Black Market Blues: Cracking Down on IP Thieves in China

On January 10, Chinese authorities lit bonfires in six locations across the country. It was their way of celebrating the midway point of a six-month crackdown on counterfeiting and intellectual property rights (IPR) infringement. Some 5.2 million books, DVDs and other counterfeit products went up in flames. Over the three months preceding the bonfires, more than six million such products had been seized, 4,000 arrests made and about US$512,000 of fines imposed, reported Gao Feng, a top official with the Ministry of Public Security, at a press conference in Beijing the day after the public crackdown.

But the actions failed to impress David Buxbaum, an American IPR lawyer with Anderson & Anderson, who has been working in Guangzhou since 1972. The first American lawyer allowed to practice in China after President Richard Nixon's icebreaker of a visit the same year, he is "not a great believer" in government drives such as the one launched back in November. From his office in Guangzhou, a city in the heartland of manufacturing and exporting, he calls IPR infringement in China a "raging epidemic," one that only a major administrative and judicial overhaul can eradicate.

"I live in a middle-class community," says Buxbaum. "Everyone can afford to buy proper discs and movies, but you cannot find one legitimate disc. They are all copies." While the number of infringement cases involving trademark, patent and unfair competition disputesgoing through China's 95 IP courts has been rising every year -- for a total of 13,000 since 2006, according to online IP litigation database, CIELA.cn -- it's a small number "considering how endemic IPR infringement is in China," he notes. "If the Chinese government wanted to put an end to infringements, it could in a matter of months…. The capabilities of the Chinese government are enormous."

Not all IPR experts are as skeptical as Buxbaum, but many also voice concern about China's struggle to control everything from hacking of computers to counterfeiting goods to high-level industrial espionage, which has become so pervasive across Corporate China that it's become a global issue. Consider counterfeit goods -- according the European Union, 64% of all fake or pirated goods that were seized in the 27-nation bloc in 2009 came from China, a 10% increase on 2008. Among the 118 million articles seized, clothing was the biggest category, but a variety of other goods, ranging from medicines to household appliances to cigarettes, along with CDs and DVDs, were also seized.

But will the problem get worse before it gets better? Already, foreign companies in some sectors have bristled at the thought that they have had to agree to transfer technology to their Chinese joint venture partners in order to win government approval for new investments. And China's drive to become a technology powerhouse by 2050 under the recently introduced "indigenous innovation" plan is nothing short of controversial, with domestic companies in several sectors encouraged to reconfigure imported technology so that a Made in China label can be slapped on their home-grown goods. The goal is to increase the "value add" in seven tech-based sectors, including new energy and high-end manufacturing, from 3% of GDP today to 8% of GDP by 2015, and 15% by 2020, according to Lilly Chung, a Deloitte partner who participated in a panel on the topic during a recent Wharton China Business Conference in Philadelphia. "The shift is huge from ‘Made in China’ to ‘Created in China.’ I think the [government's] leadership understands that having the technology is the way to create the next powerhouse in China."

But as a result, "the plan is considered by many international technology companies to be ablueprint for technology theft on a scale the world has never seen before," wrote James McGregor, China expert and senior counselor to APCO Worldwide, wrote in an analysis published last year by the U.S. Chamber of Commerce titled, "China's Drive for 'Indigenous Innovation': A Web of Industrial Policies."

What is arguably just as disconcerting to IPR experts has been the corporate response to such threats. Despite high-profile discussions about IPR infringement in China, experts say actual prevention at many companies leaves a lot to be desired. "The biggest obstacle is that many companies don't think they can do anything in China, which is a kind of a self-fulfilling prophecy," says Chris Bailey, a lawyer at Rouse Partners in Guangzhou. He recalls his surprise when visiting a large, well-known foreign soft drinks company in China to find "outdated and underfunded" IP protection, with "very basic, low-cost administrative enforcement to deal with issues, and failing to bring criminal or even administrative cases [to court]. It's probably very active in IP management in its home or key markets, but it has not translated that expertise to China."

