Defense Against the Dark Arts: Defending IP in China

This post is part of our ongoing series on Doing Business in China. You can find the introduction to this series here, this is our second post on IP in China, you can find Part I here. In our last post, we discussed the reality of Chinese companies’ pressure to acquire IP. In this post, we will discuss how to manage that when partnering for a China JV. In Part I, we pointed out that the term ‘IP’ really means whatever it is that makes your company profitable and successful. It is not just patents, but all-around know-how, competitive advantage and yes, sometimes, R&D secrets. This has some very important implications and through this understanding is a path to running a successful business in China. The ‘solution’ to this problem is to build a joint venture in a way that it is always worth more to your China partner to stay in the JV than for them to go their own way (with your IP). Your company needs to continuously deliver value and at a pace that far exceeds the local partner’s ability to keep up with it. Sound easy? In reality, this can be very difficult. To achieve this, companies need to have a very sober analysis of the true source of their competitive advantage. All too often US companies have built dominant domestic or even global positions through methods that are not as defensible as they thought. One simple example of this is consumer goods. Many global food and beverage companies have tried to enter China to very mixed results. Many of these companies exist in duopolies or highly concentrated market share in their home markets. They maintain this through superior distribution. Want to launch your new line of Organic Peanut Butter? You will find shelf space in grocery stories tightly controlled by a small number of brands. They pay the stores for prominent positioning and have the delivery trucks and mechandising staff to hold on to that position. They do not make ‘better’ peanut butter, but can dominate through superior distribution. However, when those large brands take their product to China that advantage disappears. Perhaps with time and large dollops of capital, they can replicate their distribution network, but at the outset they are entirely at the mercy of a confusing array of distribution partnerships, many of whom would be happy to copy your merchandising strategies, for a price, for a domestic brand. To truly compete in China consumer products need to build valuable brands. Once upon a time, having a Global brand carried significant weight in China. Those days are long gone, and so we have seen a big slowdown by US consumer goods entry into China. Building a brand in China is now very expensive. Possible, but not easy. It is not enough to carry the global brand, or the US brand, to China. That global brand only carries so much weight. The path to success rests in heavy marketing spending to build a brand that suits local tastes. Bringing this back to technology, we see the same pattern. Producers of commodity hardware products have been largely displaced in China. A few were able to get in early or had sufficient domestic ties to build a toehold, but for most low-margin products there is no entry. This makes sense, almost all electronics are actually built in China anyway, and so much of the technical expertise rests there as well. By contrast, software is a much more defensible position. Here we are referring not only to software itself, but also software tightly coupled to hardware or some sort of network service – Cisco and Apple have both done very well in China using this model. Companies that deliver value through software can continuously update that software and maintain their value advantage over local partners. The wrinkle in this is that selling just standalone software is very hard in China. Domestic customers are still very reluctant to pay for software, especially with the growing adoption of open source software in China. The good news is that this is not a China-only phenomenon. Technology companies are now all well-versed in the understanding that “Software¬† will eat the World” and most software products are sold ‘As a Service” allowing for constant value-adding updates. Years ago, visitors to China’s electronic shopping malls met with a wave of hawkers standing outside selling pirated software. These have long disappeared. We wrote a piece about this years ago titled “Pity the Pirates”, noting that software as a service and online distribution models had rendered the market obsolete.¬† The market for software has changed radically everywhere in the past decade and this helps when dealing with JV partners. With this ability to advance product features through software, it is possible to keep the lead over domestic competitors (i.e. your JV partner). They could steal your IP and copy your product, but all that work is rendered obsolete in the next software version. We recognize that this will still leave many companies, especially pure hardware companies, with less leverage. And we are not arguing that this is an ideal situation. That being said, this is the reality. There is a way to manage IP “Learning”, and it starts with a basic understanding of what value your company is really providing.

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