Earlier this month, Baidu's (NASDAQ:BIDU) troubled Music division merged with Taihe Music Group, a leading Chinese music label. Baidu Music is one of the largest music services in the world with 150 million active users. Rival Tencent's (NASDAQOTH:TCEHY) QQ Music has an estimated 80 million users.
The merger with Taihe adds significant strength to Baidu's legitimate music service, which originally suffered from immense piracy problems. Not only does it open access to Taihe's catalog of music, it can prevent competing services from accessing Taihe's catalog should it choose to keep some titles exclusive.
What's more, Baidu's huge head start and strategic position could prevent Apple (NASDAQ:AAPL) from finding success in an already top-heavy market. Apple entered China with Apple Music at the end of September.
Apple's rise in China
In February, the month in which Chinese New Year fell, Apple sold more phones than any other manufacturer in the country including Xiaomi, which consistently tops the charts month to month. China's appetite for Apple products has never been higher, and it's further evidenced by the 100% increase in revenue from the country last quarter.
Apple is hoping to leverage its growing Chinese user base to sell its subscription music service. At 10 yuan (about $1.56) per month, Apple Music is priced to sell. That's the same price Tencent uses for the ad-free tier of QQ Music. IFPI says that QQ Music has about 3 million paid subscribers, which wouldn't amount to more than a rounding error for Apple.
But Apple Music isn't about generating significant revenue. It's about increasing the stickiness of the iPhone through a music service that's integrated with the smartphone OS. That's something only Apple offers in China.
Baidu Music finds a home
Baidu has been looking to sell Baidu Music for several months due to the legal liability of the asset. Baidu rose to become China's No. 1 search engine mostly because of the ease of finding pirated mp3s on the site. After extensive issues with copyright laws and a government crackdown on stealing intellectual property, Baidu Music has become a less valuable asset.
Taihe adds an air of legitimacy to Baidu Music, bringing hundreds of thousands of recording licenses to the table. Suddenly, Baidu Music is a competitive force in the still relatively nascent market of legitimate digital music sales in China.
The Chinese digital music market is quite small due largely to widespread piracy. Last year, Chinese spent just $91 million on digital music. By comparison, North Americans spent $3.5 billion on digital music last year. But a study published by China Music Industry Committee in 2012 estimated the total value of the digital music sector in China at 30 billion yuan (about $4.7 billion), with just 3% going to legitimate sources.
Taking steps to offer legal alternatives to piracy will be key to transitioning those yuan from piracy portals to legal music portals. Baidu is certainly leading in users, but it's not clear how many of its users were there for the potential free access to music. As Baidu closes more holes, it must open legitimate avenues to digital downloads and streams. The tie-up with Taihe is a good step that could also provide exclusive content over Tencent and Apple.
Not enough to stop Apple
In all likelihood, the move won't stop Apple from becoming one of the more popular legitimate music services in China. Its established user base and competitive pricing should be enough for it to top competing services like QQ Music and Baidu Music.
We've seen competitors offer exclusive streaming access to music in the United States from Tidal and Spotify, and neither stopped Apple from quickly accumulating 6.5 million paid subscribers. With the potential for significant growth in the Chinese digital music market, Apple is getting in at just the right time.
That said, Baidu still has a significant opportunity as well. As mentioned, the market is set to expand as the government cracks down on piracy and more legitimate digital music services come online. The tie-up with Taihe and its existing 150 million users give it a distinct advantage in capturing a large portion of the market.
Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.