China IP theft

While waiting for my plane in the faceless, cyborg style Seattle airport, I noticed the recent issue of Bloomberg Businessweek with the catchy title “Hey China! Stop Stealing Our Stuff.” I purchased it and read the article It’s Not Paranoia if they Steal Your Secrets: Inside the Chinese Boom in Corporate Espionage. Briefly, the article relates the sorry tale of a U.S. company that claims a Chinese manufacturer stole its proprietary software for use in a Chinese wind turbine project. For someone who has worked in or with China for nearly twenty years, the response is a stifled yawn: the Chinese stole your software. How shocking!

Beyond the lurid headlines, the story does show almost precisely how NOT to protect your intellectual property and trade secrets in China. The article states without evidence that China has embarked on a program of high-tech, Internet based industrial spying leading to a massive transfer of secrets and data to the Chinese government and state owned industries. The implication is that since the form of theft is high-tech “hacking,” the proper defense is investment high-tech application of computer security, “anti-hacking” techniques.

Not true. For China, this high-tech story of hacking wizardry simply does not reflect what is happening on the ground. The article describes twenty incidents of trade secret theft. In 100% of the cases, the trade secrets were stolen by a high-ranking, trusted employee of the owner of the secrets. The thefts were done the old-fashioned way, by simply copying or downloading information. The only thing high-tech about any of this theft was that it was done through direct download, rather than through the use of a James Bond style spy camera.  In 19 of the cases, there was no evidence that anyone in China was able to make any commercial use of the information. Even for the lead story, the offending product (windmills) does not seem to function properly either, so I would suggest that the failure has been total.

So when you clear away the titillating headlines and look at the facts, the article does nothing beyond showing that nothing has changed in China. Theft of trade secrets is common and is encouraged by government policy. But the actual thefts are done the old-school way: copying done by corporate insiders and trusted employees. Even worse, much of the theft is done based on gifts from the owner of the trade secrets. Once the data is transferred to the Chinese, the Chinese find it virtually impossible to commercialize it, absent extensive training provided by the owner of the intellectual property. For reasons I cannot explain, the foreigners seem to enthusiastically provide such training.

So what are the facts about the theft of intellectual property and trade secrets in China? Here is the basic situation:

  •  Chinese companies will aggressively appropriate and sell IP that can be copied and resold without the need for any development work on the part of the Chinese. This includes the standard items of which we are all aware: commercial software, DVDs, music CDs and MP3s, digital films, trademarks, books and magazines.
  • Chinese companies will aggressively copy simple manufactured items like clothing, shoes, toys and furniture. However, in almost every case, they will do this only after the foreign owner of the IP has taken the effort to teach the Chinese company how to make the product. A favorite technique is to convince the foreign manufacturer to pay for the molds and tooling required to make the product and then transfer those items to a factory run by a cousin or uncle.
  • Chinese companies are very interested in copying complex foreign manufactured products. However, they have shown very little success in actually commercializing these complex foreign products. This is why in most of its own manufacturing technology China remains 20 to 30 years behind its foreign competitors. In most of the cases where China has succeeded in making complex manufactured products, it has been because the Chinese companies convinced the foreign owner of the technology to both transfer the technology through licensing programs and then training the Chinese side on how to use the technology. The recent Chinese “appropriation” of foreign technology in high-speed rail and jet fighter aircraft falls into this category.

So what does all this mean for foreign companies that will operate in China? It is critical that you take a realistic view of your risks and what you can do to mitigate those risks. The basic rules are as follows:

  • Do not rely just on high-tech solutions to protect your product. The unfortunate U.S. company at the center of the BusinessWeek article had protected its software behind a secure server located outside of China. This did not help when a trusted employee who had actually written the software downloaded the code and then customized it for the Chinese buyer of the product. This story has been repeated many times in China.  Low-tech protections must be employed as well.
  • When having product manufactured in China or when selling product to China, you must assume that the Chinese side will aggressively seek to appropriate your IP and your trade secrets. It is a fact of life and you must design every transaction to deal with this critical issue. The first step is to consider is not, will my IP be stolen? The first step is to recognize that the other side does plan to steal your IP, and your first job is to think about what you can realistically do to prevent that?
  • Standing alone, the technological solution is seldom adequate. Formal registration and contract remedies are required. China has an excellent system of software copyright registration. This system is used extensively in China by Chinese companies to control software piracy. When I recommend to my clients that they make use of this registration system, they far too often refuse. They usually state that their technical anti-piracy controls are sufficient. Then, when they find that their software has been stolen, they find that they are without an effective remedy. The same is true when I recommend registration of copyright in film, music, art and design, with the same predictable results.
  • Formal agreements should be used that clearly set out the IP issue and provide a clear path for IP enforcement in China. For example, when making a sale of a sophisticated manufactured product to a Chinese company, the seller should include a provision stating that the buyer agrees not to appropriate any of the technology embodied in the product. This is not something a manufacturer would normally do in the United States, but it is required for China. This provision must include a substantial penalty and it must be enforceable within China.
  • When products are being made in China, the foreign buyer must assume that the ultimate goal of the Chinese manufacturer is to appropriate the design and technology of the product for its own purposes. Preventing that appropriation must be a central feature of the contractual relation between the foreign buyer and manufacturer. The purchase agreement must provide in detail what is protected, the specific and clear penalties if piracy occurs, and the enforcement mechanism in China to ensure that the penalties are imposed.

Many companies believe that there is no way to obtain protection from IP piracy in China. As a result of this, they do little or nothing to protect themselves within China. Instead of working with registration and contracts enforceable in China, foreign companies rely solely on ineffective technical fixes and/or on worthless contracts not enforceable in China. This is a mistake. China has created a system for protecting IP, technology and trade secrets and that system works reasonably well. But it only works for companies that have taken steps in advance to protect themselves. Companies that take action only after the IP has been stolen face an impossible task in China, as is well illustrated in the Businessweek article.