Report
Beyond the Great WallIntellectual Property Strategies
for Chinese Companies
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Beyond the Great WallIntellectual Property Strategies
for Chinese Companies
David MichaelCollins Qian
Vladislav BoutenkoRalph EckardtMark Blaxill
January 2007
www.bcg.com
© The Boston Consulting Group, Inc. 2007. All rights reserved.
For information or permission to reprint, please contact BCG at:E-mail: [email protected]: +1 617 973 1339, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. Exchange Place Boston, MA 02109 USA
Beyond the Great Wall �
Note to the Reader 4
Executive Summary 5
Competing on the World Stage 6
Understanding the Five Phases of IP Development 8
Phase 1: Driving Growth Through Exports 8
Phase 2: Climbing the Value Ladder 9
Phase �: Paying the Price 11
Phase 4: Getting Serious About Intellectual Property 14
Phase 5: Profiting from Intellectual Property 19
Closing the IP Gap 21
For Further Reading 22
Contents
4
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.
For Further ContactDavid Michael BCG Beijing+86 10 6567 [email protected]
Collins QianBCG Shanghai+86 21 6375 [email protected]
Vladislav BoutenkoBCG Moscow+7 495 258 34 [email protected]
AcknowledgmentsThe authors acknowledge the contributions of BCG’s global experts in strategy and in technology and communications. They extend special thanks to David Dean, a senior vice president and director in BCG’s Munich office and the former global leader of the Technology and Communications practice, and to Michael Deimler, a senior vice president and director in BCG’s 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 MichaelSenior Vice President and Director
Collins QianVice President and Director
Vladislav BoutenkoVice President and Director
Ralph EckardtFormer Manager
Mark BlaxillFormer Senior Vice President
Note to the Reader
Beyond the Great Wall 5
Over the past five years, a rapid rise in exports has driven an unprecedented level of prosperity in China, fueling the nation’s 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.
• 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.
• 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 China’s economic growth and constrain the growth of its emerging global companies.
Chinese companies have dramatically ramped up R&D spending, but they have not proportionately increased their investment in securing international IP rights.
• 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
markets of the United States, Europe, and Japan. As a result, Chinese companies are entering these markets unprotected.
• In their key export markets, Chinese companies are already facing a rapidly increasing number of IP challenges.
• Chinese companies and industries that seek to compete globally should invest now to develop their IP strategies and capabilities—or risk ceding advantage to competitors that move more quickly and forcefully.
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.
• Developing economies move through five phases of IP development. In this report, we examine those phases, placing China’s current position in historical context.
• 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.
Executive Summary
6
Competing on theWorld Stage
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 world’s 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 applications—more than triple the number filed in 2001—with the State Intellec-tual Property Office.
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.
Although a patent count is an imprecise measure of value, the disparity between China’s 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
Austria. (See Exhibit 1.) By any measurement of IP rights, China’s performance is significantly subpar while its growth over the past five years is unparal-leled among large economies.
China’s rapid growth to the world’s sixth-largest economy has been powered largely by dramatic increases in exports, an experience typical among RDEs. Asia’s “four little dragons”—Hong Kong, Singapore, South Korea, and Taiwan—all rose to prominence on the shoulders of exports, as did Ja-pan before them.
In fact, China is the world’s second-largest export-ing nation, ranking behind only the United States. Since joining the WTO, China’s 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.
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 China’s exports went to the United States, Europe, and Japan. In these attractive markets, Chinese companies face fierce competition and a sizable IP disadvantage.
Beyond the Great Wall �
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.
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
Population
GDP
Exports
China ranks high in global demographicand economic standings
Chinese ownership of internationalIP rights remains low
Patent applications filedby nonresidents
Rank Country % of total1 China 22.12 India 18.13 United States 5.0
Rank Country % of total1 United States 9.12 China 6.63 Japan 6.3
Rank Country % of total5 United Kingdom 4.16 China 4.07 Italy 4.0
Rank Country % of total17 Austria 0.618 China 0.519 Spain 0.4
01995 2000 2005
0
5
$billions %
3,000
2,500
2,000
1,500
1,000
500
35
30
25
20
15
10
40
Exports GDP minus exports
Exports as a percentage of GDP
Exhibit 1: China’s IP Development Lags Behind Its Economic Development
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.
Exhibit 2: Strong Growth in Exports Is Driving China’s Economic Success
Sources: Economist Intelligence Unit; BCG analysis.Note: GDP and export figures are denominated in 1996 U.S. dollars.
8
Understanding the Five Phases of IP Development
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-
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.
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.)
Phase 1: Driving Growth Through Exports
When they first begin to compete in world mar-kets, developing economies rely heavily on their abundant natural resources and low labor costs.
Export-led growth serves as the economic engine during Phase 1, but the exported products—as well as the methods employed to manufacture them—are 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.
