IP Theft in China – Cost of Doing Business or Barrier to Entry? Part 2: Protecting IP through proper deal structure.

When it comes to IP protection in China, the key is to make your Chinese partners think they will profit more with you than without you.

International negotiators generally agree that contracts are of limited value for protecting IP in China – and then only if you are willing and able to litigate. Guanxi is more an obligation than protection. Mianzi, or Face, is a humorous punch-line when it comes to ensuring compliance from a Chinese partner.

So what does work? More often than not, proper deal structure is you first, last and only hope. The basic goal of a Chinese agreement should be to keep your partner engaged, honest and committed. But the traditional Western practice of adding a few penalty clauses and bonus options to a boilerplate agreement isn’t going to cut it in China. Chinese deal structure is strategic – not tactical. You have to start thinking about compliance and IP protections early – and often in novel ways.

What’s wrong with traditional risk management?
As I wrote in my recent book, The Fragile Bridge: Conflict Management in Chinese Business  – if you hand a Chinese negotiator a thick contract with penalty clauses and requirements, he just sees a rule book for a game he plans on winning. This approach works just fine in a US courtroom, but it will harm your interests in China because it undermines trust and demonstrates what a poor long-term partner you’ll be. The best negotiators in China prefer short, simple contracts and well-designed deal structures. Remember that IP theft and dissolving the partnership usually go hand-in-hand in China. They not only want your designs and technology – they want you to hit the road. You have to write an agreement where the Chinese side serves their own self-interest by keeping you around.

The easiest IP to protect is the kind that has an expiration date. Fashion houses, international auto companies, media/entertainment producers like Disney and hi-tech brands that depend on well-publicized new releases are the businesses that have the most leverage. Sure – Disney, Apple and Volkswagen will get counterfeited more in China than in the West, but at least their high-end business and official partners are usually pretty secure. You can’t expect your China business to be 100% water-tight, but you can avoid existential threats like the ones that sunk Danone and other famous fails.

5 Rules for IP protecting deal structures in China.

  1.  Have more to offer. In America, the tough negotiators say, “what have you done for me lately?” In China, even the nice guys say, “what will you do for me tomorrow?” Chinese negotiators are forward looking – in both the good way and the bad way. The good news is that they base all business decisions on what is yet to come, so you always have another chance at success. The bad news is that they don’t display much loyalty. Always be prepared to enlarge the deal with new technology, markets or opportunities. There is no autopilot switch on Chinese relationships – you must be prepared to continually prime the pump.
  2. Rising payout. Chinese negotiators are more sensitive to opportunity cost than Westerners – and less sensitive to last quarter’s sales record. Remember – the Chinese use cost-cutting as a tactical weapon for acquiring business and then try to beat down their own costs. This has a diminishing effectiveness, so there’s a good chance your partners in China really aren’t earning much per transaction. If the payout stays level, they may be dying from the inside out if inflation and costs are eating away at their tiny margin. Good negotiators find ways to incentivize Chinese partners with rising payouts – not just more business as stable rates.
  3. Know your own competitive advantage. Within a few months, the Chinese side will have figured out how to manufacture your OEM product or market your brand within China. That’s means your competitive value within the partnership will be short lived and you will outlive your usefulness very quickly. If you want to keep the Chinese side engaged and loyal to the partnership, you had better have some way of continuously proving your worth. You have to be strong where they are weak, and for most Westerners that means new product development, new technology, new models or brand improvements, and international markets.
  4. Keep something in reserve. Don’t be too quick to promise exclusivity or give away your best technology. The auto industry and other high-tech manufacturers only make older or lagging-edge technology available to Chinese partners. The same goes for international marketing agreements, exclusivity, and investment. During the guanxi-building phase of the relationship, Westerners have a bad habit of promising the world. They think that because they verbally tied future benefits to specific business conditions they are safe – but Chinese negotiators tend to hear what they want to. If you said that an exclusive partnership was contingent on selling 200,000 units for 3 consecutive months at a profit margin of 12% and expanding to 5 predetermined key markets –all they will admit to remembering is exclusivity. Use boozy relationship-building banquets to find out what their goals and hopes are – not to act like the rich uncle trying to buy their love and respect.
  5. Don’t bother with the wrong deal. Anything involving best effort sales, exclusive rights or co-developing a new technology for sale to Chinese third-parties is a non-starter. You’ve got to make it easier and more profitable for them to not steal from you. That means helping them to avoid temptation. Any deal that is A) too good to be true, or B) clear on your up-front obligations but murky on your payout is worse than a waste of time. Get out of there. Even if you have the brains not to sign an agreement, you are still coaching your new competition.

The bottom line is that the best negotiators in China are withholding – they always have a lot to offer but are slow to deliver. Don’t make promises – any incentive or technology you mention becomes an iron-clad commitment. But if you can find ways of subtly determining what they care about and making it known that you might consider someday discussing the possibility of negotiating about when you might be persuaded to share it – well, then you have something real.

IP Theft in China – Cost of Doing Business or Barrier to Entry? Part 1


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