A Run for Their Money

So rampant is IP infringement not just in China but worldwide that many multinationals reckon it's one battle in which there is no victory. "You never win this, you just manage it," Donald Blair, chief financial officer of Nike, the Oregon-based sportswear company, said during a keynote presentation at Wharton's China Business Conference. "Unfortunately, one of the things I say half-jokingly is that you don't have a counterfeiting problem unless you have a hot brand."

In China, Nike's brand is indeed hot.It's a market leader in the country, according to the CFO, and with annual revenue reaching more than US$1.7 billion in Greater China in the last fiscal year ended May 31, the company says its plans to double sales in the country by 2015 are on track.

A key to that growth is a network of nearly 200 factories in the country contracted to work for it -- "a very good relationship with our factory partners helps us manage that element of counterfeiting," he said. "Unfortunately, it's not hard to make a product that looks like Nike. It's very hard to make a product that performs like Nike. If you pick it up, you can tell the difference. A counterfeit is very heavy and it may look a lot like it but it's not the real thing."

While Blair said there's no "silver bullet" as far as combating IP theft is concerned, he can see changes moving in the right direction as Nike relies on China for more than a source of manufacturing and the country develops beyond copycat business models. "Over the last few years, quite a bit of development of our products and even some of our innovation work are being done in China," he said. "Chinese insights have helped us create such innovations as … a technology that allows us to build very durable footwear for basketball playing on the outdoor hard courts that are very common in China. That innovation was then used to drive innovation in other markets around the world."

A High Price to Pay

That's encouraging for many foreign companies in China, but Nicholas Blank, an associate managing director in Hong Kong for Kroll, a risk mitigation consultancy, says the havoc that IP theft and counterfeiting can wreak is still formidable. "We're not talking about expense fraud, or about doing things that cost a company millions and millions of U.S. dollars," he says. "It involves so much more than the amount of money; it affects the morale of the office and there are things that possibly need to disclosed to regulatory authorities."

That said, he agrees with Nike's Blair that some loss of IP is an inevitable cost of doing business today. "People would like to lock up R&D in a small room, but that's not really possible," he says. "In reality, there is always going to be a bit of IP going out the door as part of your business. The key is looking for wide open gaps that can be easily fixed."

Running background checks on job applicants is one obvious step, though its usefulness is limited in China. "Corporate records tend to be pretty extensive in China and can be hundreds of pages long. But something like a criminal search is not possible," says Blank. "A lot of the research [requires] going out and talking to people" to help companies avoid hiring what Blank calls the "parasite," a senior manager who goes from company to company every two to three years committing fraud.

"The bad news for the client is that once you've lost a trade secret, you've lost it," he says. "[An investigator] can learn what happened, and you can see what kind of damage that's been caused, but really only the best thing you can do is learn from it."

Don't Trust, Verify

Sometimes that learning curve is far steeper than companies new to the country expect. Zach Wortham, a senior manager who has worked at Wang Jing & Co. for the past five years in Guangzhou, says foreign businesses need to be better prepared for the realities of the Chinese system. For example, he says a common mistake he sees among foreign executives to assume handshakes, bouts of beer drinking and meeting each other's families deter IP infringements. The Chinese "will look for loopholes," he says. "They'll spend time studying the law themselves, they'll have an assistant do it or they'll hire in-house lawyers -- they'll do all those things so they have more knowledge than you. Then when a situation occurs, they take advantage of it…. We would call it cutthroat, but they would just call it good business."

A lot of Wortham's work is helping his clients, which are largely small to midsized foreign firms new to China, be better informed. "If you don't know what Chinese rules are, then how can you play the game?" he asks. "If you have enough information about what is actually happening in China, you can protect your intellectual property…. You have to go in with a plan and you can't expect the Chinese government to do it for you," he says. "It takes time, it takes effort and it takes money. A lot of people don't want to do that, and just say, 'I've got my intellectual property; you guys should protect us,' and the Chinese government is saying, 'You've got to protect yourself. We don't have the manpower to do that right now.'"