When developing economies are still nascent, they are “technology poor.” That is, they invest little in R&D and own virtually no intellectual property. Since exports are basic rather than high-tech, com-panies do not need—and rarely acquire—interna-tional protection for intellectual property.
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, Japan’s 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.
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,
Beyond the Great Wall 9
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 country’s ex-ports are currently produced by enterprises at least partly owned by foreign interests, and less than 10 percent are shipped under Chinese brands.
Phase 2: Climbing the Value Ladder
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.
Companies often enter Phase 2 by copying the products and emulating manufacturing methods deployed by the foreign players that purchase
their exports. Eventually, the young companies begin to invest in R&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 Korea’s 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.
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 China’s high-tech exports totaled $195 billion. Given South Korea’s experiences, the proportion of China’s products that are high-tech is likely to continue growing for at least the next five years.
China has also seen domestic corporate investment in R&D rise more than fivefold from $19 billion in 1994 to $97 billion in 2004. As a share of GDP,
By learning
the lessons of
history, China
can avoid
many of the
pitfalls that
normally
confound
developing
economies.
IP strength
Exports
Exports of low-tech products drive growth, exploiting the low cost of labor and materials
An increase in R&D spending and acquired knowledge drives growth in the export of higher-tech products
Companies suffer consequences when IP owners from developed nations defend their markets
Companies in developing countries invest to manage and protect their intellectual property
Companies in developing countries achieve parity and may capture advan-tage through IP rights
Phase 1: Driving growth through exports
Phase 2: Climbing the value ladder
Phase 3: Paying the price
Phase 4: Getting serious about intellectual property
Phase 5: Profiting from intellectual property
R&D spending
Net royalties paid
Exhibit 3: In Their IP Development, RDEs Follow a Common Path
Source: BCG analysis.
10
R&D spending by Chinese companies rose during this ten-year period from 3 percent to 5 percent.
Alongside R&D spending, patent applications have increased in China, but the vast majority of these applications have been filed domestically. Even though the number of overseas patent applica-tions is growing rapidly, it is minuscule compared with the number of domestic applications.
In 2004, for example, the same year Chinese en-tities filed nearly 66,000 patent applications in China, they filed fewer than 2,000 in the United States, just over 400 in the European Patent Of-fice, and about 250 in Japan. As a result, China’s increased R&D spending over the past decade has not translated into a strategically relevant increase in international protection of IP rights for Chinese companies.
Against the backdrop of China’s rapid growth in exports and its increasingly high-tech product mix, the disparity between the number of domestic and overseas patents suggests that Chinese com-panies have left themselves exposed to overseas IP problems. First, Chinese companies have obtained fewer triadic patents—that is, patents that protect the same invention in the United States, Europe, and Japan—per dollar invested in R&D than their counterparts in the developed world. (See Exhibit 4.) A triadic patent signals the importance of the innovation: owners are unlikely to invest the time and expense of filing in three jurisdictions unless they believe that an invention has commercial po-tential.
In context, this finding reveals that China’s in-vestment in triadic patents is so low relative to its R&D investment that Chinese companies would
1
IP protection1Developed countries Developing countries
100,000
10,000
1,000
100
10
10 100 1,000 10,000 100,000 1,000,000Innovation2 ($)
Investment in IP protectionis lower than in R&D
Investment in IP protectionis higher than in R&D
China
U.S.Japan
Germany
France
U.K.
Estonia
Latvia
Iceland
New ZealandHungary
Luxembourg
IrelandSingapore
NorwayCanada
DenmarkAustria
FinlandBelgium
Israel
Australia
NetherlandsSwitzerland Sweden
Italy
Lithuania RomaniaSlovak Republic
Spain
Russian FederationTaiwan
TurkeyPortugal
Czech RepublicMexico
PolandGreece
Argentina
Slovenia
South Korea
South AfricaIndia
Exhibit 4: China Has Boosted Investments in R&D, but IP Protection Has Not Kept Pace
Source: OECD, Compendium of Patent Statistics 2005.1IP protection, measured on a logarithmic scale, is based on the average number of triadic patents granted from 1996 to 2002 to residents in each country.2Innovation, measured on a logarithmic scale, is based on the average domestic corporate investment in R&D from 1995 to 2001, denominated in 2000 U.S. dollars.
Beyond the Great Wall 11
HighLow
Low
High
IP protection
IP-dependentrevenues
The target The superpower
The sharkThe minnow
With sizable revenues at risk—and insufficient IP rights to defend themselves—these players are targets for sharks and superpowers
Boasting a great deal of IP rights but also risking a great deal of sales, these players must actively deploy IP rights to protect their strong, balanced position
With few IP rights and low sales related to IP, these players are typically ignored
With extensive IP rights and little revenue at risk, these players can aggressively pursue other competitors
Exhibit 5: The IP Strategy Matrix Illustrates How Companies with IP Rights Grow Strong— and How Those Without IP Rights Become Vulnerable
Source: BCG analysis.
need to increase their investments in international IP protection by a factor of 30 in order to achieve parity with companies in developed countries. Sec-ond, China’s investments in international IP pro-tection fall well below even those of other develop-ing countries.
