China Manufacturing. Do not be assimilated.
Manufacturing in China. Do not be assimilated.

My message to foreign tech companies (particularly those involved with Internet of Things devices) who do manufacturing in China is:

Protect yourself. It can be done.

Despite the horror stories you read about Chinese technology theft and counterfeiting, you can prevail against Chinese manufacturers provided you understand what is going on and provided you make use of key weapons available to you.

In previous posts on China NNN Agreements and China Product Development Agreements, we described how foreign companies  need to protect their technology in China in the period prior to full, production-ready commercialization. In fact, in transactions that we have reviewed over the past year, we find that the vast majority of foreign tech companies give away their valuable technology during the development phase in China. By the time the product is ready for commercial production, the IP in technology is already lost.

One reason for this is that the Chinese government has concluded that Chinese companies will never develop the R&D expertise required to develop their own technical base. So the only alternative is for Chinese companies to “assimilate” foreign technology.

The term “assimilate” is just a nice way to say: appropriate the foreign technology without paying for it. The basic situation in China is laid out clearly in a CASS (China Academy of Social Sciences) report issued around ten years ago, stating as follows:

  • Japan and Korea developed their industrial base by licensing or purchasing foreign technology as their first step.
  • After Japan and Korea legally acquired the technology, their companies and technicians devoted considerable effort to mastering the technologies so that they could commercialize them. Japan’s work with the transistor is one example.
  • CASS research shows Japan spent about $2.50 in R&D and commercialization for every $1.00 in technology it purchased. Korea went beyond Japan and spent $5.00 for every dollar.
  • The companies of Japan and Korea did not steal the foreign technology; they paid real money for it. Moreover, private companies made these technology purchases, not the government. These fund outlays put tremendous pressure on these companies to turn their expenses into marketable products as quickly as possible.

CASS reported that the situation in China is quite different. There are two fundamental differences:

  • Chinese companies have been reluctant to pay the fees required to legitimately acquire foreign technology. Chinese companies have preferred infringement over legitimate purchase.
  • Without regard to the method by which Chinese companies have acquired foreign technology, they have invested very little in the R&D required to master the acquired technology. As many Chinese commentators have stated, it is not possible to do any creative commercialization work until after the technology has been mastered. As an illustration of the fundamental issue, CASS reported that Chinese companies spend about 78 cents on R&D for every $1.00 in technology they acquire. This work is also not really R&D. Instead, most of this effort by Chinese companies is spent on dumbing down the advanced technology to make it suitable for more primitive Chinese devices and manufacturing techniques.

CASS then concluded there is no way in the near term to convince Chinese companies to change their approach to technology R&D and technology transfer. Therefore Chinese companies will never be able to develop technology required for advanced products on their own.

You might then conclude that CASS would recommend that Chinese companies increase their budget for the legitimate purchase and licensing of foreign technology. You would be wrong.

This is NOT what CASS recommended. Instead, CASS recommended that Chinese companies abandon their independent R&D efforts and instead devote their efforts towards “assimilation” of foreign technology. By assimilation they mean: appropriate the foreign technology in violation of IP protection terms and without paying for it.

The CASS report then gives two examples of how to do this:

  • The theft by Chinese manufacturers of Russian jet fighter technology that resulted in the production of the current J20 fighter jet line.
  • The theft by Chinese manufacturers of high speed rail engine technology from five different foreign manufacturers.

CASS uses these two projects as examples for how Chinese companies should proceed in the future. Both projects used the same technique. The first step is to enter into a technology licensing agreement. The second step is to provide for a long term pay out, where the technology is transferred early and payments are made very late in the process. The third step is to convince the foreign parties to teach the Chinese side how to use the technology in a commercial setting. The fourth and final step is triggered on the day the Chinese have decided they have learned enough to go forward on their own. When this day occurs, the Chinese company will breach the technology transfer agreement by refusing to make any more payments and by producing the product in direct violation of the technology transfer agreements. With so many of the payments pushed so far into the future, the Chinese company acquired the technology and received the training at a substantial discount.

