China and IP ownership: a risk worth taking?

Foreign companies with operations in China can find their intellectual property (IP) and trade secrets slipping into the hands of a competitor, as one US-based chemical manufacturer discovered the hard way.

The company found profits and product quality in its Chinese subsidiary began to decline but an investigation did not uncover anything definitive, other than poor corporate governance controls. However, the company had its suspicions that local executives had taken the formula being manufactured at the plant, adjusted it and then allowed a rival Chinese firm to begin making it.

Whatever the reality, the incident, which occurred a few years ago, proved costly for the US company, says Dawn Williford, risk advisory service partner at accountant BDO’s Houston, Texas office. The CEO and vice-president of China operations had to resign and the company wound up losing several customer accounts, says Ms Williford, who began working with the chemical manufacturer after these events took place.

Microsoft makes an exception

This is not an unusual occurrence in China, a country notorious for its ability to siphon away foreign companies’ intellectual property, particularly trade secrets. Nor is it a new issue. For years, partner countries have complained – most recently it has been the subject of US president Donald Trump’s bellicose Tweets. The EU Chamber of Commerce in China’s annual report also cited, among other concerns about market access, the issue of forced technology transfer.

This is not to say that all foreign companies have lost IP from their China operations. A few years ago Microsoft formed a joint venture, called C&M Information Technologies, with the China Electronics Technology Group Corp. The joint venture, in which Microsoft owns a 49% stake, was to develop a customised version of Windows 10 for the Chinese government and state-owned enterprise clients in China, according to Xiaomeng Lu, manager of international public policy at Washington, DC-based Access Partnership.

Earlier this year, Microsoft announced that its Windows 10 Chinese government edition was ready to go. “It is unclear whether there was any technology spillover in this arrangement and how Microsoft protects its IP at a time [when[ the Chinese government and companies intend to replace foreign technology with indigenous ones,” says Ms Lu.

Legally lacking

Microsoft, though, appears to be the exception to foreign companies’ experiences in China, while Ms Williford’s chemical manufacturer client is the rule. This is because even if the latter company had been able to prove that its formula had been stolen, there would have been little that it could do about it.

What many people do not realise is that there is no legal protection for trade secrets even as China has worked assiduously to improve its patent protection, says Brian O’Shaughnessy, a partner at law firm Dinsmore & Shohl in Washington, DC, and the president and chair of the Licensing Executives Society board.

“China is using the ruse of a strong patent system to give foreign companies false comfort in the hopes that they will bring in foreign dollars and technology into [the country’s] border so it can access it,” he says. This is done by a variety of means but the most common is requiring a foreign company to form a joint venture with a domestic firm, he adds, saying: “That joint venture usually necessitates the sharing of trade secret technology.”

In addition, the Chinese government is notorious for monitoring everything that goes over the internet, including consultations with local attorneys or discussions with the home headquarters overseas, according to Mr O’Shaughnessy. “So if you are exchanging data or trade secrets over the internet, the government can take possession of them.”

Culture gap

It should also be noted that almost every expert or businessperson fDi spoke to emphasised the cultural gap between how the Chinese view IP and trade secrets and how the West does.

“In many ways, IP doesn’t exist in China,” says Andrew Pearson, founder and president of Intelligencia, a Hong Kong and Macau-based analytics and social media company. “They don’t have that feeling that if you create something you should own it,” he adds.

Perhaps more tellingly, Mr O'Shaughnessy says: “In the Chinese language there is no symbol for trade secret; it is a foreign concept.”

At the same time, the Chinese view technology as an important lever to be used for world market domination. Indeed, the appropriation of foreign technology does not have to take place in China: it can also be seen it in the acquisitions and joint ventures that Chinese companies form in foreign markets, according to Steven Shill, partner and national leader of the BDO Center for Healthcare Excellence & Innovation in Orange County, California.

“Just recently we saw a publicly traded radiation oncology business acquired by a private equity firm that’s China based, with the intention of taking the technology to China,” he says. “We warn risk managers and compliance departments to be aware of this because the value of the investment will be diluted.”

Guidance for investors

Does any of this mean that China’s market should be shunned? It is unlikely that any ambitious business embarking upon international expansion will consider such a possibility. However, any foreign company with valuable technology would be wise to follow certain guidelines.

First, understand who your partner is, says BDO Consulting managing director Pei Li Wong, who is based in New York. “You never know when you are doing business with someone who might have less than honourable intentions,” she says.

Even after you vet your partner, ensure that you understand all of the rights and obligations of both parties, advises Mr O’Shaughnessy. “To the extent possible, avoid having any cutting-edge technology in or accessible to China,” he adds. Instead, he advises, use the country for low-end manufacturing or activities that do not require much IP.

Ms Lu says firms should also try to form partnerships with non-state-owned enterprises, preferably one with a significant overseas presence. Better yet, this company should be publicly traded in a stock exchange outside China.

For example, when Microsoft first launched Windows Azure in China, it did it through a partnership with the Shanghai municipal government and the Chinese company 21Vianet Group, which has close ties to the Chinese government but also is traded on Nasdaq. “If the US company’s IP is stolen by the Chinese partner, the US company can file a lawsuit outside of China where it has more legal leverage,” says Ms Lu.

Microsoft did not follow this advice for its next go around in China; its joint venture partner in C&M Information Technologies was a state-owned enterprise with no overseas operation, she adds.

Leave or stay?

Even if a company takes all of these steps, it might still find its technology has been lost to the China market. That does not necessarily mean it should decamp. Ms Williford’s client, the US chemical manufacturer, did not leave China even after it suspected that it had been robbed. Instead, it doubled down on its corporate governance, she says.

The parent company no longer allowed the subsidiary to do new product development and also sent in its own people as managers, and increased communication at all levels of the company so it did not have to rely on just one narrative being told by upper management, she says.

Finally, it established a rule that the functional head of every department had to be able to speak English. Since those changes, there have not been major problems, according to Ms Williford says. “All it took was better visibility and communication,” she says.