Other countries have been in this position. In the mid-1980s, for example, South Korea found itself in virtually the same position as China and India are in today. Yet even if their position seems un-derstandable, Chinese companies should be taking steps to boost international IP protection if they want to minimize the time they spend in the next phase—one that history has shown to be trying and difficult.
Phase �: Paying the Price
During the third phase of IP development, the dis-parity between exports and IP holdings eventually ensnares companies from less developed econo-mies. As their exports grow, these companies
appear on the radar screen of IP owners and, as outlined in BCG’s IP-strategy matrix, become vul-nerable to attack. (See Exhibit 5, and for greater detail about the matrix, see the sidebar “Sharks, Minnows, and Targets: Understanding IP Strategy” on page 12.)
The IP strategy matrix helps explain how compa-nies become exposed to IP risk. Early in their devel-opment, companies in countries such as China find themselves in the lower-left corner of the matrix. They have little intellectual property and also very low sales—in this case, export sales—at risk, and thus they are largely ignored by companies higher in the food chain. As these companies develop and move through Phase 2, their sales grow as a result, in part, of their low labor costs. Yet, as we have seen previously, their IP rights do not grow pro-portionately, and the companies find themselves in the upper-left corner of the matrix in the vul-nerable position we call the target. As the compa-nies grow, they capture market share and begin to threaten developed-country competitors, yet they lack the IP rights they need to defend themselves.
12
BCG’s IP-strategy matrix allows a company to understand and assess its relative IP position within a market or a tech-nology segment. At a conceptual level, it can help senior managers make sense of the complexities inherent in an IP domain.
The matrix consists of four quadrants. In the lower right, sharks have a strong IP position and little or no revenue at risk to an IP challenge. Often, these players buy patents on an opportunistic basis and exploit them as assets, collect-ing licensing fees rather than protecting a manufactured product or invention. Because sharks can freely assert their IP rights without having to worry about counterassertions, they can be extremely aggressive. And because they make or sell no products of their own—or at least very few—they are invulnerable to IP attacks.
In the lower left, minnows (small fish) have low sales, as well as a weak position in intellectual property. Because min-nows typically don’t pose a competitive threat, it is rarely worthwhile for an IP owner to attack them.
Some minnows, however, grow up to be targets (in the upper left of the matrix). Although these players have weak posi-tions in intellectual property just as the minnows do, more of their sales are unprotected by intellectual property. Com-panies in this position are vulnerable to IP attacks because their large size makes them worth pursuing.
Finally, superpowers, in the upper right, enjoy strong and bal-anced IP positions. In many industries, it is common for these leading companies to cross-license intellectual prop-erty with key competitors. If two companies have propor-tionately strong IP portfolios, neither can gain advantage by asserting its intellectual property. This balanced position is reminiscent of the Cold War, when the vast stockpiles of nuclear weapons held by the United States and the former Soviet Union fostered “mutually assured destruction” and kept an uneasy peace. In this same vein, when two compa-nies are capable of destroying each other through IP claims, a peace typically prevails on the patent front.
Companies can use these four simple categories to assess the IP landscape of competitors. By understanding the rela-tive position of the various players in a sector, a company can quickly identify whether it or some other competitor is the most advantaged or the most vulnerable. Managers and IP professionals can also use the IP strategy matrix as an analytical tool to assess risk, identify vulnerabilities, and find opportunities—and then set a course of action. The matrix can be useful in selecting attractive partners, iden-tifying IP assets to acquire, and determining the areas on which patenting activity should focus. BCG has developed additional proprietary methods for assessing IP strength, as well as methods for assessing how closely technologies are related and the likelihood that infringement will occur between any two patents or patent portfolios.
Sharks, Minnows, and Targets: Understanding IP Strategy
Beyond the Great Wall 1�
Elevated Costs. The market for Chinese-manu-factured DVD players vanished not because the consortium denied Chinese companies a license to their intellectual property. Rather, Chinese manu-facturers chose not to license the technology: the $20 cost per unit would have driven prices of their products prohibitively high and made them un-competitive in the marketplace.
How is it that China, a “low-cost country,” found that it could not produce competitively priced DVD players? Manufacturers from other countries were able to access the technology at a much lower cost. Specifically, because those manufacturers held patents that they could cross-license with the members of the DVD consortium, their net licens-ing costs were lower. The surprising moral of this story is that when all costs are considered, devel-oping countries may not always be low-cost loca-tions after all.
Across a wide range of products, the costs to ac-cess or license technology are consuming a grow-ing share of the total cost of goods sold. For the DVD players cited in the example, license fees rep-resented 20 to 30 percent of production costs; the percentages can be even higher in other technol-ogy sectors. Analysts estimate, for example, that the total cost of IP licensing for third-generation mobile handsets may be as high as 25 to 35 per-cent of the final selling price for those manufactur-ers that do not hold patents for 3G technologies. Increasingly, corporations that lack an IP portfolio will be relegated to low-end commodity markets.
