Beyond the Great Wall: Intellectual Property Strategies for Chinese Companies

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This was one of my favorite projects at BCG. Did some really neat research into the impact of IP on economic development and built a strategic framework for developing nations as they come to participate with the global IP marketplace.

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<ul><li> 1. ReportBeyond the Great Wall Intellectual Property Strategies for Chinese Companies</li></ul><p> 2. Since its founding in 1963, The Boston Consulting Group has focusedon helping clients achieve competitive advantage. Our firm believesthat best practices or benchmarks are rarely enough to create lastingvalue and that positive change requires new insight into economicsand markets and the organizational dynamics to chart and deliver onwinning strategies. We consider every assignment to be a unique setof opportunities and constraints for which no standard solution willbe adequate. BCG has 63 offices in 37 countries and serves companiesin all industries and markets. For further information, please visit ourWeb site at www.bcg.com. 3. Beyondthe Great WallIntellectual Property Strategiesfor Chinese Companies David MichaelCollins Qian Vladislav Boutenko Ralph EckardtMark Blaxill January 2007www.bcg.com 4. The Boston Consulting Group, Inc. 2007. All rights reserved.For information or permission to reprint, please contact BCG at:E-mail: bcg-info@bcg.comFax: +1 617 973 1339, attention BCG/PermissionsMail: BCG/PermissionsThe Boston Consulting Group, Inc.Exchange PlaceBoston, MA 02109USA 5. ContentsNote to the Reader4Executive Summary 5Competing on the World Stage6Understanding the Five Phases of IP Development 8Phase 1: Driving Growth Through Exports 8Phase 2: Climbing the Value Ladder 9Phase 3: Paying the Price11Phase 4: Getting Serious About Intellectual Property 14Phase 5: Profiting from Intellectual Property 19Closing the IP Gap 21For Further Reading22 Beyond the Great Wall 6. Note to the ReaderThis research report is a joint product For Further ContactAcknowledgmentsof the Strategy practice and theDavid MichaelThe authors acknowledge theBCG BeijingTechnology and Communications +86 10 6567 5755 contributions of BCGs global expertspractice of The Boston Consulting michael.david@bcg.comin strategy and in technology andGroup. The authors welcome yourcommunications. They extend specialquestions and feedback. Collins Qian thanks to David Dean, a senior viceBCG Shanghai+86 21 6375 8618 president and director in BCGs Munichqian.collins@bcg.com office and the former global leader of the Technology and CommunicationsVladislav Boutenko practice, and to Michael Deimler, aBCG Moscow+7 495 258 34 34 senior vice president and director inboutenko.vladislav@bcg.com BCGs Atlanta office and global leader of the Strategy practice. 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. David Michael Senior Vice President and Director Collins Qian Vice President and Director Vladislav Boutenko Vice President and Director Ralph Eckardt Former Manager Mark Blaxill Former Senior Vice President 7. Executive SummaryOver the past five years, a rapid rise in exports has markets of the United States, Europe, and Japan.driven an unprecedented level of prosperity inAs a result, Chinese companies are entering theseChina, fueling the nations emergence as an eco-markets unprotected.nomic powerhouse. To sustain its trajectory of im-pressive growth, China will become even more reli- n their key export markets, Chinese companies Iant on exports. That means that Chinese companiesare already facing a rapidly increasing number ofwill need to become ever more sophisticated aboutIP challenges.operating in global markets. hinese companies and industries that seek to C ntellectual property (IP) strategy is one of the ar-Icompete globally should invest now to developeas in which it is most critical that Chinese compa- their IP strategies and capabilitiesor risk cedingnies boost their sophistication. Despite rapid and advantage to competitors that move more quicklywell-documented improvements in the IP systemand forcefully.within China, Chinese companies still lag behindcompetitors from developing and developed coun-China is not the first rapidly developing economytries in securing international protection for their (RDE) to suffer growing pains in IP development.proprietary knowledge. In their evolution, all developing economies have followed a similar path. ithout strong international IP rights, ChineseWcompanies may face exclusion from international eveloping economies move through five phases Dmarkets, have to pay onerous royalties, or find it of IP development. In this report, we examinenecessary to enter into disadvantageous partner- those phases, placing Chinas current position inships with foreign companies that have stronger IP historical context.portfolios. These consequences could stall Chinaseconomic growth and constrain the growth of its