merger/ amalgamation) the ability of the merged entity to carry forward the business losses/ unabsorbed l osses of the merging/ amalgamating entity is extremely important. However, the t ax laws only permit such a benefit to entities which have industrial undertaking s. The entertainment industry, primarily a service industry, would not be eligib le for these benefits and accordingly, it acts as a hindrance to the growth and consolidation of the industry. In case of demergers (i.e. carve-outs) the accumu lated losses/ unabsorbed depreciation of the demerged (carved out) undertaking w ould be available to be carried forward by the resulting entity. Scheme of taxat ion Film producing and distributing companies typically go through cycles of pro fit and losses, which cannot be predicted. Specific methods of accounting and pr ovisions for taxation for the film industry could be evolved to take into accoun t such fluctuations. 148 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Potential service area India is a globally preferred destination for setting up call centres and business process outsourcing centres. One of the reasons for th is is the English speaking skills of the Indians. Even Indian teachers are in de mand overseas for teaching in English language. These language skills could be u sed for making India a global centre for dubbing in English language. Transfer p ricing India has transfer pricing regulations in place. Transactions between a r esident and non-resident being associated enterprises are considered as internat ional transactions. The Indian Income-tax Act specifically provides that “any inco me arising from an international transaction must be transacted at an arm's leng th price. Accordingly, determination of taxable income of foreign companies in ” e ntertainment industry having a “permanent establishment” in India may have to be don e in accordance with such transfer pricing regulations. The transfer pricing reg ulations also contain provisions for maintenance of documents to evidence that t he transactions have been effected at an arms length price. Global scenario The film industry is a highly mobile, globally competitive industry, and all dev eloped countries use incentives to attract and retain film production. For insta nce, a foreign investor in an East European country is entitled to exercise thre e tax incentives viz. tax incentive on production/ co-production, development ta x allowance and accelerated depreciation. A certain Asia Pacific country has int roduced a “refundable tax offset” to encourage production of large budget films. The incentive represents a cash subsidy of 9 - 12.5 percent of the total budget of a production, on satisfying certain prescribed conditions. The treaty co-product ion system has existed for decades and has been used extensively to encourage a pooling of creative, artistic, technical and financial resources among producers of treaty countries. Films produced under the terms of a co-production treaty q ualify as national content in the country of each participating co-producer and thus make the production eligible for applicable cash assistance/ rebates from t he Government and tax benefits from each coproduction territory. Currently, coun tries such as Australia, UK, France, Germany, Italy, New Zealand etc have entere d into such co production treaties. India currently does not have any co-product ion treaties. Indian film/ content production/ post production entities would be nefit with such co-production treaties. 149 A CII - KPMG Report

Indirect tax laws There are other levies (central and state) also which are applicable to the film industry. Excise duty, customs duty, sales tax, service tax, entertainment tax are some levies, which directly affect the film industry. Excise duty is payable on manufacture. The central excise tariff covers various cinematographic goods. Presently, the excise duty rate for exposed and developed cinematographic films is nil. Accordingly, production of films does not attract any excise duty. Howe ver, excise duty is payable on manufacturing, processing and development of film s. This is also subject to certain exemptions. Further, manufacture of equipment s such as camera, projectors and other equipment are also liable to excise duty. A state High Court has held that production and sale of a film resulted in crea tion of a work of art and not sale of goods. However, some other state sales tax laws have included films as 'goods' liable to sales tax. Further, certain state s levy sales tax on intangibles like copyright and also on grant of film rights to use/ hire. There is need for greater consistency and uniformity in taxation f or such an important industry. Entertainment tax is levied on various modes of e ntertainment such as on film tickets, cable television, live entertainment etc. The rates of entertainment tax payable by theatre owners vary form 0 percent in Andhra Pradesh to 130 percent in Assam. India has one of the highest rates of en tertainment tax across the globe. Recently, some states have granted exemption f rom entertainment tax to multiplexes. In addition to the above taxes, service ta x is now becoming a major source of indirect tax revenue for the government. Cur rently, service tax at the rate of 10.2 percent is levied on the following servi ces relating to the entertainment industry: ! ! ! ! ! ! Advertising agency servi ces Broadcasting services Cable services Event management services Sound recordi ng services Video production agency services 150 Fo c u s 2 010 : D r e a m s t o r e a l i t y

Glossary AIR ARPU BFA BPO BSNL C&S CAGR CAS CIS DRB DSL/ xDSL DTH EPG FDI FMCG FTA FTII G DP HDTV IDBI IIM IIT IMI INR IP IP-TV IPO IPRS IT LCO LIC MFA MSO NASSCOM NRS NT P OECD PPL PVR RJ SEC SMS STB TG TRAI TRP UAE USD All India Radio Average Revenue Per User Bachelor of Fine Arts Business Process Outsourcing Bharat Sanchar Nigam Limited, A leading Indian telecommunications co mpany Cable and Satellite Compounded Annual Growth Rate Conditional Access Syste m Commonwealth of Independent States Digital Radio Broadcasting Digital Subscrib er Line (variants) Direct To Home Electronic Programming Guide Foreign Direct In vestment Fast Moving Consumer Goods Free To Air Film and Television Institute of India Gross Domestic Product High Definition Television Industrial Development Bank of India Indian Institute of Management Indian Institute of Technology Indi an Music Industry Indian Rupees Intellectual Property Internet Protocol Televisi on Initial Public Offering Indian Performing Rights Society Information Technolo gy Local Cable Operator Life Insurance Corporation of India Master of Fine Arts Multi System Operator National Association of Software and Service Companies Nat ional Readership Survey New Telecommunications Policy Organisation for Economic Cooperation and Development Phonographic Performance Ltd. Personal Video Recorde r Radio Jockey Socio Economic Category Short Messenger Service Set Top Box Targe t Group Telecom Regulatory Authority of India Television Rating Points United Ar ab Emirates United States Dollar

