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  • 1. ReportBeyond the Great Wall Intellectual Property Strategies for Chinese Companies

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: [email protected]: +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 [email protected] 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 [email protected] 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 [email protected] 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&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&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&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 corporate investmentproducts and emulating manufacturing methodsin R&D rise more than fivefold from $19 billiondeployed by the foreign players that purchase in 1994 to $97 billion in 2004. As a share of GDP,Exhibit 3: In Their IP Development, RDEs Follow a Common Path ExportsR&D spending Net royalties paid IP strengthPhase 1: Phase 2: Phase 3:Phase 4: Phase 5:Driving growth Climbing the Paying the priceGetting serious aboutProting fromthrough exportsvalue ladder intellectual propertyintellectual propertyExports of low-techAn increase in R&D Companies sufferCompanies in developing Companies in developingproducts drive growth, spending and acquiredconsequences when IPcountries invest to countries achieve parityexploiting the low cost of knowledge drives growthowners from developed manage and protect theirand may capture advan-labor and materialsin the export of higher- nations defend theirintellectual property tage through IP rights tech productsmarketsSource: BCG analysis.Beyond the Great Wall 12. R&D spending by Chinese companies rose during Against the backdrop of Chinas rapid growth inthis ten-year period from 3 percent to 5 percent. exports and its increasingly high-tech product mix,the disparity between the number of domesticAlongside R&D spending, patent applications haveand overseas patents suggests that Chinese com-increased in China, but the vast majority of thesepanies have left themselves exposed to overseas IPapplications have been filed domestically. Even problems. First, Chinese companies have obtainedthough the number of overseas patent applica- fewer triadic patentsthat is, patents that protecttions is growing rapidly, it is minuscule comparedthe same invention in the United States, Europe,with the number of domestic applications. and Japanper dollar invested in R&D than theircounterparts in the developed world. (See ExhibitIn 2004, for example, the same year Chinese en- 4.) A triadic patent signals the importance of thetities filed nearly 66,000 patent applications in innovation: owners are unlikely to invest the timeChina, they filed fewer than 2,000 in the Unitedand expense of filing in three jurisdictions unlessStates, just over 400 in the European Patent Of-they believe that an invention has commercial po-fice, and about 250 in Japan. As a result, Chinastential.increased R&D spending over the past decade hasnot translated into a strategically relevant increase In context, this finding reveals that Chinas in-in international protection of IP rights for Chinesevestment in triadic patents is so low relative to itscompanies.R&D investment that Chinese companies wouldExhibit 4: China Has Boosted Investments in R&D, but IP Protection Has Not Kept PaceDeveloped countriesDeveloping countriesIP protection1100,000 Investment in IP protectionis higher than in R&D U.S.Japan 10,000 Germany Switzerland SwedenFranceNetherlands ItalyBelgiumU.K.1,000 FinlandAustralia South KoreaAustriaCanada Denmark Israel Norway Spain China100 SingaporeTaiwanIreland Russian FederationNew ZealandHungary India Luxembourg MexicoSouth Africa Greece Czech Republic10 SloveniaPoland Iceland TurkeyPortugalArgentinaInvestment in IP protectionEstoniaSlovak Republicis lower than in R&DLatvia Romania Lithuania 1 10 100 1,000 10,000 100,0001,000,000Innovation2 ($)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.10 13. need to increase their investments in international appear on the radar screen of IP owners and, asIP protection by a factor of 30 in order to achieve outlined in BCGs IP-strategy matrix, become vul-parity with companies in developed countries. Sec-nerable to attack. (See Exhibit 5, and for greaterond, Chinas investments in international IP pro- detail about the matrix, see the sidebar Sharks,tection fall well below even those of other develop-Minnows, and Targets: Understanding IP Strategying countries.on page 12.)Other countries have been in this position. In theThe IP strategy matrix helps explain how compa-mid-1980s, for example, South Korea found itselfnies become exposed to IP risk. Early in their devel-in virtually the same position as China and India opment, companies in countries such as China findare in today. Yet even if their position seems un-themselves in the lower-left corner of the matrix.derstandable, Chinese