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Innovation In China. They Still Need Us And It Might All Just Work Out Fine.

Posted in China Business

By:  Steve Dickinson

One of China’s primary challenges is fostering technology innovation. The Chinese authorities want China to transform its industrial model from a low value added/low level technology model to the opposite. To combat stagnating economic growth and the threat of energy and resource restraints, government policy is to try to effect this change as quickly as possible.

This transformation will require access to cutting edge technologies. If China relies on foreign technology to make the leap, there will be two significant negative consequences. The first is that the cost of acquiring foreign technology may simply be too high. The second is that by relying on foreign technology China will become progressively more dependent on foreigners, which conflicts with China’s current drive to become an independent, “stand alone” world power.

As part of its 12th Five Year Plan, China has therefore embarked on a domestic innovation program. The fundamental concept is that Chinese companies will independently develop the technologies required to drive China to its new, high tech future. There are many limitations on the ability of companies in any country to become innovators in the technology realm. The factors can be broken into two basic components: capacity for innovation (intangible) and corporate spending on research and development (tangible).

The position of Chinese companies as compared with the rest of the world is illustrated by Booz & Company’s recently issued 2012 Global Innovation 1000 study. The Study shows that China has a long way to go in all areas of innovation. First, consider the intangible side. The Study lists the 10 most innovative companies in the world. Headed by Apple, eight of the top ten come from the United States, with Samsung from Korea (at number  four) and Toyota from Japan (at number seven) rounding out the list. No European company nor any BRIC company made the list.  The list shows that when it comes to the intangible side of innovation, the United States remains the overwhelming leader in the area of technical innovation.

The Study shows that not only are Chinese companies nowhere to be seen in the intangible side of innovation, they also are nowhere to be seen on the investment side.  Simply stated, Chinese companies do not spend a significant amount on innovation. The Study lists the top twenty spenders on innovation and none are Chinese. Toyota of Japan heads up the list on spending in 2011 at 9.9 billion dollars. The top six on the list all spent at least nine billion dollars on R&D in 2011. The top twenty spent $153.6 billion as a group on R&D, a 9.9% increase over the previous year. In terms of geographic distribution, eight companies are European, eight are from North America, three are from Japan and one is from Korea.

How does China measure up? The number of Chinese companies in the Global 1000 has grown from 15 in 2008 to 47 in 2011. China has two companies in the top 100: Huawei and Petro China. China is thus far ahead of the other BRIC countries (Brazil, India and Russia). India is Chinese closest competitor among the BRICs and China dwarfs India.  China has 47 companies in the top 1000 while India has only 9. China’s total expenditure is $14.8 billion while India’s total expenditure is only $1.5 billion.  Thus, compared to the rest of the BRIC countries, China is far ahead in innovation spending.

However, a closer look at the data shows that China remains far behind the developed world. Consider first the total amount of investment. China’s 47 companies in the top 1000 spent a total of $14.8 billion on R&D in 2011. This is substantially less than the amount spent by the top two individual companies in the top 1000 and it is less than 10% of that spent by the top twenty as a group. Equally important, China’s commitment to spending is decreasing rather than increasing. China increased its spending by over 27% in 2011. However, this was a decline from the 38% increase in 2010. [ Statistics from Booz & Co data summary. ]

The numbers therefore show what anyone who works in China would expect. China’s capacity for innovation remains far behind the developed world and there is little prospect for substantial improvement in the future. The reasons are simple. On the intangible side, Chinese companies have little capacity for internally generated innovation. On the tangible side, Chinese companies do not invest substantial amounts on innovation. The trend in both these areas suggests that this pattern will not change in the near future.

It is therefore clear that establishing a sound technology base for China’s future industrial and service economy remains a daunting challenge. The numbers show that if the Chinese regulators and businesses are serious about moving to a high technology economy, most of the technology necessary to make that move will need to come from sources outside of China.

All of this means that the opportunities in China for foreign owners of technology are considerable. However, success for these foreign technology owners will depend in large part to the answers to two questions about China. First, will China’s legal system protect the ownership rights of the foreign owners of the technology? Second, will the Chinese players be willing to pay the price to acquire the first tier technology required. An honest assessment of the performance of the Chinese government and business over the last thirty years would say that it is not at all clear that the answer to these two questions has been in the affirmative.

However, the past is past and looking to the next decade, we are seeing some sprouts indicating that China realizes it must improve.  Protection of intellectual property is very slowly, yet very surely improving. China’s courts are more likely today to enforce intellectual property rights than they were five years ago.  Perhaps even more importantly, we are far more often finding ourselves on the opposite side of the table dealing with Chinese companies that realize that it is in their own best interests to pay for top tier technologies from foreign companies and then abide by their agreements with those companies regarding technology and intellectual property assets.

We have written technology licensing agreements with Chinese companies where we were surprised that the Chinese companies chose to pay for the technology, rather than just steal it. In most of these instances, the Chinese company chose to go the legal route because it valued the relationship with the foreign technology company that would go along with their doing so.  Many times, the foreign company was able to “sell” the Chinese company on the value proposition, convincing the Chinese company that it would learn more faster by paying full freight, rather than just trying to go it alone.