Lost Profits. The outlay of large royalty payments signals that a company or a country is in Phase 3 of the IP development process. Chinese compa-nies are just beginning to foot the bill, but other economies, such as South Korea and Japan, have already experienced this phenomenon.
In 2005 South Korea made royalty payments of about $4.5 billion on exports of about $250 bil-lion. (See Exhibit 6, page 14.) Assuming an aver-age profit margin of 10 percent of sales, we can see that South Korea paid around 20 percent of its total profits from exports as royalties to foreign companies. Although this figure sounds extraordi-
The
surprising
moral of this
story is that
when all costs
are considered,
developing
countries
may not always
be low-cost
locations
after all.
Targets are vulnerable to at least three types of attacks by competitors that have stronger IP po-sitions: market exclusion, elevated costs, and lost profits. Market Exclusion. As developing countries move from simply manufacturing under contract to companies from other countries to designing, pro-ducing, and marketing their own products, they in-variably imitate the products and manufacturing methods that they have seen and learned about from others. This “copying,” whether intentional or not, may infringe existing IP rights. When this happens, IP owners can exercise their fundamental rights to preclude others from making use of their protected inventions. Patent holders can work through the courts, the U.S. International Trade Commission (ITC), and the WTO to prohibit the sale of infringing products in the markets covered by their patents. The outcome of such suits and claims can be disastrous for a developing economy, with companies and even entire industry segments effectively shut down.
Over the past several years, the number of ITC complaints citing Chinese companies for patent in-fringement has grown dramatically. Twenty years ago, Japan was the most common target of IP complaints filed with the ITC; ten years ago, that distinction fell to South Korea; and today, China’s explosive growth places it in the bull’s-eye. Com-plaints are not limited to high-tech products: Chi-nese products such as pet foods, insect traps, and toothbrushes have been subject to ITC actions.
It is interesting that formal and legal complaints are not the only route to market exclusion. Some-times, patent holders can curtail infringing prod-ucts in more subtle ways. Consider, for instance, the case of the disappearing market for DVD play-ers manufactured in China. In this well-publicized example, more than 300 Chinese manufacturers of DVD players exited the business after purchas-ing patterns shifted. Chinese manufacturers found themselves essentially locked out of their largest export market when a consortium of patent hold-ers successfully pressured retailers in the United States and Europe to purchase DVD players only from manufacturers that held IP licenses.
14
the nine defendants agreed to pay Texas Instru-ments more than $1 billion over five years. This experience motivated many Japanese and South Korean companies to advance to the next phase in IP development.
Phase 4: Getting Serious About Intellectual Property
If they want to move beyond Phase 3, developing-market companies quickly realize that competing successfully in world markets will require that they dramatically enhance their IP position. The question is, How?
It takes a long time to reverse an IP deficit. Lead-ing technology companies have built their IP posi-tions over decades and mastered the art of patent
filing, and it is not easy for still-emerging companies to over-come the barrier to entry that legacy patents pose. Significant investment and dogged perse-verance are required to escape the IP trap. Although we cannot provide all the possible solutions in this report, we highlight four criti-cal levers that companies can deploy to overcome their IP deficits: partnering, acquiring intellectual property, building a focused IP portfolio, and play-ing the standard-setting game.
Partnering. Given the long lead-time required to build a powerful patent portfolio, a quicker way to forestall mar-ket exclusion is to collaborate with IP-rich corporations. This approach holds down the costs associated with gaining access to technology, although it also presents significant drawbacks in other areas.
nary, such high costs are common for countries in Phase 3.
Our analysis of several developing economies re-veals that royalty payments typically peak at be-tween 2 and 3 percent of revenues from export sales. Assuming the same 10 percent profit margin that we have calculated for South Korea, we can see that developing countries pay up to 30 percent of their total export profits to access foreign-owned intellectual property.
The semiconductor industry provides a powerful example of how companies in developing econo-mies can escape this kind of IP checkmate. During the 1980s, in a market flooded with lower-priced chips from Japanese and South Korean manufac-turers, U.S. manufacturers of DRAM chips strug-gled to make money. The pain was so great that several U.S. manufacturers decided to exit the market.
Like other U.S. chipmakers, Texas Instruments struggled, but unlike its peers, the com-pany also held a trump card. Texas Instruments owned sev-eral fundamental patents on DRAM technology. Historically, the company had used the IP rights only passively, as barter in cross-licensing deals.
Rather than abandon the mar-ket, Texas Instruments decided to turn these patents into com-petitive weapons. The company simultaneously sued nine Japa-nese and South Korean compa-nies for patent infringement. The legal assault was unprec-edented in the semiconductor industry, with the court battle occurring against a backdrop of political and diplomatic in-trigue.