companies should be takingThey have little intellectual property and also verysteps to boost international IP protection if theylow salesin this case, export salesat risk, andwant to minimize the time they spend in the nextthus they are largely ignored by companies higherphaseone that history has shown to be trying in the food chain. As these companies develop andand difficult.move through Phase 2, their sales grow as a result,in part, of their low labor costs. Yet, as we haveseen previously, their IP rights do not grow pro-Phase 3: Paying the Price portionately, and the companies find themselvesin the upper-left corner of the matrix in the vul-During the third phase of IP development, the dis-nerable position we call the target. As the compa-parity between exports and IP holdings eventually nies grow, they capture market share and begin toensnares companies from less developed econo- threaten developed-country competitors, yet theymies. As their exports grow, these companieslack the IP rights they need to defend themselves.Exhibit 5: The IP Strategy Matrix Illustrates How Companies with IP Rights Grow Strongand How Those Without IP Rights Become Vulnerable HighThe targetThe superpowerWith sizable revenues at riskand insufficientBoasting a great deal of IP rights but alsoIP rights to defend themselvesthese playersrisking a great deal of sales, these playersare targets for sharks and superpowersmust actively deploy IP rights to protect theirstrong, balanced positionIP-dependentThe minnowThe sharkrevenuesWith few IP rights and low sales related to IP, With extensive IP rights and little revenue atthese players are typically ignored risk, these players can aggressively pursueother competitorsLowLowHighSource: BCG analysis.IP protectionBeyond the Great Wall11 14. Sharks, Minnows, and Targets: Understanding IP StrategyBCGs IP-strategy matrix allows a company to understand Finally, superpowers, in the upper right, enjoy strong and bal-and assess its relative IP position within a market or a tech-anced IP positions. In many industries, it is common fornology segment. At a conceptual level, it can help senior these leading companies to cross-license intellectual prop-managers make sense of the complexities inherent in anerty with key competitors. If two companies have propor-IP domain.tionately strong IP portfolios, neither can gain advantageby asserting its intellectual property. This balanced positionThe matrix consists of four quadrants. In the lower right,is reminiscent of the Cold War, when the vast stockpiles ofsharks have a strong IP position and little or no revenue atnuclear weapons held by the United States and the formerrisk to an IP challenge. Often, these players buy patents onSoviet Union fostered mutually assured destruction andan opportunistic basis and exploit them as assets, collect- kept an uneasy peace. In this same vein, when two compa-ing licensing fees rather than protecting a manufacturednies are capable of destroying each other through IP claims,product or invention. Because sharks can freely assert theira peace typically prevails on the patent front.IP rights without having to worry about counterassertions,they can be extremely aggressive. And because they make Companies can use these four simple categories to assessor sell no products of their ownor at least very fewtheythe IP landscape of competitors. By understanding the rela-are invulnerable to IP attacks. tive position of the various players in a sector, a companycan quickly identify whether it or some other competitorIn the lower left, minnows (small fish) have low sales, as well is the most advantaged or the most vulnerable. Managersas a weak position in intellectual property. Because min- and IP professionals can also use the IP strategy matrix asnows typically dont pose a competitive threat, it is rarelyan analytical tool to assess risk, identify vulnerabilities, andworthwhile for an IP owner to attack them.find opportunitiesand then set a course of action. Thematrix can be useful in selecting attractive partners, iden-Some minnows, however, grow up to be targets (in the uppertifying IP assets to acquire, and determining the areas onleft of the matrix). Although these players have weak posi- which patenting activity should focus. BCG has developedtions in intellectual property just as the minnows do, more additional proprietary methods for assessing IP strength,of their sales are unprotected by intellectual property. Com- as well as methods for assessing how closely technologiespanies in this position are vulnerable to IP attacks becauseare related and the likelihood that infringement will occurtheir large size makes them worth pursuing. between any two patents or patent portfolios.12 15. Targets are vulnerable to at least three types ofElevated Costs. The market for Chinese-manu-attacks by competitors that have stronger IP po- factured DVD players vanished not because thesitions: market exclusion, elevated costs, and lostconsortium denied Chinese companies a license toprofits. their intellectual property. Rather, Chinese manu- facturers chose not to license the technology: theMarket Exclusion. As developing countries move $20 cost per unit would have driven prices of theirfrom simply manufacturing under contract toproducts prohibitively high and made them un-companies from other countries to designing, pro-competitive in the marketplace.ducing, and marketing their own products, they in-variably imitate the products and manufacturingHow is it that China, a low-cost country, foundmethods that they have seen and learned aboutthat it could not produce competitively pricedfrom others. This copying, whether intentional DVD players? Manufacturers from other countriesor not, may infringe existing IP rights. When this were able to access the technology at a much lowerhappens, IP owners can exercise their fundamentalcost. Specifically, because those manufacturersrights to preclude others from making use of their held patents that they could cross-license with theprotected inventions. Patent holders can workmembers of the DVD consortium, their net licens-through the courts, the U.S. International TradeCommission (ITC), and the WTO to prohibit thesale of infringing products in the markets coveredT he 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- surprisingby their patents. The outcome of such suits andtions after all.claims can be disastrous for a developing economy,moral of thiswith companies and even entire industry segments story is that Across a wide range of products, the costs to ac-effectively shut down. cess or license technology are consuming a grow-when all costs ing share of the total cost of goods sold. For theOver the past several years, the number of ITC are considered, DVD players cited in the example, license fees rep-complaints citing Chinese companies for patent in-developing resented 20 to 30 percent of production costs; thefringement has grown dramatically. Twenty yearspercentages can be even higher in other technol-ago, Japan was the most common target of IPcountries ogy sectors. Analysts estimate, for example, thatcomplaints filed with the ITC; ten years ago, that may not alwaysthe total cost of IP licensing for third-generationdistinction fell to South Korea; and today, Chinasmobile handsets may be as high as 25 to 35 per-be low-costexplosive growth places it in the bulls-eye. Com- cent of the final selling price for those manufactur-plaints are not limited to high-tech products: Chi-locations ers that do not hold patents for 3G technologies.nese products such as pet foods, insect traps, and after all.Increasingly, corporations that lack an IP portfoliotoothbrushes have been subject to ITC actions. will be relegated to low-end commodity markets.It is interesting that formal and legal complaints Lost Profits. The outlay of large royalty paymentsare not the only route to market exclusion. Some-signals that a company or a country is in Phasetimes, patent holders can curtail infringing prod- 3 of the IP development process. Chinese compa-ucts in more subtle ways. Consider, for instance,nies are just beginning to foot the bill, but otherthe case of the disappearing market for DVD play-economies, such as South Korea and Japan, haveers manufactured in China. In this well-publicized already experienced this phenomenon.example, more than 300 Chinese manufacturersof DVD players exited the business after purchas-In 2005 South Korea made royalty payments ofing patterns shifted. Chinese manufacturers foundabout $4.5 billion on exports of about $250 bil-themselves essentially locked out of their largest lion. (See Exhibit 6, page 14.) Assuming an aver-export market when a consortium of patent hold-age profit margin of 10 percent of sales, we caners successfully pressured retailers in the United see that South Korea paid around 20 percent ofStates and Europe to purchase DVD players only its total profits from exports as royalties to foreignfrom manufacturers that held IP licenses.companies. Although this figure sounds extraordi-Beyond the Great Wall 13 16. nary, such high costs are common for countries in the nine defendants agreed to pay Texas Instru-Phase 3.ments more than $1 billion over five years. Thisexperience motivated many Japanese and SouthOur analysis of several developing economies re-Korean companies to advance to the next phase inveals that royalty payments typically peak at be- IP development.tween 2 and 3 percent of revenues from exportsales. Assuming the same 10 percent profit marginthat we have calculated for South Korea, we canPhase 4: Getting Serious Aboutsee that developing countries pay up to 30 percentof their total export profits to access foreign-owned Intellectual Propertyintellectual property.If they want to move beyond Phase 3, developing-The semiconductor industry provides a powerfulmarket companies