e examine lessons from other countries and Wemerging global companies. companies, and demonstrate how China can rapidly improve its IP position. We hope that, byChinese companies have dramatically ramped updrawing on these lessons, Chinese companies willR&amp;D spending, but they have not proportionatelyrecognize the importance of developing superiorincreased their investment in securing international skills in IP management and learn how to prosperIP rights. beyond the Great Wall. f Chinese companies are to match the standardIset by their competitors in developed countries,these businesses will need to invest 30 times morein international IP rights than they do today.The vast majority of the patents currently heldby Chinese companies and inventors have beenfiled within China rather than in the major exportBeyond the Great Wall 8. Competing on theWorld StageSince joining the World Trade Organiza- Austria. (See Exhibit 1.) By any measurement of IPtion (WTO) in 2001, China has worked rights, Chinas performance is significantly subparmightily to improve its IP system, laws, while its growth over the past five years is unparal-and enforcement. To date, the govern-leled among large economies.ment has made great strides, and thecountry appears to be on a path toward meeting Chinas rapid growth to the worlds sixth-largestthe worlds standards for IP protection. Perhaps economy has been powered largely by dramaticthe best evidence of this evolution is the dramaticincreases in exports, an experience typical amongincrease in patent filings by Chinese companiesRDEs. Asias four little dragonsHong Kong,and inventors. In 2005 Chinese entities filed more Singapore, South Korea, and Taiwanall rose tothan 93,000 patent applicationsmore than triple prominence on the shoulders of exports, as did Ja-the number filed in 2001with the State Intellec-pan before them.tual Property Office. In fact, China is the worlds second-largest export-At the same time, however, overseas patent fil-ing nation, ranking behind only the United States.ings by Chinese companies and inventors remain Since joining the WTO, Chinas exports have moreat negligible levels. In 2005, for example, Chinesethan doubled to nearly $600 billion, with exportsentities submitted fewer than 2,200 patent appli-catapulting from 20 percent of gross domesticcations to the U.S. Patent and Trademark Office. product (GDP) in 2001 to 37 percent in 2005. (SeeThat number is a tiny fraction of the 17,219 patentExhibit 2.) Amazingly, exports from Chinese com-applications filed there by South Korean inventors panies are growing at an annual rate that is sixand the 71,994 filed by Japanese investors. And thetimes as fast as that of global GDP.Chinese have been even less prolific in the exportmarkets of Japan and Europe. There is, however, a downside to export growth. As Chinese companies become increasingly depen-Although a patent count is an imprecise measuredent on overseas sales, the need for these compa-of value, the disparity between Chinas economic nies to operate in the most highly developed IP re-stature and its global IP standing is nonethelessgimes in the world is also growing. During the firststriking. When patent applications worldwide are eight months of 2006, for example, nearly half ofclassified by the countries where the applicants re- Chinas exports went to the United States, Europe,side, China accounts for only 0.5 percent of the ap- and Japan. In these attractive markets, Chineseplications filed by nonresidents in 2005. This per-companies face fierce competition and a sizable IPformance ranked China eighteenth, just behinddisadvantage. 9. When challenged by Chinese competitors, incum- to exclude the Chinese companies from the mar-bent companies in developed countries can draw kets or to exact profit-draining royalty payments.on their well-established IP rights to constrain the These companies can avoid this continued perilgrowth and profitability of the new entrants. In only by cultivating world-class capabilities in ac-recent months, for example, Chinese companiesquiring, developing, and managing intellectualfrom sectors as disparate as floor coverings and property.consumer electronics have faced patent infringe-ment claims in overseas markets. The claims aimExhibit 1: Chinas IP Development Lags Exhibit 2: Strong Growth in Exports IsBehind Its Economic DevelopmentDriving Chinas Economic SuccessChina ranks high in global demographicGDP minus exportsExports and economic standings Exports as a percentage of GDP Population $billions%Rank Country % of total1China22.13,000 402India18.13United States 5.0 Exports35Rank Country % of total 2,5001United States 9.12China 6.6303Japan 6.3GDP2,000Rank Country % of total255United Kingdom4.16China 4.07Italy 4.01,500 20151,000Chinese ownership of internationalIP rights remains low10Patent applications ledby nonresidents 500RankCountry % of total517Austria 0.618China 0.519Spain 0.4 00Sources: Economist Intelligence Unit; OECD; World Intellectual