Eventually, the accused compa-nies began to settle. Altogether,
0
1,000
2,000
3,000
4,000
5,000
1980 1985 1990 1995 2000 2005
Royalty payments made by South Korean companies ($millions)1
Exhibit 6: Companies in South Korea Have Already Seen Their Royalty Payments Soar
Sources: Bank of Korea; Economist Intelligence Unit CountryData; BCG analysis.1Data for years prior to 1998 are estimated on the basis of derived growth rates.
Beyond the Great Wall 15
• What IP rights does the Chinese company retain if the joint venture dissolves?
Acquiring Intellectual Property. Frequent-ly, acquiring an IP position is the fastest way to build a portfolio. Remember those Japanese and South Korean companies that were forced to pay huge royalties to Texas Instruments for access to semiconductor technology? There is more to the story.
Recognizing that Texas Instruments would want to extend the initial five-year licenses, several of the Japanese and South Korean licensees spent the five years building up their own IP portfolios. Achiev-ing IP parity within five years through internal pat-ent filings alone would have been impossible, how-ever, so the Asian competitors took advantage of the sorry state of the U.S. DRAM industry to pur-chase struggling U.S. companies that held strong intellectual property. When the time came to renegotiate with Texas Instruments, the licensees found themselves in a much stronger negotiating position.
This strategy has not been limited to the DRAM market. During their rise to IP sophistication, Japa-nese companies completed at least 450 acquisitions of U.S. companies that held valuable intellectual property, including more than 90 such acquisitions in the semiconductor and semiconductor-manu-facturing industries alone. Certainly, many factors motivated Japanese companies to take these steps, but IP considerations no doubt played an impor-tant part.
Other nations have learned this lesson, too. In a recent study of Chinese outbound mergers and acquisitions, The Boston Consulting Group found that between 2000 and 2004, the companies in 13 RDEs consummated 776 acquisitions of companies in developed countries.1
It is interesting to note that nations such as In-dia, South Africa, and Malaysia used this strategy more aggressively than China. Although China
1. China’s Global Challengers: The Strategic Implications of Chi-nese Outbound M&A, BCG report, May 2006.
Chinese
companies
also have
been joining
forces with
non-Chinese
companies
in IP-oriented
joint ventures.
The U.S. National Science Foundation reports that between 1985 and 2000, Japanese corporations created more than 820 joint ventures with U.S. companies in industries in which intellectual prop-erty was important—namely, information tech-nology, biotechnology, new materials, aerospace and defense, automotive, and chemicals. These partnerships provided an IP shield that allowed Japanese firms to compete successfully in markets and technology domains from which they might otherwise have been excluded.
Over the past decade, and increasingly over the past five years, Chinese companies also have been joining forces with non-Chinese companies in IP-oriented joint ventures. To these relationships, Chinese companies typically bring a low-cost labor pool, manufacturing capabilities, and the promise of access to the domestic Chinese market. Their joint-venture partners typically bring technology, intellectual property, investment capital, global distribution channels, and management expertise.
Unfortunately, the junior members of many of these partnerships run the risk that their IP-own-ing partners will capture most of the value. Con-sequently, IP-oriented partnerships are not a long-term solution. Nonetheless, they can provide significant short-term advantages and can put companies on a path toward IP development. Ulti-mately, the success of a partnership depends on its structure. As they negotiate a partnership, emerg-ing Chinese companies should carefully consider IP issues, among them:
• Does the joint venture own the intellectual property, or is the partner merely providing a license?
• Does the Chinese company have full access to the technology contributed by its partner? Or, for ex-ample, does the partnership agreement severely limit the use or application of the technology?
• Who owns the intellectual property created with-in the joint venture? Who has the right to license the joint venture’s intellectual property or en-force its patents? What forms of redress does the Chinese company have if the parties disagree?
16
liquid. Small “IP shops” eager to amass attractive patent portfolios are forming. Public IP auctions and merchant banks specializing in IP assets are beginning to emerge.
These developments are helping an increasing number of corporate players commercialize their patents. Many universities and research-oriented companies also engage in these sales, hoping to maximize returns on their investments in innova-tion. Moreover, because a truly liquid market for intellectual property does not yet exist, and be-cause the same intellectual property holds differ-ent value for different buyers, Chinese companies may be able to acquire desirable portfolios at at-tractive prices.
The challenge for would-be acquirers is to identify the right targets. A good way to start is by map-
represented almost 30 percent of the combined GDP of all countries studied, it accounted for only 82 transactions—less than 11 percent of the total. (See Exhibit 7.) Intellectual property played a sig-nificant role in a number of these deals, most no-tably the Lenovo Group’s acquisition of IBM’s PC business and the acquisition of Thomson’s televi-sion division by the Chinese electronics player TCL International Holdings. Both acquisitions not only helped pave the way for significant global expan-sion but also dramatically shifted the IP landscape in their markets.