quickly realize that competingexample of how companies in developing econo- successfully in world markets will require thatmies can escape this kind of IP checkmate. During they dramatically enhance their IP position. Thethe 1980s, in a market flooded with lower-pricedquestion is, How?chips from Japanese and South Korean manufac-turers, U.S. manufacturers of DRAM chips strug-It takes a long time to reverse an IP deficit. Lead-gled to make money. The pain was so great that ing technology companies have built their IP posi-several U.S. manufacturers decided to exit the tions over decades and mastered the art of patentmarket. filing, and it is not easy for still- Exhibit 6: Companies in South Koreaemerging companies to over-Like other U.S. chipmakers,Have Already Seen Their Royaltycome the barrier to entry thatTexas Instruments struggled, Payments Soarlegacy patents pose. Significantbut unlike its peers, the com-Royalty payments made byinvestment and dogged perse-pany also held a trump card.South Korean companies 1verance are required to escape($millions)Texas Instruments owned sev-5,000the IP trap.eral fundamental patents onDRAM technology. Historically, Although we cannot providethe company had used the IPall the possible solutions in this4,000rights only passively, as barter report, we highlight four criti-in cross-licensing deals.cal levers that companies can deploy to overcome their IPRather than abandon the mar-3,000deficits: partnering, acquiringket, Texas Instruments decided intellectual property, building ato turn these patents into com-focused IP portfolio, and play-petitive weapons. The companying the standard-setting game.2,000simultaneously sued nine Japa-nese and South Korean compa- Partnering. Given the longnies for patent infringement.lead-time required to build aThe legal assault was unprec- 1,000powerful patent portfolio, aedented in the semiconductor quicker way to forestall mar-industry, with the court battleket exclusion is to collaborateoccurring against a backdrop with IP-rich corporations. This0of political and diplomatic in- 1980 1985 1990 1995 20002005 approach holds down the coststrigue.Sources: Bank of Korea; Economist Intelligence Unit CountryData; associated with gaining access BCG analysis. 1 to technology, although it alsoData for years prior to 1998 are estimated on the basis of derivedEventually, the accused compa- growth rates. presents significant drawbacksnies began to settle. Altogether,in other areas.14 17. The U.S. National Science Foundation reports that What IP rights does the Chinese company retain between 1985 and 2000, Japanese corporations if the joint venture dissolves?created more than 820 joint ventures with U.S.companies in industries in which intellectual prop-Acquiring Intellectual Property. Frequent-erty was importantnamely, information tech- ly, acquiring an IP position is the fastest way tonology, biotechnology, new materials, aerospacebuild a portfolio. Remember those Japanese andand defense, automotive, and chemicals. TheseSouth Korean companies that were forced to paypartnerships provided an IP shield that allowedhuge royalties to Texas Instruments for accessJapanese firms to compete successfully in marketsto semiconductor technology? There is more toand technology domains from which they might the story.otherwise have been excluded. Recognizing that Texas Instruments would want toOver the past decade, and increasingly over theextend the initial five-year licenses, several of thepast five years, Chinese companies also have beenJapanese and South Korean licensees spent the fivejoining forces with non-Chinese companies in IP- years building up their own IP portfolios. Achiev-oriented joint ventures. To these relationships, ing IP parity within five years through internal pat-Chinese companies typically bring a low-cost labor ent filings alone would have been impossible, how-pool, manufacturing capabilities, and the promiseever, so the Asian competitors took advantage ofof access to the domestic Chinese market. Theirjoint-venture partners typically bring technology,intellectual property, investment capital, global C hinese 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 tocompaniesdistribution channels, and management expertise. renegotiate with Texas Instruments, the licensees also have found themselves in a much stronger negotiatingUnfortunately, the junior members of many ofbeen joining position.these partnerships run the risk that their IP-own-forces withing partners will capture most of the value. Con-This strategy has not been limited to the DRAMsequently, IP-oriented partnerships are not a non-Chinesemarket. During their rise to IP sophistication, Japa-long-term solution. Nonetheless, they can provide companiesnese companies completed at least 450 acquisitionssignificant short-term advantages and can putof U.S. companies that held valuable intellectualcompanies on a path toward IP