Beyond the Great Wall: Intellectual Property Strategies for Chinese

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<ul><li><p>Report</p><p>Beyond the Great WallIntellectual Property Strategies </p><p>for Chinese Companies</p></li><li><p>Since its founding in 1963, The Boston Consulting Group has focused on helping clients achieve competitive advantage. Our firm believes that best practices or benchmarks are rarely enough to create lasting value and that positive change requires new insight into economics and markets and the organizational dynamics to chart and deliver on winning strategies. We consider every assignment to be a unique set of opportunities and constraints for which no standard solution will be adequate. BCG has 63 offices in 37 countries and serves companies in all industries and markets. For further information, please visit our Web site at www.bcg.com.</p></li><li><p>Beyond the Great WallIntellectual Property Strategies </p><p>for Chinese Companies</p><p>David MichaelCollins Qian</p><p>Vladislav BoutenkoRalph EckardtMark Blaxill</p><p>January 2007</p><p>www.bcg.com</p></li><li><p> The Boston Consulting Group, Inc. 2007. All rights reserved.</p><p>For information or permission to reprint, please contact BCG at:E-mail: bcg-info@bcg.comFax: +1 617 973 1339, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. Exchange Place Boston, MA 02109 USA</p></li><li><p>Beyond the Great Wall </p><p>Note to the Reader 4</p><p>Executive Summary 5</p><p>Competing on the World Stage 6</p><p>Understanding the Five Phases of IP Development 8</p><p>Phase 1: Driving Growth Through Exports 8</p><p>Phase 2: Climbing the Value Ladder 9</p><p>Phase : Paying the Price 11</p><p>Phase 4: Getting Serious About Intellectual Property 14</p><p>Phase 5: Profiting from Intellectual Property 19</p><p>Closing the IP Gap 21</p><p>For Further Reading 22</p><p>Contents</p></li><li><p>4</p><p>This research report is a joint product of the Strategy practice and the Technology and Communications practice of The Boston Consulting Group. The authors welcome your questions and feedback.</p><p>For Further ContactDavid Michael BCG Beijing+86 10 6567 5755michael.david@bcg.com</p><p>Collins QianBCG Shanghai+86 21 6375 8618qian.collins@bcg.com</p><p>Vladislav BoutenkoBCG Moscow+7 495 258 34 34boutenko.vladislav@bcg.com</p><p>AcknowledgmentsThe authors acknowledge the contributions of BCGs global experts in strategy and in technology and communications. They extend special thanks to David Dean, a senior vice president and director in BCGs Munich office and the former global leader of the Technology and Communications practice, and to Michael Deimler, a senior vice president and director in BCGs Atlanta office and global leader of the Strategy practice.</p><p>In addition, the authors would like to thank Amit Nisenbaum, project leader; Daniel Maloney, associate; and Laura Rees, associate. These colleagues formed the project team that supported this research. Finally, the authors express gratitude to the following members of the BCG editorial and production staff: Barry Adler, Katherine Andrews, Gary Callahan, Matthew Clark, Mary DeVience, Elyse Friedman, Kim Friedman, and Mark Voorhees.</p><p>David MichaelSenior Vice President and Director</p><p>Collins QianVice President and Director</p><p>Vladislav BoutenkoVice President and Director</p><p>Ralph EckardtFormer Manager</p><p>Mark BlaxillFormer Senior Vice President</p><p>Note to the Reader</p></li><li><p>Beyond the Great Wall 5</p><p>Over the past five years, a rapid rise in exports has driven an unprecedented level of prosperity in China, fueling the nations emergence as an eco-nomic powerhouse. To sustain its trajectory of im-pressive growth, China will become even more reli-ant on exports. That means that Chinese companies will need to become ever more sophisticated about operating in global markets. </p><p> Intellectual property (IP) strategy is one of the ar-eas in which it is most critical that Chinese compa-nies boost their sophistication. Despite rapid and well-documented improvements in the IP system within China, Chinese companies still lag behind competitors from developing and developed coun-tries in securing international protection for their proprietary knowledge.</p><p> Without strong international IP rights, Chinese companies may face exclusion from international markets, have to pay onerous royalties, or find it necessary to enter into disadvantageous partner-ships with foreign companies that have stronger IP portfolios. These consequences could stall Chinas economic growth and constrain the growth of its emerging global companies. </p><p>Chinese companies have dramatically ramped up R&amp;D spending, but they have not proportionately increased their investment in securing international IP rights.</p><p> If Chinese companies are to match the standard set by their competitors in developed countries, these businesses will need to invest 30 times more in international IP rights than they do today. The vast majority of the patents currently held by Chinese companies and inventors have been filed within China rather than in the major export </p><p>markets of the United States, Europe, and Japan. As a result, Chinese companies are entering these markets unprotected.