Not all IP-oriented acquisitions need to be large. In fact, acquisitions of small technology-focused companies with strong IP positions are becoming more common. While it was once rare for compa-nies to acquire IP assets—a patent portfolio, for example—this market is becoming increasingly
0India
South AfricaMalaysia
ChinaRussia
MexicoBrazil
PolandTurkey
HungaryThailand
Czech RepublicIndonesia
50
100
150
200
250Number of acquisitions that companies in RDEs made in developed countries(2000–2004)
Chinese companies accounted for nearly one-third of the GDP of RDEs in 2003 but only about one-tenth of RDEs’ foreign acquisitions in developed countries
Percentage of RDE GDP (2003)
Percentage of RDE M&A transactions
12.5
201
169
8882
6556
25 20 20 16 14 11 9
3.3 2.2 29.4 9.0 13.1 10.3 4.4 5.0 1.7 3.0 1.8 4.3
25.9 21.8 11.3 10.6 8.4 7.2 3.2 2.6 2.6 2.1 1.8 1.4 1.2
Exhibit 7: China Lags Behind Other RDEs in Acquiring Companies from Developed Countries
Source: Thomson Financial. Note: Because of rounding, percentages may not total 100.
Beyond the Great Wall 1�
and litigation risk in the U.S. market tend to be higher than in many European countries, but so is the reward. The U.S. economy is larger than any European economy, and hence the revenue up-side in the United States is greater.
Historically, when companies in developing coun-tries have gotten more serious about protecting their intellectual property in export markets, they have exponentially increased their patent filings overseas. Samsung, one of the South Korean com-panies that settled with Texas Instruments when the DRAM patents were litigated, serves as per-haps the best example.
In addition to the settlement, Samsung has paid billions of dollars in royalty payments to foreign IP holders in recent years. Today, however, Samsung is using all available levers to minimize royalty payments and generate a higher return on its IP investments. Patents provide one key measure of this activity. In 1990 Samsung was granted only 60 U.S. patents, but by 2005, Samsung had become the fifth most-prolific grantee, with 1,641 U.S. pat-ents. In public statements, Samsung officials have said that the company wants to attain a third-place ranking by 2007. In contrast, no Chinese company has broken into the top 100.
Playing the Standard-Setting Game. Although a detailed examination of the highly complex ways in which international standards for technology are set transcends the scope of this report, no dis-cussion of IP strategy would be complete without at least a brief mention of the practice. Leading companies excel at using the international stan-dard-setting process to execute their IP strategy.2
Through the standard-setting process, competitors reach agreement about common interoperability protocols. This ritual is rife with politics and in-trigue, as industry competitors try to balance the need for cooperation with their drive for advan-tage. In these complex multilateral negotiations, companies’ power and influence depend on three
2. In this report, we use the term international standards to refer only to negotiated multilateral standards and not to de facto standards created through consumer or user ac-ceptance.
The real key
is to focus
on securing
those patents
that strategistsknow will
bring both
access and
differentiation.
ping the IP landscape in an industry onto the ma-trix highlighted in Exhibit 5. After this quick cut has identified the most attractive players, deeper analytical techniques can help determine exactly which IP assets would be most effective in over-coming an IP deficit.
Two types of acquisitions are possible. First, com-panies should acquire intellectual property to protect their existing or soon-to-be-introduced products. Second, they might want to consider acquiring patents that competitors are most likely to infringe. The latter assets could prove to be a valuable trading commodity when competitors at-tempt to exclude emerging companies from key markets or to constrain their profits through roy-alty payments.
Building a Focused IP Portfolio. The third criti-cal lever for overcoming an IP deficit is achieved by honing one’s own IP portfolio. This kind of tar-geted and mindful approach differs radically from the more passive one many companies pursue. Today many firms invest in R&D and file patent applications on the basis of what inventors think might be patentable. But the real key is to focus on securing those patents that strategists know will bring both access and differentiation.
Because securing global protection for intellectual property is expensive, setting priorities is essential. For emerging companies in developing countries, the critical goal should be gaining affordable ac-cess to export markets by avoiding crippling roy-alty payments. Ownership of directly relevant in-tellectual property is important, but sophisticated IP owners also seek patents in areas of their com-petitors’ vulnerability. They can use such patents as leverage during negotiations.
To begin, companies must identify the competi-tors that represent the most significant threats and then determine the specific technology domains critical to those players. Holding a few key patents can make a major difference when it comes time to negotiate with these companies. Moreover, dif-ferent markets represent varying levels of threat and opportunity, and companies must invest ac-cordingly. For instance, patent protection costs
18
When it comes to setting an international stan-dard, companies in RDEs have three choices. They can adopt the dominant international standard and make sizable royalty payments, as South Korea did; attempt to influence the direction of the international standard by relying on the strength of either their market or a powerful ally; or create their own domestic standard.