Part of those plans need to include joint venture partners. In countries like the U.S., partners could have good faith or oral agreements and be fairly well protected, says Wortham. "In China, unless it is explicitly said, you aren't protected. If you go into a joint venture agreement, you have to have it explicitly written that 'This is my IP, this is exactly how it is going to be used, and any violation is a breach of contract, and you'll suffer this, this and this penalty [for a breach]. You can't just say it's a breach; you've got to detail what the penalties will be in order to have any success in the courtroom."

According to IP experts, more and more companies can expect success in the courtroom, and enforcement, particularly in larger cities, has improved. "The majority of people coming to China to do business have a negative impression about IPR, which I think was warranted in the past," says Wortham. "What a lot of people don't realize is that the legal system is in place."

In general, adds Rouse's Bailey, "we advise them to [start on] the assumption that the enforcement system works to a great extent." But he says he'd like to see more companies bringing their cases to court. "Administrative raids are useful, but I'm very dismayed with companies whose enforcement strategies rely on them heavily," he says. "A raid is quite useful for retail or smaller companies that you want to send a message to. It's a stepping stone to other forms of action. But if people think a raid on its own is going to be effective and put people in jail, that's not the case. It's a blunt tool, and the fines are low. It has its place but a diminishing role. Ten years ago, everything was done through raids."

Law and (Dis)order

But Buxbaum of Anderson & Andersonasserts that companies don't bring more cases to civil and criminal courts for good reason. "Businesses generally don't trust the institutions enforcing IPR because they are weak -- not only the courts, but also the prosecutors, copyright and IP bureaus, and the Administration for Industry and Commerce (AIC), which enforces trademark and unfair competition rules."

A big part of the problem is corruption, according to Buxbaum "Today, people in the court system are much more audacious, despite the fact that from time to time judges get jailed," says Buxbaum. He also says people use connections in the court system to get a ruling in their favor or have a case taken from the usual three judges presiding over an IPR case and send it to a higher court, essentially "taking away the independence of the judiciary."

Judges, meanwhile, undermine their own independence by conferring with a higher court about a case to get an opinion on how they should rule, which "undermines the appeal system," he says. "Any appeal is a waste of time because the higher court has already intervened in the case." There is also a lack of a "law of evidence" in China, which codifies how evidence is presented in court. "In other countries, [law of evidence] is as thick as a book," Buxbaum says. "There isn't anything comparable in China and it's crazy."

There are other hurdles. Along with bureaucratic delays, a company that wins an IPR ruling and is issued an enforcement action must then pass through a tribunal to get compensation. But this often can "appear as if you're going through a second trial" before judges who don't know much about the case, says Buxbaum. What often happens is that the party who lost in the IPR court makes an objection to the tribunal to weaken the enforcement action or drag out the process.

But if there's a consolation it's that local companies want change as much as foreigners do. Experts note that around 95% of the IPR cases that go to court involve Chinese parties suing other Chinese parties, and more domestic firms will be pushing for improvements as they become more innovative and have IP of their own in need of protecting. "A lot of the changes that China has been making to its IP regime are not really the result of international pressures, but what [the government] knows from their local businesses," says Bailey of Rouse Partners.

He predicts that these issues should also be a wake-up call for the growing number of Chinese firms expanding overseas and face IP concerns that they have watched foreign companies in their country grapple with. "Chinese companies will go through a lot of the same things that a lot of U.S. or European SMEs have gone through when going abroad," he says. "Unfortunately they will have to go through pain."

At home or abroad, however, “Chinese companies should spend more time to create and innovate, not simply imitate, or copy somebody else," noted Fengming Liu, chief legal officer of a U.S. software firm and a visiting fellow at Princeton University's Center for Information Technology Policy, during the Wharton conference. "If China wants to be global, it must pay attention to these kinds of [IPR] issues.... Otherwise, China will always remain as a manufacturing base, and that would be bad for China's future.”


Published : 2011.03.30



 
















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