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.

The Globe and Mail did a story the other day, entitled, “Bombardier to share railway technology with Chinese.”  The story is on how Bombardier has granted a ten year license of its tram technology to “a subsidiary of China South Locomotive & Rolling Stock Corp. Ltd., the biggest player in the railway manufacturing sector.”  Under the deal, “Bombardier will supply documentation, training and other assistance in manufacturing and selling the streetcars to South China unit CSR Puzhen.”

The article raises IP concerns about such a deal:

This type of licensing-only agreement and other partnerships, however, raise concerns in some quarters that Bombardier is simply helping China develop its rail expertise so as to eventually become a major global rival in manufacturing trains and subway cars.

“I don’t think Bombardier is going to get much of a bump on this. Bombardier will regret it in 10 years when China starts mass producing their own versions,” said Malcolm Johnston, a transit advocate based in British Columbia.

Bombardier seeks to refute such worries by stating that “the key to these types of partnerships or joint ventures is to stay ahead of the innovation curve.”  The Facebook buzz, among people I greatly respect, is decidedly negative about Bombardier’s deal, and I note the following comments:

  • It’s the maglev technology transfer all over again.
  • Canadians
  • GE is the American version of Bombardier. They’ve been trading away entire industries.
  • If history is a good predictor of things to come, then I look forward to seeing their partner “innovate” upon the technology transferred and export “their” technology to markets around the world.

I eventually chimed in with the following and got the following responses:

Me: May turn out to be a brilliant move. Not kidding.

Response: How do you figure this will turn out any different from any other foreign company that has placed their technology in Chinese hands, Dan? The goals of the Chinese haven’t changed.  I don’t blame the Chinese for copying as much as I blame gullible foreigners for making it so easy.

Me:  You-all are making all sorts of conclusions. I will do a post on this, asserting that this sort of deal MAY be the wave of the future. Of course the goals of the Chinese haven’t changed and of course they do and will do whatever they can to steal technology. That isn’t the issue.

Response: I look forward to your post on this, Dan. From what I can tell “this sort of deal” looks like most of the others that have come before. It seems reasonable to expect a similar outcome.

Okay, here goes.

First off, let me say that I have represented hundreds of businesses in my legal career, ranging from one person operations all the way up to the largest company in the world (at the time) and, generally, I have found that nobody knows their business better than the people whose job it is to know the business. That alone makes me reluctant to criticize a company for a prospective move, especially when I no doubt lack many of the relevant facts.

The facts in the press are not enough to know whether Bombardier’s China technology licensing deal makes sense for Bombardier or not.  What if Bombardier is being paid $10 billion a year?  It’s a great deal, right?  What if Bombardier is licensing out an existing technology and it knows it is only a year or two away from a next generation technology that will put the existing one to shame?  What if this is an industry where the product is only one small aspect of a buyer’s decision, and Bombardier is rightly confident that no Chinese company will ever be able to compete on the more important aspects of installation of product, maintenance of product, and/or repair of product?  Or what if Bombardier knows that the product it is licensing is going to be surpassed by various competitors’ products within the next year or so and this deal is a profitable way to unload it? I do not know if any of these things are true, but isn’t it more likely that Bombardier knows what is best for Bombardier than my friends on Facebook? And anyway, what were Bombardier’s alternatives if it was going to make money in China?  I don’t know, do you?

This is not a comment about my friends on Facebook (who were participating in a relatively private discussion), but it has always bothered me how there are some China pundits out there who are always quick to criticize how certain companies are doing in China (usually noting how they are not moving fast enough), while ignoring all of the China factors that make doing what the pundit suggests so difficult.

I actually like what Bombardier is doing and it is something that we are seeing with increasing frequency among our SME clients. Licensing a technology to a Chinese company for a fee and then charging that Chinese company even more money to teach it about the technology oftentimes makes sense for SMEs without the capital or the desire to go into China on their own. I hate to equivocate like a lawyer, but the bottom line is that sometimes licensing makes sense and sometimes it doesn’t, and it is hard for us to judge from afar those companies that do it.

For more on licensing to China, check out the following:

  • China Intellectual Property (IP). I Hate Cats, in which we give the following advice to help assure payment from those to whom you license your IP:
    • Base your pricing on the assumption that you will not get full payment on your final payments.
    • Do whatever you can to make sure the Chinese company still needs you at the end of the deal so that the Chinese company has no choice but to keep paying you.
    • Put in some killer provisions in your contract that deal with a situation where the Chinese company stops paying at the end.

What do you think?