The above approach to assimilating foreign technology is now standard procedure in China and every foreign company looking to transfer technology to China must understand this and take measures to prevent assimilation from taking place. It can be done, but it requires an aggressive strategy that combines proper documentation with other, practical techniques. In my next post, I will discuss how to fight back against assimilation.

  • Yes this is quite common. In many cases, the foreign company gives them the blueprints + the training (by helping technically during development and by purchasing a few production runs).
    Another example is the Airbus JV in Tianjin. Who doesn’t believe that many engineers who worked on that assembly plant didn’t help with the development of China’s domestic planes?

    • Philip Bracq

      You should learn a few Chinese words and move your behind to China to truly appreciate the level this country has achieved in a few years while you guys sat on your behind screaming from the top of your lungs that Chinese are incapable of innovating.
      So frigging dumb.

      • I have been living in the mainland for 9 years and I commented about things I have seen first hand. Not sure why you write this.

  • Philip Bracq

    What a load. China produces thousands upon thousands of talented ingeeners every years. US, a few, loaded with debt…
    Most research in the US is done by foreigners with one white guy sitting at the top of the hierarchy taking all credit for it.

    • Jatin Grover

      Maybe you should move your behind to USA and see why you are wrong. Load of lies. Been working in Chinese manufacturing facilities for last 6 months. Haven’t met a single Chinese electrical engineer who seems capable enough to work independently. I have to guide senior engineers everyday for manufacturing. They don’t know shit about wireless engineering.

      BTW I am Indian and living/working in USA (Silicon Valley) for last 10 years. I work in a hardware startup in San Francico with 10% immigrants and 90% Americans. I have seen many talented engineers but haven’t seen a single talented engineer in China yet in the “big name” factory I worked in. So you are wrong in everything you said. There is a big maker movement going on in USA, in SF Bay Area particularly and China is just doing the dirty work for US companies. US economy is suffering due to greedy banks and corporations who buy out the government. But private sector and tech companies are doing much better now.

      The work culture in China is caustic. Its not good for innovation.

  • Ward Chartier

    One technique to protect IP is to contract with several vendors, each of which assembles and tests different sub-assemblies. The vendors ship their sub-assemblies to a distribution center possibly owned by the customer. As end customer orders arrive, the distribution center sends sub-assemblies to a final assembly, test, and inspection facility for completion into the finished product. This solution is not perfect, nor can it apply to all products, but it works well for the right products.

  • The time has come when strict laws should come in force to give a befitting reply to such arrogance. As any country should pay proper pay package for the hired, else the people should every right to file a defamation against any failure.

  • Peter gardner

    I must agree with Renaud on this, in the case of Airbus, (I have lived in Tianjin since 2002) I know for a fact there has been “knowledge transfer”. I have direct knowledge so many instances when knowledge transfer has happened, even to the point of theft of computer hard drives form a small German stamping operation for machine and product drawings.
    Yes there have been big steps forward, but even in my small firm, we have all the USB shut down, No-one has access to their C drive, everyone has a drive on the server. Internet access is heavily restricted. Access to web email accounts is blocked. Company email accounts are again restricted.
    Any email with attachment being sent out of the company (even mine) is held until IT in the US have checked the attachment.
    All drawings are held on servers based in the US. very few hard copied are printed and if they are they are signed for daily and returned to the secure print rioom and shredded daily.
    No phones with cameras are allowed in the plant, we supply dumb phones to auditors, customers and vendors if required.
    We make extensive use of NNN agreements, NDA simply don’t work.
    Unfortunately, the technical, Quality skills and the conscientousness/moral compass to do the right thing are lacking in so many people that it is operationally challenging to manufacture here without higher headcounts and inefficiencies that are higher than expected. Not that it can’t be done, it just needs more commitment and drive from the right senior management be they local or an Expat.

  • russnelson

    This is kinda crazy. You don’t get ahead by stealing, because the people you steal from will take steps to prevent you from stealing from them. And if you’re working with these people? YOU are going to be paying for these steps. And if they have to employ Harris & Moure? YOU are going to be paying their bills with money that could have gone to you.

    Honesty really *is* the best policy.