</p><p> In their key export markets, Chinese companies are already facing a rapidly increasing number of IP challenges.</p><p> Chinese companies and industries that seek to compete globally should invest now to develop their IP strategies and capabilitiesor risk ceding advantage to competitors that move more quickly and forcefully.</p><p>China is not the first rapidly developing economy (RDE) to suffer growing pains in IP development. In their evolution, all developing economies have followed a similar path. </p><p> Developing economies move through five phases of IP development. In this report, we examine those phases, placing Chinas current position in historical context. </p><p> We examine lessons from other countries and companies, and demonstrate how China can rapidly improve its IP position. We hope that, by drawing on these lessons, Chinese companies will recognize the importance of developing superior skills in IP management and learn how to prosper beyond the Great Wall.</p><p>Executive Summary</p></li><li><p>6</p><p>Competing on theWorld Stage</p><p>S ince joining the World Trade Organiza-tion (WTO) in 2001, China has worked mightily to improve its IP system, laws, and enforcement. To date, the govern-ment has made great strides, and the country appears to be on a path toward meeting the worlds standards for IP protection. Perhaps the best evidence of this evolution is the dramatic increase in patent filings by Chinese companies and inventors. In 2005 Chinese entities filed more than 93,000 patent applicationsmore than triple the number filed in 2001with the State Intellec-tual Property Office.</p><p>At the same time, however, overseas patent fil-ings by Chinese companies and inventors remain at negligible levels. In 2005, for example, Chinese entities submitted fewer than 2,200 patent appli-cations to the U.S. Patent and Trademark Office. That number is a tiny fraction of the 17,219 patent applications filed there by South Korean inventors and the 71,994 filed by Japanese investors. And the Chinese have been even less prolific in the export markets of Japan and Europe. </p><p>Although a patent count is an imprecise measure of value, the disparity between Chinas economic stature and its global IP standing is nonetheless striking. When patent applications worldwide are classified by the countries where the applicants re-side, China accounts for only 0.5 percent of the ap-plications filed by nonresidents in 2005. This per-formance ranked China eighteenth, just behind </p><p>Austria. (See Exhibit 1.) By any measurement of IP rights, Chinas performance is significantly subpar while its growth over the past five years is unparal-leled among large economies. </p><p>Chinas rapid growth to the worlds sixth-largest economy has been powered largely by dramatic increases in exports, an experience typical among RDEs. Asias four little dragonsHong Kong, Singapore, South Korea, and Taiwanall rose to prominence on the shoulders of exports, as did Ja-pan before them.</p><p>In fact, China is the worlds second-largest export-ing nation, ranking behind only the United States. Since joining the WTO, Chinas exports have more than doubled to nearly $600 billion, with exports catapulting from 20 percent of gross domestic product (GDP) in 2001 to 37 percent in 2005. (See Exhibit 2.) Amazingly, exports from Chinese com-panies are growing at an annual rate that is six times as fast as that of global GDP. </p><p>There is, however, a downside to export growth. As Chinese companies become increasingly depen-dent on overseas sales, the need for these compa-nies to operate in the most highly developed IP re-gimes in the world is also growing. During the first eight months of 2006, for example, nearly half of Chinas exports went to the United States, Europe, and Japan. In these attractive markets, Chinese companies face fierce competition and a sizable IP disadvantage.</p></li><li><p>Beyond the Great Wall </p><p>to exclude the Chinese companies from the mar-kets or to exact profit-draining royalty payments. These companies can avoid this continued peril only by cultivating world-class capabilities in ac-quiring, developing, and managing intellectual property. </p><p>When challenged by Chinese competitors, incum-bent companies in developed countries can draw on their well-established IP rights to constrain the growth and profitability of the new entrants. In recent months, for example, Chinese companies from sectors as disparate as floor coverings and consumer electronics have faced patent infringe-ment claims in overseas markets. The claims aim </p><p>Population</p><p>GDP</p><p>Exports</p><p>China ranks high in global demographicand economic standings</p><p>Chinese ownership of internationalIP rights remains low</p><p>Patent applications filedby nonresidents</p><p>Rank Country % of total1 China 22.12 India 18.13 United States 5.0</p><p>Rank Country % of total1 United States 9.12 China 6.63 Japan 6.3</p><p>Rank Country % of total5 United Kingdom 4.16 China 4.07 Italy 4.0 </p><p>Rank Country % of total17 Austria 0.618 China 0.519 Spain 0.4</p><p>01995 2000 2005</p><p>0</p><p>5</p><p>$billions %</p><p>3,000</p><p>2,500</p><p>2,000</p><p>1,500</p><p>1,000</p><p>500</p><p>35</p><p>30</p><p>25</p><p>20</p><p>15</p><p>10</p><p>40</p><p>Exports GDP minus exports </p><p>Exports as a percentage of GDP</p><p>Exhibit 1: Chinas IP Development Lags Behind Its Economic Development</p><p>Sources: Economist Intelligence Unit; OECD; World Intellectual Property Organization, WIPO Patent Report: Statistics on Worldwide Patent Activities, 2006 Edition.Note: Export figures are from 2004; patent data are from 2005.