Property19952000 2005Organization, WIPO Patent Report: Statistics on Worldwide Patent Activities,2006 Edition.Sources: Economist Intelligence Unit; BCG analysis.Note: Export figures are from 2004; patent data are from 2005. Note: GDP and export figures are denominated in 1996 U.S. dollars.Beyond the Great Wall 10. Understanding the Five Phases ofIP DevelopmentAlthough daunting, the challenges thatExport-led growth serves as the economic engineChina faces in IP development areduring Phase 1, but the exported productsashardly new. In addressing them, there- well as the methods employed to manufacturefore, Chinese companies do not needthemare decidedly low-tech. At this early stage,to reinvent the wheel. In recent dec-manufacturing typically entails either the final as-ades, Japan, Taiwan, and South Korea have trav-sembly of imported components or labor-intensiveeled down a similar path of IP development. In fact, production that requires low levels of capital. Theall developing economies make the same journey.garment industry offers an excellent example ofEven the United States, which in the 1800s reliedthis phenomenon.heavily on European technologies to build its in-dustrial base, has followed a similar evolutionary When developing economies are still nascent, theyroad. By learning the lessons of history, Chineseare technology poor. That is, they invest little incompanies can avoid many of the pitfalls that nor- R&amp;D and own virtually no intellectual property.mally confound RDEs. Furthermore, by mastering Since exports are basic rather than high-tech, com-IP strategy, they can transform a current weakness panies do not needand rarely acquireinterna-into a source of enduring advantage. tional protection for intellectual property.Our research has found that developing econo-Less than 50 years ago, Japan was in Phase 1.mies and their leading companies move throughToday it is hard to believe that the phrase Madefive common phases of IP development: drivingin Japan once served as shorthand for low tech-growth through exports, climbing the value ladder, nology and poor quality. In the 1960s and 1970s,paying the price, getting serious about intellectual however, Japans leading companies quickly be-property, and profiting from intellectual property.came dissatisfied with this state of affairs and de-(See Exhibit 3.) veloped higher aspirations. In recent years, other developing countries have followed suit, investing heavily and reconfiguring their industrial policiesPhase 1: Driving Growthso that they could enter the next phase of IP de- velopment.Through Exports Even though the exports of developing economiesWhen they first begin to compete in world mar- may begin to grow rapidly during this phase, thesekets, developing economies rely heavily on their countries continue to capture only minimal value.abundant natural resources and low labor costs.Most of the gains flow either to foreign companies, 11. which develop, design, and market the productstheir exports. Eventually, the young companiesthat incorporate the sourced components, or tobegin to invest in R&amp;D and may even begin to ac-customers, who benefit from lower prices. In Chi- quire some intellectual property. This type of evo-na, for example, more than half of the countrys ex-lution has been exemplified in South Korea overports are currently produced by enterprises at leastthe past several decades. Through the late 1970spartly owned by foreign interests, and less than 10 and throughout the 1980s, high-tech products aspercent are shipped under Chinese brands. By learninga share of South Koreas overall exports climbed,rising from the high single digits to 15 percent in1989. Over the next decade, the mix of exportsPhase 2: Climbing the the lessons ofshifted dramatically toward high-tech products,more than doubling to 32 percent by 1999.Value Ladder history, Chinacan avoidToday China is beginning to exhibit exactly theAs companies in developing economies gain first- many of thesame pattern. High-tech products as a percent-hand experience in exporting and manufacturing,pitfalls thatage of exports rose from single digits in the 1990sthey invariably find ways to add and capture great- to 14 percent when China entered the WTOer value in the global marketplace. These players normallyin 2001. By 2004 the share of high-tech prod-quickly learn that low labor costs alone cannot confounducts doubled to about 28 percent of total exports,provide a solid foundation for sustainable success. and in 2005 Chinas high-tech exports totaled developingInstead, they ascend the value ladder by mastering$195 billion. Given South Koreas experiences, themore high-tech manufacturing methods; produc-economies. proportion of Chinas products that are high-teching more complex components; and then develop-is likely to continue growing for at least the nexting, designing, and marketing their own products. five years.Companies often enter Phase 2 by copying theChina has also seen domestic corporat...</p>