development. Ulti- in IP-orientedproperty, including more than 90 such acquisitionsmately, the success of a partnership depends on itsjoint ventures. in the semiconductor and semiconductor-manu-structure. As they negotiate a partnership, emerg- facturing industries alone. Certainly, many factorsing Chinese companies should carefully considermotivated Japanese companies to take these steps,IP issues, among them: but IP considerations no doubt played an impor- tant part. Does the joint venture own the intellectualproperty, or is the partner merely providing a Other nations have learned this lesson, too. In alicense? recent study of Chinese outbound mergers and acquisitions, The Boston Consulting Group found oes the Chinese company have full access to theDthat between 2000 and 2004, the companies in 13technology contributed by its partner? Or, for ex- RDEs consummated 776 acquisitions of companiesample, does the partnership agreement severely in developed countries.limit the use or application of the technology? It is interesting to note that nations such as In- ho owns the intellectual property created with-Wdia, South Africa, and Malaysia used this strategyin the joint venture? Who has the right to license more aggressively than China. Although Chinathe joint ventures intellectual property or en-force its patents? What forms of redress does the. Chinas Global Challengers: The Strategic Implications of Chi-Chinese company have if the parties disagree?nese Outbound M&A, BCG report, May 2006.Beyond the Great Wall 15 18. represented almost 30 percent of the combinedliquid. Small IP shops eager to amass attractiveGDP of all countries studied, it accounted for onlypatent portfolios are forming. Public IP auctions82 transactionsless than 11 percent of the total. and merchant banks specializing in IP assets are(See Exhibit 7.) Intellectual property played a sig- beginning to emerge.nificant role in a number of these deals, most no-tably the Lenovo Groups acquisition of IBMs PC These developments are helping an increasingbusiness and the acquisition of Thomsons televi-number of corporate players commercialize theirsion division by the Chinese electronics player TCLpatents. Many universities and research-orientedInternational Holdings. Both acquisitions not only companies also engage in these sales, hoping tohelped pave the way for significant global expan-maximize returns on their investments in innova-sion but also dramatically shifted the IP landscapetion. Moreover, because a truly liquid market forin their markets.intellectual property does not yet exist, and be- cause the same intellectual property holds differ-Not all IP-oriented acquisitions need to be large. ent value for different buyers, Chinese companiesIn fact, acquisitions of small technology-focusedmay be able to acquire desirable portfolios at at-companies with strong IP positions are becomingtractive prices.more common. While it was once rare for compa-nies to acquire IP assetsa patent portfolio, forThe challenge for would-be acquirers is to identifyexamplethis market is becoming increasingly the right targets. A good way to start is by map-Exhibit 7: China Lags Behind Other RDEs in Acquiring Companies from Developed CountriesNumber of250Chinese companies accounted for nearly one-third of theacquisitionsGDP of RDEs in 2003 but only about one-tenth of RDEsthat companiesforeign acquisitions in developed countriesin RDEs madein developed 201countries200(20002004)169 150 100 8882 655650 252020 1614 119 0India MalaysiaRussiaBrazilTurkey Thailand IndonesiaSouth Africa China MexicoPolandHungary Czech RepublicPercentage of12.5 3.32.2 29.49.013.110.34.45.0 1.7 3.01.84.3RDE GDP (2003)Percentage of RDE 25.921.811.310.68.4 7.23.2 2.62.6 2.1 1.81.41.2M&A transactionsSource: Thomson Financial.Note: Because of rounding, percentages may not total 100.16 19. ping the IP landscape in an industry onto the ma-and litigation risk in the U.S. market tend to betrix highlighted in Exhibit 5. After this quick cuthigher than in many European countries, but so ishas identified the most attractive players, deeper the reward. The U.S. economy is larger than anyanalytical techniques can help determine exactly European economy, and hence the revenue up-which IP assets would be most effective in over- side in the United States is greater.coming an IP deficit. Historically, when companies in developing coun-Two types of acquisitions are possible. First, com-tries have gotten more serious about protectingpanies should acquire intellectual property to their intellectual property in export markets, theyprotect their existing or soon-to-be-introducedhave exponentially increased their patent filingsproducts. Second, they might want to consideroverseas. Samsung, one of the South Korean com-acquiring patents that competitors are most likely panies that settled with Texas Instruments whento infringe. The latter assets could prove to be a the DRAM