About CII The Confederation of Indian Industry (CII) works to create and sustain an enviro nment conducive to the growth of industry in India, partnering industry and gove rnment alike through advisory and consultative processes. CII is a non-governmen t, not-for-profit, industry led and industry managed organisation, playing a pro active role in India's development process. Founded over 108 years ago, it is In dia's premier business association, with a direct membership of over 4,800 compa nies from the private as well as public sectors, including SMEs and MNCs and ind irect membership of over 50,000 companies from 283 national and regional sectora l associations. A facilitator, CII catalyses change by working closely with gove rnment on policy issues, enhancing efficiency, competitiveness and expanding bus iness opportunities for industry through a range of specialised services and glo bal linkages. It also provides a platform for sectoral consensus building and ne tworking. Major emphasis is laid on projecting a positive image of business, ass isting industry identify and execute corporate citizenship programmes. With 45 o ffices in India, 13 overseas in Australia, Austria, China, France, Israel, Japan , Malaysia, Russia, Singapore, South Africa, Switzerland, UK, USA and institutio nal partnerships with 239 counterpart organisations in 101 countries, CII serves as a reference point for Indian industry and the international business communi ty. About KPMG KPMG is the global network of professional services firms of KPMG International. KPMG member firms provide audit, tax and advisory services through industry foc ussed, talented professionals who deliver value for the benefit of their clients and communities. With nearly 100,000 people worldwide, KPMG member firms span 7 15 cities in 148 countries. The member firms of KPMG International in India were established in September 1993. As members of the cohesive business unit that se rves the Middle East and South Asia (KPMG's MESA business unit), they respond to a client service environment by leveraging the resources of a globally aligned organisation and providing detailed knowledge of local laws, regulations, market s and competition. KPMG has offices in India in Mumbai, Delhi, Bangalore, Chenna i, Hyderabad and Kolkata and services over 2,000 international and national clie nts. The firms in India have access to more than 900 Indian and expatriate profe ssionals, many of whom are internationally trained. KPMG strives to provide rapi d, performance-based, industry focussed and technology enabled services, which r eflect a shared knowledge of global and local industries and our experience of t he Indian business environment.

www.in.kpmg.com For further information contact: www.ciionline.org Confederation of Indian Industry Jayant Bhuyan Deputy Director General E-mail: [email protected] Gayatri Gul ati Executive Officer E-mail: [email protected] Mumbai 105, Kakad Cha mbers, 1st Floor 132, Dr Annie Besant Road, Worli Mumbai 400 018 Telephone: +91 22 24931790/0565/0287 Fax: +91 22 24939463/24945831 Head Office CII Mantosh Sond hi Centre 23, Institutional Area, Lodhi Road New Delhi 110 003 Telephone: +91 11 24629994 Fax: +91 11 24621649/24633168 KPMG Rajesh Jain National Industry Director Information, Communication and Entertainm ent E-mail: [email protected] Anindya Roychowdhury Associate Director E-mail: anin [email protected] Anuj Poddar Manager E-mail: [email protected] Mumbai KPMG House, Kamala Mills Compound 448, Senapati Bapat Marg, Lower Parel M umbai 400 013 Telephone: +91 22 24913131 Fax: +91 22 24913132 Delhi 4B, DLF Corp orate Park DLF City, Phase III Gurgaon 122 002 Telephone:+91 124 2549191 Fax: +9 1 124 2549101 Bangalore KPMG House, 20/2, Vittal Mallya Road Bangalore 560 001 T elephone: +91 80 22276000 Fax: +91 80 22273000 Chennai Wescare Towers 16 Cenotap h Road,Teynampet Chennai 600 018 Telephone: +91 44 24332533 Fax:+91 44 24348856 Hyderabad II Floor, Merchant Towers Road No. 4, Banjara Hills Hyderabad 500 034 Telephone: +91 40 23350060 Fax:+91 40 23350070 Kolkata Park Plaza, Block F, Floo r 6 71 Park Street Kolkata 700 016 Telephone: +91 33 22172858 Fax: +91 33 221728 68 The information contained herein is of a general nature and is not intended to a ddress the circumstances of any particular individual or entity. The content pro vided here treats the subjects covered here in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Although we endeavour to provide accurate and time ly information, there can be no guarantee that such information is accurate as o f the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Specialist advice sho uld be sought with respect to any individual circumstances. KPMG International i s a Swiss cooperative consisting of separate KPMG member firms in countries thro ughout the world. '2005 KPMG, the Indian member firm of KPMG International, a Swiss cooperative. A ll rights reserved. Printed in India.

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