If these companies don’t command a strong posi-tion in technology and intellectual property, how-ever, their influence and ultimate success will be severely limited in their pursuit of the latter op-tions. All the strategies call for companies in devel-oping economies to collaborate in varying degrees with standard-setting activities supported by the leading players. (See Exhibit 8.)
Fortunately, China boasts a major advantage over South Korea and most other nations: a large do-
primary factors: the best technology, the strong-est intellectual property, and the largest mar- ket share.
In terms of these factors, most companies from developing economies are relatively weak, so stan-dards are often set without their input. When a developing economy adopts an international stan-dard, therefore, companies in that country can wind up paying hefty royalties to foreign competi-tors that hold patents essential to the standard.
South Korea, the first country to adopt the Code Di-vision Multiple Access (CDMA) standard for wire-less telecommunications, provides a window into this phenomenon. Because South Korean compa-nies held virtually no relevant IP rights when the CDMA standard was adopted, they found them-selves having to pay billions of dollars to CDMA patent holders.
LowHigh
Factors
Technology and IP strength
• Strong technology and IP are required to exert significant influence
• Strong technology and IP are helpful but may not be necessary
• An ally with strong technology and IP may be able to help secure favorable treatment
• A strong technol-ogy and IP position is required
Participating in normal discussions on
setting a standard
Using the weight of China’s market to set a
winning standard
Working with a partner to build a China-
favorable standard
Participating inthe normal process
Drawing strengthfrom the market
Working with apowerful ally Going it alone
Description Using Chinese technology and IP to set
an alternate standard
Collaboration withdominant players
Size of the relevant market
• Large market size a�ords China a stronger voice
• If China’s market is large, its support may set the winning standard
• A large relevant market is an attractive lure for a potential ally
• A large local market is required for a go-it-alone e�ort to succeed
Coordination of the response from Chinese companies
• Coordination among Chinese companies will increase influence
• Coordination, perhaps led by the government, will be necessary
• A coordinated response will be more likely to attract potential allies
• A coordinated e�ort by Chinese players is more likely to succeed
Fragmentation of existing e�orts in setting a standard
• Fragmentation a�ords Chinese companies greater influence
• Chinese influence may be high
• Given fragmentation, it may be easier to attract an ally
• Strategy is likely to work only if existing e�orts are highly fragmented
Exhibit 8: Standard-Setting Strategies Should Vary Depending on Market, Technology, and Other Factors
Source: BCG analysis.
Beyond the Great Wall 19
Payments Receipts
Royalty payments and receipts of South Korean companies ($millions)1
4,000
0
1,000
2,000
3,000
4,000
5,000
1,000
2,000
3,000
5,00019651960 1970 1975 1980 1985 1990 1995 2000 2005
Net royalty payments
Exhibit 9: Companies in South Korea Are Beginning to Offset Royalty Payments with Royalty Receipts
Sources: Bank of Korea; Economist Intelligence Unit CountryData; BCG analysis.1For 1980 to 199�, royalty receipts were derived from compound annual growth rates for 1998 to 2001, and royalty payments were calculated as the diffe-rence between net royalties and the derived royalty receipts.
what Chinese companies can expect and hope for in their future.
South Korea, which of course started down the IP development path more recently than Japan did, is about to turn the corner and enter Phase 5. Several of South Korea’s leading companies, for example, Samsung, have already made this tran-sition, and they are now acquiring state-of-the-art skills in IP management.
We highlighted South Korea’s rising royalty pay-ments in Exhibit 6; it is equally important to note that South Korea’s royalty proceeds are also growing rapidly—an indicator of the country’s progress. (See Exhibit 9.) In fact, the country’s roy-alty proceeds are growing so quickly that net royal-ty payments by South Korean companies are now flat. If the current trends continue, we expect that over the next several years, as these companies be-
mestic market. Many companies want to sell goods and services in China, and in some instances—for example, in order to gain market access—they may be willing to compromise and adopt stan-dards that are more favorable to Chinese compa-nies. Until Chinese companies can bolster their positions in technology and intellectual property, the size of their domestic market may be their best bargaining chip.
Phase 5: Profiting from Intellectual Property
Throughout this report, we have cited South Ko-rea and Japan as examples of countries that are making successful transitions from weakness to strength in intellectual property. The current ex-periences of both of these countries exemplify
20
ent of royalty payments for the first time. (See Ex-hibit 10.)
Historically, Japanese companies have been re-luctant to use their intellectual property in aggres-sive ways or as a competitive weapon. Today that reluctance has begun to wane. Over the last two years, for example, the number of patent-related suits filed by Japanese companies has doubled. Although Japan’s new attitude about intellectual property elicits immediate concern among Chi-nese and other companies around the world, it also should inspire hope. Japan’s shift proves that countries and companies can make progress in IP development. Certainly, Japan could not afford to take its new stance if companies there had not in-vested significantly to secure greater international IP protection over the past two decades.
come sophisticated managers of intellectual prop-erty, they will see their net royalty payments begin to decline.