patents were litigated, serves as per-valuable trading commodity when competitors at-haps the best example.tempt to exclude emerging companies from keymarkets or to constrain their profits through roy- In addition to the settlement, Samsung has paidalty payments. billions of dollars in royalty payments to foreign IP holders in recent years. Today, however, SamsungBuilding a Focused IP Portfolio. The third criti-cal lever for overcoming an IP deficit is achievedby honing ones own IP portfolio. This kind of tar-T he real key is using all available levers to minimize royalty payments and generate a higher return on its IP investments. Patents provide one key measure ofis to focusgeted and mindful approach differs radically fromthis activity. In 1990 Samsung was granted only 60the more passive one many companies pursue. on securingU.S. patents, but by 2005, Samsung had becomeToday many firms invest in R&D and file patent those patents the fifth most-prolific grantee, with 1,641 U.S. pat-applications on the basis of what inventors thinkents. In public statements, Samsung officials havethat strategistsmight be patentable. But the real key is to focussaid that the company wants to attain a third-placeon securing those patents that strategists know willknow willranking by 2007. In contrast, no Chinese companybring both access and differentiation.bring both has broken into the top 100.Because securing global protection for intellectual access and Playing the Standard-Setting Game. Although aproperty is expensive, setting priorities is essential. differentiation. detailed examination of the highly complex waysFor emerging companies in developing countries,in which international standards for technologythe critical goal should be gaining affordable ac- are set transcends the scope of this report, no dis-cess to export markets by avoiding crippling roy-cussion of IP strategy would be complete withoutalty payments. Ownership of directly relevant in-at least a brief mention of the practice. Leadingtellectual property is important, but sophisticatedcompanies excel at using the international stan-IP owners also seek patents in areas of their com- dard-setting process to execute their IP strategy.petitors vulnerability. They can use such patentsas leverage during negotiations. Through the standard-setting process, competitors reach agreement about common interoperabilityTo begin, companies must identify the competi- protocols. This ritual is rife with politics and in-tors that represent the most significant threats and trigue, as industry competitors try to balance thethen determine the specific technology domains need for cooperation with their drive for advan-critical to those players. Holding a few key patents tage. In these complex multilateral negotiations,can make a major difference when it comes time companies power and influence depend on threeto negotiate with these companies. Moreover, dif-ferent markets represent varying levels of threat. In this report, we use the term international standards to refer only to negotiated multilateral standards and notand opportunity, and companies must invest ac- to de facto standards created through consumer or user ac-cordingly. For instance, patent protection costs ceptance.Beyond the Great Wall 17 20. primary factors: the best technology, the strong-When it comes to setting an international stan-est intellectual property, and the largest mar-dard, companies in RDEs have three choices. Theyket share. can adopt the dominant international standard and make sizable royalty payments, as SouthIn terms of these factors, most companies from Korea did; attempt to influence the direction of thedeveloping economies are relatively weak, so stan- international standard by relying on the strengthdards are often set without their input. When aof either their market or a powerful ally; or createdeveloping economy adopts an international stan- their own domestic standard.dard, therefore, companies in that country canwind up paying hefty royalties to foreign competi- If these companies dont command a strong posi-tors that hold patents essential to the standard.tion in technology and intellectual property, how- ever, their influence and ultimate success will beSouth Korea, the first country to adopt the Code Di- severely limited in their pursuit of the latter op-vision Multiple Access (CDMA) standard for wire- tions. All the strategies call for companies in devel-less telecommunications, provides a window intooping economies to collaborate in varying degreesthis phenomenon. Because South Korean compa- with standard-setting activities supported by thenies held virtually no relevant IP rights when the leading players. (See Exhibit 8.)CDMA standard was adopted, they found them-selves having to pay billions of dollars to CDMA Fortunately, China boasts a major advantage overpatent holders.South Korea and most other nations: a large do-Exhibit 8: Standard-Setting Strategies Should Vary Depending on Market, Technology,and Other FactorsParticipating inDrawing strength Working with a Going it alonethe normal processfrom the marketpowerful allyParticipating inUsing the weight ofWorking with a partnerUsing Chinese Description normal discussions on Chinas market to set a to build a China- technology and IP to set setting a standardwinning standard favorable standardan alternate standardFactors Technology and IP Strong technology Strong technology An ally with strong A strong technol- strength and IP are required and IP are helpfultechnology and IP ogy and IP positionto exert signicant but may not bemay be able to help is requiredinuencenecessary secure favorabletreatment Coordination of the Coordination among Coordination, A coordinated A coordinated response from ChineseChinese companies perhaps led by theresponse will be effort by Chinese companieswill increase government, willmore likely to attract players is moreinuencebe necessarypotential allies likely to succeed Fragmentation of Fragmentation Chinese inuence Given fragmentation, Strategy is likely to existing efforts in affords Chinese may be highit may be easier towork only if setting a standardcompanies greaterattract an allyexisting efforts are inuencehighly fragmented Size of the relevant Large market size If Chinas market A large relevant A large local marketaffords China ais large, its market is an market is required stronger voice support may set attractive lure for afor a go-it-alonethe winning potential ally effort to succeedstandardCollaboration with HighLowdominant playersSource: BCG analysis.18 21. mestic market. Many companies want to sell goods what Chinese companies can expect and hope forand services in China, and in some instancesfor in their future.example, in order to gain market accesstheymay be willing to compromise and adopt stan- South Korea, which of course started down thedards that are more favorable to Chinese compa-IP development path more recently than Japannies. Until Chinese companies can bolster theirdid, is about to turn the corner and enter Phasepositions in technology and intellectual property, 5. Several of South Koreas leading companies, forthe size of their domestic market may be their bestexample, Samsung, have already made this tran-bargaining chip. sition, and they are now acquiring state-of-the-art skills in IP management.Phase 5: Profiting fromWe highlighted South Koreas rising royalty pay- ments in Exhibit 6; it is equally important toIntellectual Propertynote that South Koreas royalty proceeds are also growing rapidlyan indicator of the countrysThroughout this report, we have cited South Ko-progress. (See Exhibit 9.) In fact, the countrys roy-rea and Japan as examples of countries that arealty proceeds are growing so quickly that net royal-making successful transitions from weakness to ty payments by South Korean companies are nowstrength in intellectual property. The current ex- flat. If the current trends continue, we expect thatperiences of both of these countries exemplify over the next several years, as these companies be-Exhibit 9: Companies in South Korea Are Beginning to Offset Royalty Paymentswith Royalty Receipts Payments Receipts Net royalty paymentsRoyalty 5,000payments andreceipts ofSouth Korean4,000companies1($millions) 3,0002,0001,00001,0002,0003,0004,0005,000196019651970 19751980 19851990 19952000 2005Sources: Bank of Korea; Economist Intelligence Unit CountryData; BCG analysis.1 For 1980 to 1997, 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.Beyond the Great Wall19 22. come sophisticated managers of intellectual prop-ent of royalty payments for the first time. (See Ex-erty, they will see their net royalty payments begin hibit 10.)to decline. Historically, Japanese companies have been re-Farther down the path, Japan has already begun luctant to use their intellectual property in aggres-to benefit from its long and patient investments sive ways or as a competitive weapon. Today thatin intellectual property, making it an even more reluctance has begun to wane. Over the last twopowerful exemplar of the type of opportunities years, for example, the number of patent-relatedthat lie ahead for Chinese companies. Today, Jap-suits filed by Japanese companies has doubled.anese companies hold 40 percent of the worlds Although Japans new attitude about intellectualpatentsmore than any other country. Althoughproperty elicits immediate concern among Chi-Japanese patenting practices skew that percentagenese and other companies around the world, itupward, the measure nonetheless highlights the also should inspire hope. Japans shift proves thatremarkable turnaround that can be achieved bycountries and companies can make progress in IPa country determined to turn intellectual property development. Certainly, Japan could not afford tointo strength. In 2003 Japan became a net recipi- take its new stance