There is no question about China’s demand for technology. The question is whether there is a commercially reasonable market to meet that demand. The challenge for all interested parties — foreign companies with technology, Chinese companies seeking technology, Chinese courts and governments, and even the lawyers doing the technology deals — is to do our part to make the answer a yes rather than a no. We cannot wait for the Chinese side to do it all on their own.

Innovation in China over the next decade?  It’s a strong maybe.

What do you think.

  • Hong Kong Ren

    Your China optimism over innovation is very unlikely to be realized in actual fact. There are VC firms in China encouraging IP theft by target companies there as its a short cut to IPO’s, did you know that? China is still backwards in innovation, they continue to copy and without a system that encourages individualism and entrepreneurial behavior are not going to be making much progress. Its all hype. The real deal and leader in this is India whose entrepreneurs and real inventors are several global classes above the Chinese. Many of the so-called “China Patents” people point to are existing technologies taken and protected in China by businessmen who had no technical input in the design of their registration. You’re dreaming if you believe differently.

    • Bobby315

      I think you are right. But we can’t say that there is no
      innovation in China, they have their own path of dealing. But as the author
      mentioned in blog that China is on its own way to become superpower without any dependency. I would say that this is not possible at all. Every country needs
      another country. It’s not a one way. We all need to share ideas to make our
      (world) future.

  • Mark Elliott

    Extremely interesting read. I have been working for 5 years for a Chinese company that produces music events (concerts, club nights & festivals). As a foreigner, I have found it frustrating (very) that the Chinese company seems to be overly concerned in keeping costs low, and has shown no interest in developing its technology to increase revenue. The technology I would think is necessary relates to (1) promotion; (2) ticketing/security; (3) Enterprise Content Management. The issues I have faced are EXACTLY as you’ve explained them in your article.

  • beeluci

    “We have written technology licensing agreements with Chinese companies
    where we were surprised that the Chinese companies chose to pay for the
    technology, rather than just steal it.”

    This is hilarious. Intentional? I see a Mel Brooks movie…

  • http://www.inpraiseofchina.com/ Godfree Roberts

    They managed to invent almost everything (see Joseph Needham) prior to our invading them.

    At the macro end they’ve invented a national economy, that grew 10% annually for 30 years, with a clutch mechanism that switches smoothly to a sustainable, targeted 7.5% – while lifting 600 million people out of poverty and establishing 90% home ownership.

    On the micro end they managed to create a unique $1 million weapon that neutralizes a $12 billion aircraft carrier.

    My guess is that they’re capable of filling in the gap.

    One factor supporting my optimism: approximately 55% of peer-reviewed articles (innovation’s ground floor) on significant technological innovations have Chinese co-authors. All that’s needed to attract those investigators back home is venture capital and open arms. Expect to see both during the next 10 years.

  • twofish

    1) You’ll never see real innovation in large companies. Large companies are focused at maintaining the status quo and are just aren’t going to see disruptive technologies coming out of them.

    2) Overly strong IP laws get in the way of innovation in small companies since everyone just hires lawyers rather than making process improvements. You can see this with smart phones. You can’t start a small smartphone company in the United States but you can in China.

    There are three inventions that are wide spread in China but practically non-existent in the US

    1) ultra-cheap smartphones and tablets. There are three or four semiconductor companies that have created plug and play systems on a chip smartphones.

    2) solar water heaters – what you do is to vacuum seal the water so that it can get hot via solar radiation even on cold days. you then use process improvements to reduce cost

    3) electric bikes – electric cars are a dud in China, but electric bikes have really taken off

    Now none of these products are made by large companies, but that goes to the point that innovation especially in China doesn’t happen in large companies. That doesn’t mean that large companies are useless, since you need a telephone company around before people will buy cheap smartphones.

    However, having a small company trying to build an electric bike means that your efforts are going to be focused mainly at building the bike rather then hiring lots of management consultants to create a bunch of Powerpoints.

    But I’m less worried about Chinese innovation than I am about Western smugness. In China you have people on the ground doing stuff, whereas in the West you are increasingly having things run by management consultants with no clue.

    The report is sad and ironic because it talks about Bell Labs and neglects to mention that 1) it existed large because of a state sponsored monopoly and 2) once the management people got a hold of it, it got killed.

  • Jay

    I’m sure there might be some relation between actual R&D and innovation and the amount of cash spent on R&D and innovation. But not a 1:1 relation, at least not in China (in the sector I’m in). Typically, most cash spent on innovation goes into building large office buildings that stand mostly empty, or are rented out at particularly non-innovative companies, for a percentage, of course. Some companies (with sufficient guangxi; the application forms for subsidy specifically ask for your connections; ability seems less important) receive millions to achieve specific R&D outcomes. Contracts are signed between company and ‘Beijing’ stating that the company shall A) self-develop gizmo XYZ to so-and-so standard and B) not copy, license or steal a foreign XYZ and make some modifications. The company then spends the subsidy on cars and apartments for its management team, buys or steals a foreign XYZ that does not meet so-and-so standard, changes the name and make some other cosmetic changes, and voila… innovation! In my industry (high-tech high-value components supplying all the big China brands like Haier, Huada, Huawei, ZTE and so on), this is still the norm, not the exception. So, I’m not holding my breath…

  • TheBugisStreetWarrior

    Innovation in China? Ripped off IP, dodgy patents based on someone elses work and the typical competition tactic is to undercut the opposition and trade on wafer thin margins. China trade can’t afford innovation.