Farther down the path, Japan has already begun to benefit from its long and patient investments in intellectual property, making it an even more powerful exemplar of the type of opportunities that lie ahead for Chinese companies. Today, Jap-anese companies hold 40 percent of the world’s patents—more than any other country. Although Japanese patenting practices skew that percentage upward, the measure nonetheless highlights the remarkable turnaround that can be achieved by a country determined to turn intellectual property into strength.3 In 2003 Japan became a net recipi-
3. Japanese patent laws—which limit the number of claims that can be filed under one patent—and the patent-filing practices of Japanese companies result in a large number of typically narrow patents.
Payments Receipts Net royalty payments
Royalty payments and receiptsfor Japanese companies(�billions)
1,200
0
300
600
900
1,200
1,500
300
600
900
1,50019651960 1970 1975 1980 1985 1990 1995 2000
2003 marked Japan’s first year with positive cash flow from royalties
Exhibit 10: Japanese Companies Have Made the Leap from Paying High Royalty Fees to Collecting Them
Sources: Bank of Japan; BCG analysis.
Beyond the Great Wall 21
T he path through IP development will be long for China as a nation, but that’s not necessarily the case for lead-ing Chinese companies. Each Chinese company can set its own pace and
milestones for moving through the IP develop-ment process.
Through targeted acquisitions, increased patent filings, and an emphasis on IP management, some leading Chinese companies are already beginning to accelerate their IP development. Pioneers in China, these players are following a trail blazed by others, and their knowledge of history is helping them shape a more competitive future.
We encourage all Chinese players to examine and embrace these time-tested approaches. By devel-oping world-class IP management skills, they can move beyond the Great Wall to compete success-fully in the global marketplace.
For Chinese companies that want to move aggres-sively in developing their intellectual property, we provide a checklist of the steps to consider.
Determine your company’s position within the five phases of IP development.
• How important are exports for the success of your business?
• Are your exported products high- or low-tech?
• Are you appropriately balancing your investment in IP protection with your investment in R&D?
• How strong is your IP position relative to that of your international competitors?
Closing the IP Gap
Map your IP position and that of international competitors in your key technologies and markets.
• How vulnerable are you to financial or market-place penalties?
• Which competitors could most easily expose your IP vulnerabilities?
Learn how leading international companies man-age their intellectual property.
• How do leading companies in your industry man-age intellectual property?
• How do leading companies in other sectors or-ganize, prioritize, and manage their intellectual property?
Develop a plan for turning intellectual property from a weakness into a strength.
• How can you develop an IP strategy that is close-ly linked with your corporate strategy?
• Can you build a world-class IP organization?
• Can you articulate all your IP vulnerabilities and risks?
• Can you evaluate and execute partnership and acquisition opportunities in order to change your position?
• Where can you invest to secure international pro-tection for your intellectual property?
22
The Boston Consulting Group has published other reports and articles on global expansion, intellectual property, and related areas. Recent examples include:
Looking Eastward: Tapping China and India to Reinvigorate the Global Biopharmaceutical IndustryA report by The Boston Consulting Group, August 2006
China’s Global Challengers: The Strategic Implications of Chinese Outbound M&AA report by The Boston Consulting Group, May 2006
The New Global Challengers: How 100 Top Companies from Rapidly Developing Economies Are Changing the WorldA report by The Boston Consulting Group, May 2006
Organizing for Global Advantage in China, India, and Other Rapidly Developing EconomiesA report by The Boston Consulting Group, March 2006
A Game Plan for China: Rising to the Productivity Challenge in Biopharma R&DA Focus by The Boston Consulting Group, December 2005
“Spurring Innovation Productivity”Opportunities for Action in Industrial Goods, November 2005
“The New Economics of Global Advantage: Not Just Lower Costs but Higher Returns on Capital”Opportunities for Action in Operations, July 2005
“Globalizing R&D: Building a Pathway to Profits”Opportunities for Action in Operations, May 2005
“Globalizing R&D: Knocking Down the Barriers”Opportunities for Action in Operations, May 2005Navigating the Five Currents of Globalization: How Leading Companies Are Capturing Global Advantage A Focus by The Boston Consulting Group, January 2005
Facing the China Challenge: Using an Intellectual Property Strategy to Capture Global AdvantageA report by The Boston Consulting Group, September 2004
Capturing Global Advantage: How Leading Industrial Companies Are Transforming Their Industries by Sourcing and Selling in China, India, and Other Low-Cost CountriesA report by The Boston Consulting Group, April 2004
“What Is Globalization Doing to Your Business?”Opportunities for Action in Industrial Goods, February 2004
For Further Reading
For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.com.
To receive future publications in electronic form about this topic or others, please visit our subscription Web site at www.bcg.com/subscribe.
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