IP Theft in China – Cost of Doing Business or Barrier to Entry?

IP theft in China is not going away, and Western firms doing business in China have to plan accordingly.

Westerners considering doing business in China have to plan on someone making a play for your IP. It’s not a matter of “if”, but “when” – and “who”. If your technology is any good, someone in your China supply chain is going to try to access it. It may be a partner – but it could also be a distributor, a sales manager, an engineer, a supplier, or even a client or customer. If someone doesn’t try to steal your designs and ideas, then something is wrong with your product or process.

When you consider the dangers of IP theft, don’t confine your thinking too narrowly to technology or patents – it can be copyrighted material, trademarks, logos, brands, business process, sales material, look & feel design elements and everything else. (Westerners in China used to tell stories of seeing their own likeness – either random photos or profile pictures from the internet – appropriated for use in advertisements and promotional material. Imagine driving to work and seeing your own face on a billboard hawking a product you’ve never heard of.

Isn’t the situation getting better? People who matter are definitely saying more encouraging things than they did a decade ago, but IP theft is still the rule rather than the exception. Our good friend from across the water, Seamus Grimes – research professor in Social Sciences and Public Policy at the NUI Galway, recently gave an interview to TechinAsia.com in an article titled, “The China R&D Dilemma for Foreign Tech Companies.” Seamus said,

“There are widespread concerns about IP in China, and at the same time there is general acknowledgement among foreign companies that progress is being made, particularly in relation to the IP regime which has been put in place. The difficulty lies with implementation and judicial independence. There is a strong culture of copying and reengineering products by Chinese companies and changing this culture will take considerable time.”

If you are a Fortune 100 company with the legal resources of a Disney or Apple, your IP protections plans can include a sustained legal & political lobbying campaign – but for most businesses entering the China market your choices are a good deal simpler. There are really only two practical approaches to IP theft in China, and you have to decide which applies to your situation. For some Western businesses, IP theft is a cost of doing business. For others, it should be a serious barrier to entry. The trick is to know which one applies to your business – and bake it into your China strategy from the first day of planning.

Cost of Doing Business.
Some companies are best off taking a CODB approach. You know your technology will get stolen, and you plan accordingly. If your business model involves regularly scheduled upgrades or seasonal lines, you can even turn this to your advantage – as have haute couture fashion houses and hi-tech companies like Apple. The snobbery of upscale Chinese consumers acts as a self-policing mechanism – no one who matters would want to be caught with a fake or an out-of-season version of a hot product.

Another approach is to release trailing-edge technologies that are a year or two behind the products being sold in the US or Europe. This used to be more successful when Chinese consumers were less sophisticated and had less to spend, but nowadays this is a higher risk strategy. Auto companies can still get away with it – electronics companies cannot. It’s simply not done in the fashion world.

A lucky few have actually benefited from China’s rampant piracy and counterfeiting – at least in terms of branding and marketing… One of the trends that even Megatrends author John Naisbitt couldn’t foresee was that his book would be a million-seller and he would be a household name across the PRC years before a single copy of his work could be legally sold. Microsoft has lost untold millions in product sales – but thanks to the industrious work of small-scale pirates throughout China, MS Windows and Office are hands-down market leaders. Less apparent but possibly more significant is that fact that Microsoft doesn’t have a single viable Chinese competitor …anymore. Old China hands may remember a Taiwanese upstart from the 1990s called ChinaStar that did much the same thing as Office, but cost about 20% what a legal copy of the Microsoft software suite cost. If not for rampant piracy, Microsoft might have had to contend with its own version of Huawei, HTC or Lenovo.

How can you decide if your firm should consider IP theft a cost of doing business?

  • You are constantly rolling out new products or new versions of existing products.   Example: Apple iPad
  • You are a fashion or technology products that regularly get upgraded.  Example: Fashion brands, autos
  • You are ready willing and able to mount huge legal challenges   Example: Disney

Barrier to Entry
There are many industries with IP theft is not a cost, but an existential threat to your business. As the Chinese economy develops and more money is spent on services relative to products, IP theft takes on new meaning. Counterfeits of physical objects can eventually be detected – pirating digital goods or services often can’t be. If you are in a “knowledge business” such as consulting or software, then once someone has your IP they have your competitive advantage. There was a time when you had to worry about IP theft harming your ability to sell into the China market – but now the threat has gone international and your home markets are in jeopardy. When Chinese firms helped themselves to European, Canadian and Japanese maglev rail technology, it was a blow to the incumbents’ China plans. But now that China is selling complete high-speed rail systems in major markets around the world, the true extent of the damage is just being revealed.

<How can you tell if your company should consider IP theft a barrier to entry?

  • You are in a business where the learning curve is steep for the Chinese side and they won’t need you once they have mastered 70% of your technology.
  • One of the main requirements for doing business with Chinese partners is teaching them the technology or soft-skills needed to sell your products or services in China.
  • The design is the product.
  • You are delivering cookie-cutter services to Chinese end-users.
  • There is low brand identity or obvious differentiation between firms in your industry.
  • You are providing value-added services to an SOE or government bureau that will in turn resell the service within China.

I was recently called by a US engineering firm that presented me with a deal that they had been offered. A subsidiary of a giant SOE in a highly protected PRC “Pillar Industry”  wanted the US consultant to develop a specialized version of a sophisticated piece of production equipment. The Chinese firm’s offer was to enter into a JV with the American consultant and split profits from sales within China.

The representative of the US firm asked me what I thought of the proposal. I considered my answer for a moment – there was so much wrong with this plan that I didn’t know where to begin. To their credit, the US consultants seemed to know how seriously flawed this plan was, but thought that there might be an angle they could play to protect their IP.

There wasn’t – and I told them that the more they talked to the Chinese side, the weaker their position would be. Chinese negotiators know that Westerners are wary of IP theft, and have become adept at gleaning little chunks of valuable data from seemingly casual pre-negotiation conversations.

Next: Protecting IP through proper deal structure.

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