</p><p>Exhibit 2: Strong Growth in Exports Is Driving Chinas Economic Success</p><p>Sources: Economist Intelligence Unit; BCG analysis.Note: GDP and export figures are denominated in 1996 U.S. dollars.</p></li><li><p>8</p><p>Understanding the Five Phases of IP Development</p><p>Although daunting, the challenges that China faces in IP development are hardly new. In addressing them, there-fore, Chinese companies do not need to reinvent the wheel. In recent dec-</p><p>ades, Japan, Taiwan, and South Korea have trav-eled down a similar path of IP development. In fact, all developing economies make the same journey. Even the United States, which in the 1800s relied heavily on European technologies to build its in-dustrial base, has followed a similar evolutionary road. By learning the lessons of history, Chinese companies can avoid many of the pitfalls that nor-mally confound RDEs. Furthermore, by mastering IP strategy, they can transform a current weakness into a source of enduring advantage.</p><p>Our research has found that developing econo-mies and their leading companies move through five common phases of IP development: driving growth through exports, climbing the value ladder, paying the price, getting serious about intellectual property, and profiting from intellectual property. (See Exhibit 3.) </p><p>Phase 1: Driving Growth Through Exports </p><p>When they first begin to compete in world mar-kets, developing economies rely heavily on their abundant natural resources and low labor costs. </p><p>Export-led growth serves as the economic engine during Phase 1, but the exported productsas well as the methods employed to manufacture themare decidedly low-tech. At this early stage, manufacturing typically entails either the final as-sembly of imported components or labor-intensive production that requires low levels of capital. The garment industry offers an excellent example of this phenomenon.</p><p>When developing economies are still nascent, they are technology poor. That is, they invest little in R&amp;D and own virtually no intellectual property. Since exports are basic rather than high-tech, com-panies do not needand rarely acquireinterna-tional protection for intellectual property.</p><p>Less than 50 years ago, Japan was in Phase 1. Today it is hard to believe that the phrase Made in Japan once served as shorthand for low tech-nology and poor quality. In the 1960s and 1970s, however, Japans leading companies quickly be-came dissatisfied with this state of affairs and de-veloped higher aspirations. In recent years, other developing countries have followed suit, investing heavily and reconfiguring their industrial policies so that they could enter the next phase of IP de-velopment.</p><p>Even though the exports of developing economies may begin to grow rapidly during this phase, these countries continue to capture only minimal value. Most of the gains flow either to foreign companies, </p></li><li><p>Beyond the Great Wall 9</p><p>which develop, design, and market the products that incorporate the sourced components, or to customers, who benefit from lower prices. In Chi-na, for example, more than half of the countrys ex-ports are currently produced by enterprises at least partly owned by foreign interests, and less than 10 percent are shipped under Chinese brands.</p><p>Phase 2: Climbing the Value Ladder </p><p>As companies in developing economies gain first-hand experience in exporting and manufacturing, they invariably find ways to add and capture great-er value in the global marketplace. These players quickly learn that low labor costs alone cannot provide a solid foundation for sustainable success. Instead, they ascend the value ladder by mastering more high-tech manufacturing methods; produc-ing more complex components; and then develop-ing, designing, and marketing their own products.</p><p>Companies often enter Phase 2 by copying the products and emulating manufacturing methods deployed by the foreign players that purchase </p><p>their exports. Eventually, the young companies begin to invest in R&amp;D and may even begin to ac-quire some intellectual property. This type of evo-lution has been exemplified in South Korea over the past several decades. Through the late 1970s and throughout the 1980s, high-tech products as a share of South Koreas overall exports climbed, rising from the high single digits to 15 percent in 1989. Over the next decade, the mix of exports shifted dramatically toward high-tech products, more than doubling to 32 percent by 1999. </p><p>Today China is beginning to exhibit exactly the same pattern. High-tech products as a percent-age of exports rose from single digits in the 1990s to 14 percent when China entered the WTO in 2001. By 2004 the share of high-tech prod- ucts doubled to about 28 percent of total exports, and in 2005 Chinas high-tech exports totaled $1...</p></li></ul>