In which the word “Encourage” does a lot of work
A lot happened last month around China and intellectual property (IP) and as we started to write about it we realized we needed to cover a lot of background material first. So today’s post looks back at China, patents and other IP, and then tomorrow we will review the latest developments. We are going to examine IP through the lens of IP for mobile devices, in part because it is a good proxy for IP more broadly, but also because it represents a fairly extreme example and is probably a good indicator of how China’s government views the whole global IP complex.
Don’t Hate the Player; Hate the Game
Like all rising economies, China has long sought to maximize its relationship to IP – they want more of it for the least possible cost. And as much as everyone else complains about this, this is just a function of how all countries have approached IP since the dawn of the Industrial Revolution, if not longer. US history text books used to always mention men like Francis Cabbott Lowell who stole plans for British steam mills and brought them to the US in the 18th and 19th century. In recent decades those textbook mentions have disappeared, but the point remains that much of the US’s early progress on industrialization benefited in some form from what we would call industrial espionage. We are not making apologies or excuses for anyone, just pointing out that simple fact.
When China first opened its economy in the 1980’s, they established a pattern that continues to this day. US companies were allowed to open factories in China, but were strongly “encouraged” to transfer know-how to their joint venture (JV) partners in these factories. Those Chinese parties had IP transfer as part of their mission. In the 1980’s this largely meant manufacturing systems, lessons that China clearly learned and then mastered. As many of these practices and systems were hybrid or adopted from other companies anyway, there was little uproar from US companies. These things were not really patented or protected systematically.
In the 1990’s as the US economy shifted away from manufacturing towards services and software, the question of IP started to become contentious between the two countries. This was best seen in the fight over software protection. Microsoft and others fought a seemingly-impossible battle to stem the tide of software piracy. For many years, anyone could buy any software on the streets of Shenzhen or the markets of Beijing for pennies on the dollar.
US companies tried every means they could to counter this. They tried all sorts of anti-counterfeiting measures, but everything digital was eventually cracked. We remember one notorious incident where US companies attached a holographic sticker to their original software (back when software shipped on physical discs), only to find that a state-owned research facility in Shenzhen was selling counterfeit stickers. The US companies worked with the courts and with China’s nascent IP protection agency. And while this led to some crackdowns on the most egregious copy-mills, it ultimately failed to change the facts on the ground. After years of this fight, we know many US software companies adopted a policy of resignation to the reality. Their stance essentially became that eventually Chinese companies would reach the point where they cared about IP themselves, they would then lobby their government in ways that foreigners could not, and only then would the Chinese government adopt tougher IP enforcement policies. Cue eery foreshadowing music.
Ultimately, the Internet and the rise of the software as a service (SaaS) model broke software piracy. But this did not eliminate the conflict between Chinese and foreign positions on IP, and instead it shifted to other arenas.
As with manufacturing, China’s approach to IP, gave domestic companies the breathing room to learn from foreigners and adapt their practices to compete globally. This does not mean that ignoring IP was the sole factor in allowing China’s rise, it was just one of many forces at play in China’s developing economy.
The Standards War
As this was playing out, mobile phones began to emerge. In the 1990’s the European Union pushed the wireless operators and equipment makers to standardize mobile phones, so that devices would work across national boundaries. The outcome of this was the GSM 2G standard and the framework that we still use today to set wireless standards. The US government took a more hands-off approach. This led to a fair amount of fragmentation among US operators, but it also allowed for innovative companies to try different approaches. In particular, this meant Qualcomm was able to develop the CDMA standard. In the late 1990’s Qualcomm entered full-evangelist mode doing everything they could to encourage adoption of their standard in the face of the by-then global GSM standard. One chapter of this played out in China, which was then trying to win US backing to enter the World Trade Organization (WTO). That is a whole other saga, but one small part of this process brought CDMA to China’s Unicom operator. The US government appears to have strongly encouraged this adoption, and it seems likely that this lesson was not lost on the Chinese government. And while we rarely hear about this process anymore, we have the distinct impression that early on mobile IP became very important to the Chinese government.
In the early 2000’s, China greatly expanded its effort to grow its IP position. Domestic companies were given all kinds of incentives to increase R&D, and this eventually led to an explosion in Chinese patent filing that continues to this day. Patent filings were just one part of China’s efforts. And here we seem to cross a boundary as to how foreign companies view China’s IP efforts. This is where that effort by US companies to get Chinese companies to care more about IP really comes full circle (more on this in the next post). It is easy to view China’s IP efforts over the past decade and a half entering a “by any means necessary” mode. Tactics moved from partnering and copying to forced IP transfers, strict IP requirements and outright industrial espionage. Again, we want to avoid passing moral judgments here. We have literally had a conversation with someone at a large Chinese electronics firm who asked “Why are Westerners so mad at us?!? We are just doing what you taught us to do.” Many in China view this as a fair exchange – low costs goods traded for advanced know how. It gets very grey and very murky morally, but something definitely changed in this period.
Going back to mobile we need to make a quick detour to South Korea. That country went through a similar development path, albeit one using far more staid methods of increasing IP and know-how. By this point, Samsung and LG had become leading makers of mobile phones. The advent of merchant modems from companies like Qualcomm enabled this, but by the 2000’s the price of that was becoming apparent. For many years, IP license payments to Qualcomm were so large as to register as major contributors in South Korea’s national balance of payments statistics. So it is probably no coincidence that the South Korean government took a lot of interest in Qualcomm, repeatedly sending the tax, anti-trust, and other regulators on raids of Qualcomm’s local offices. (And for some reason, the timing of these raids often seemed to coincide with periods when Qualcomm and Samsung were negotiating contracts.)
We suspect that Chinese regulators were aware of this situation, and become more keenly aware of them as Chinese handset companies began to claim global market share in mobiles. In 2014, China set its regulators on Qualcomm, going so far as to put its country head under house arrest for several years. In the end, Qualcomm essentially agreed to lower the royalty rate it charged its Chinese handset licensees, paving the way for their consolidation and massive global share positions today. Qualcomm was also encouraged to enact various measures to transfer IP to Chinese companies [euphemism alert].
Mobile is just one industry, and other sectors have seen similar patterns, mixed with other tactics. Networking equipment is a primary example, and one that has attracted considerable accusations of industrial espionage (google Nortel for an example of this vein). We have seen many other examples around industrial systems, consumer goods and a host of other segments. As always, there may be a grain of truth to these concerns, but even if true they are just one factor among many.
It is important to understand that China’s approach towards mobile IP is much more aggressive than in other sectors. We once worked with a company that was looking to license its IP for mobiles and made no progress after a decade of attempts. At the same time, the company also sold products in other electronics categories. In those, they found much more interest and acceptance from vendors. It was clear that mobile companies had been given some form of instructions at a national level to not engage, while the instructions for other sectors were only interested in acquiring whatever IP they needed. As we have said repeatedly, China is not a monolith. These nuances matter as the economy evolves.
And once again, the focus of conflict has shifted, now towards semiconductors and “AI”. Once again, China is trying to move its economy up the value chain, and many of its methods appear to run afoul of global norms.
Tomorrow, we will look at more recent events, as China is taking the next step in building its IP capabilites by projecting its power outward.