if companies there had not in- vested significantly to secure greater international. Japanese patent lawswhich limit the number of claims IP protection over the past two decades.that can be filed under one patentand the patent-filingpractices of Japanese companies result in a large number oftypically narrow patents.Exhibit 10: Japanese Companies Have Made the Leap from Paying High Royalty Feesto Collecting Them Payments Receipts Net royalty payments2003 marked Japans rst year with positive cash ow from royaltiesRoyalty 1,500paymentsand receiptsfor Japanese1,200companies(billions)90060030003006009001,2001,50019601965197019751980 1985 1990 19952000Sources: Bank of Japan; BCG analysis.20 23. Closing the IP GapT he path through IP development willMap your IP position and that of international be long for China as a nation, but competitors in your key technologies and markets. thats not necessarily the case for lead- ing Chinese companies. Each Chinese How vulnerable are you to financial or market- company can set its own pace and place penalties?milestones for moving through the IP develop-ment process. Which competitors could most easily expose yourIP vulnerabilities?Through targeted acquisitions, increased patentfilings, and an emphasis on IP management, some Learn how leading international companies man-leading Chinese companies are already beginning age their intellectual property.to accelerate their IP development. Pioneers inChina, these players are following a trail blazed by How do leading companies in your industry man-others, and their knowledge of history is helping age intellectual property?them shape a more competitive future. ow do leading companies in other sectors or-HWe encourage all Chinese players to examine and ganize, prioritize, and manage their intellectualembrace these time-tested approaches. By devel- property?oping world-class IP management skills, they canmove beyond the Great Wall to compete success-Develop a plan for turning intellectual propertyfully in the global marketplace.from a weakness into a strength.For Chinese companies that want to move aggres- How can you develop an IP strategy that is close-sively in developing their intellectual property, wely linked with your corporate strategy?provide a checklist of the steps to consider. Can you build a world-class IP organization?Determine your companys position within thefive phases of IP development. Can you articulate all your IP vulnerabilitiesand risks? ow important are exports for the success ofHyour business? an you evaluate and execute partnership andCacquisition opportunities in order to change your re your exported products high- or low-tech?A position? re you appropriately balancing your investmentA Where can you invest to secure international pro-in IP protection with your investment in R&D? tection for your intellectual property? ow strong is your IP position relative to that ofHyour international competitors?Beyond the Great Wall 21 24. For Further ReadingThe Boston Consulting Group hasLooking Eastward: Tapping ChinaGlobalizing R&D: Building a Pathwaypublished other reports and articles onand India to Reinvigorate the Global to Profits Biopharmaceutical Industry Opportunities for Action in Operations,global expansion, intellectual property, A report by The Boston Consulting Group, May 2005and related areas. Recent examples August 2006include:Globalizing R&D: Knocking Down the Chinas Global Challengers: TheBarriers Strategic Implications of ChineseOpportunities for Action in Operations, Outbound M&A May 2005 A report by The Boston Consulting Group, Navigating the Five Currents of May 2006 Globalization: How Leading CompaniesAre Capturing Global Advantage The New Global Challengers: HowA Focus by The Boston Consulting Group, 100 Top Companies from Rapidly January 2005 Developing Economies Are Changing the WorldFacing the China Challenge: Using A report by The Boston Consulting Group, an Intellectual Property Strategy to May 2006 Capture Global AdvantageA report by The Boston Consulting Group, Organizing for Global AdvantageSeptember 2004 in China, India, and Other Rapidly Developing Economies Capturing Global Advantage: How A report by The Boston Consulting Group, Leading Industrial Companies Are March 2006 Transforming Their Industries bySourcing and Selling in China, India, A Game Plan for China: Rising to and Other Low-Cost Countries the Productivity Challenge inA report by The Boston Consulting Group, Biopharma R&DApril 2004 A Focus by The Boston Consulting Group, December 2005What Is Globalization Doing to YourBusiness? Spurring Innovation Productivity Opportunities for Action in Industrial Opportunities for Action in Industrial Goods, February 2004 Goods, November 2005 The New Economics of Global Advantage: Not Just Lower Costs but Higher Returns on Capital Opportunities for Action in Operations, July 200522 25. 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