foreign companies doing business in China

How to negotiate with Chinese companiesIn this series of posts I am looking at themes explored by Lucian Pye in his work Chinese Commercial Negotiating Style. Pye concludes that the way most Sino-Foreign negotiations are conducted helps the Chinese side apply its preferred strategies and tactics. My first post looked at how Chinese companies tend to control the preliminaries during what I have called the “courtship” phase. The second post considered what Pye has to say about the Chinese tendency to prefer agreements on generalities. In this third post I examine what he has to say about specific Chinese negotiating tactics.

According to Pye, Chinese negotiators tend to use the following tactics:

Open with flattery — In response to flattering remarks the foreigner feels compelled to give an enthusiastic affirmation. The foreigner is then called on to give an emphatic denial of a feigned, self-deprecating remark. This puts the foreigner on the back foot from the outset.

Operate on two levels — There is the manifest level of bargaining about the concrete and there is also the latent level at which attempts are made to strike emotional bargains based on dependency. Chinese negotiators seek relations in which the foreigner will feel solicitous toward China, thus implicitly becoming a protector and more a superior than an equal.

Focus on mutual interests — Westerners like to think of themselves as conciliators. The Chinese tend to reject the principle of compromise and prefer instead to stress mutual interests. When mutual interests have been established it is easier to ask the foreign party to bear a heavier burden without protest.

Use meetings as seminars — Negotiations are seen partly as information-gathering operations. Foreign competitors are played off against against one another to extract maximum technical intelligence from presentations. Negotiating sessions are used frequently for training purposes. The foreigner is encouraged to perform so as to impress the passive Chinese host. The obliging guest entertains in repayment for hospitality and brings “gifts of knowledge”. Put simply, Chinese companies often claim to want to do a deal with you when all they really want is to get access to your technology or know-how. I cannot stress enough how often our China lawyers see this sort of situation.

Blur the lines of authority — You can’t tell who reports to whom or where the apparent leader fits in the hierarchy of the Chinese company. Negotiating teams tend to be large but the lines of authority are diffuse and vague. Chinese negotiators are often unsure of their mandates and of the probable decisions of their superiors. They therefore tend to give inaccurate signals about the state of negotiations. Foreigners persist in trying to find a particular person who has command authority at each level. In China it cannot be assumed that power is tied to responsibility. Proof of a person’s importance often lies precisely in their being shielded from accountability.

Never say “no” — Chinese negotiators will frequently seem to be agreeing when they say something is “possible” but often this is an ambiguous way of saying “no”. They will often respond with silence to a proposal and then at a much later date suddenly return with interest.

Never telegraph their next move — Chinese negotiators don’t telegraph their next moves through displays of emotion. The level of friendliness or impersonality remains the same whether negotiations are heading for success or failure. This brings surprises. Warm and progressively friendly meetings can lead to disappointing outcomes. Chinese negotiators are quite prepared to end meetings or negotiations on a negative note. As negotiators often have little authority they often find it prudent to maintain a negative attitude. At the same time, apparently disinterested negotiators can suddenly announce that a positive agreement is possible.

Exploit Chinese members of the foreign team — Ethnic Chinese associated with the foreign team will be sought out in the belief that they are naturally sympathetic to China. Our China attorneys have also seen many instances where an Ethnic Chinese person on the foreign side is accused of disloyalty for not siding with the Chinese side in the negotiations — always in Chinese, of course.

Use “shaming” — Chinese negotiators may be quick to point out “mistakes” in an effort to put the foreign party on the defensive. There is a deep belief that people will be shattered by the shame of their faults so there is a tendency to make an issue over trivial slip-ups and misstatements.

Make big asks — Chinese negotiators often have no hesitation in presenting what they must understand are unacceptable demands. These demands are often accompanied by a hint that they will be withdrawn in return for only modest or symbolic concessions. Extreme language is often used to obtain symbolic victories.

Stall — Chinese negotiators are masters of creative use of fatigue. They have, according to Pye, great staying power and almost no capacity for boredom. These traits keep foreigners’ hopes alive. This approach may also reflect lack of experience, bureaucratic problems or a subordinate’s fear of criticism from above. Conversely, when agreement reached it is often the Chinese who become impatient for deliveries by the foreigners. For more on this tactic, see Doing Business In China Requires Patience. Don’t Just Be Leaving On That China Jet Plane.

As I have said before, Pye never moralizes or suggests there is anything wrong with the Chinese approach. He merely points out how different it is from the typical Western approach, leaving readers to conclude that foreigners ignore or disregard Chinese negotiating tactics at their own peril. This is certainly consistent with our view that one should not rush to blame the Chinese when things go wrong.

In my final post in this series I will outline Pye’s tips for foreigners when negotiating with Chinese companies.

Okay, no sooner do I tout a list of ten keys for doing business in China but a loyal reader sends me another such list by which he swears. This list was created by Michael Witt, an INSEAD Professor of Asian Business and it makes up a Forbes article, entitled, The Ten Principles For Doing Business In China. It is described as “ten insights intended to help your business be successful in its China operations” and it too contains excellent pointers for foreign companies doing business in China.

Here is that list with my comments in italics:

1. Do your homework. When China operations get into trouble, a lack of preparation is a common theme. Very true. I hate to say this, but in my experience, foreign companies that get in trouble in China are usually at fault for not having better prepared.  

2. Beware of industrial dynamics. A common cause of losses in China is that foreign firms are so focused on market growth rates that they neglect the basics of competitive analysis. In the beer industry, for instance, more than 20 foreign brewers entered in the mid-1990s, each of them planning to capture on average 15 percent of their market segment. In a market lacking clear differentiation, they also found themselves competing with around 600 local brewers, many of them subsidised by local governments. Some expected these issues to disappear over time, but almost twenty years later, the fundamental situation has changed little. Many industries in China resemble the beer industry, with overcapacity, high levels of fragmentation, subsidised local competition, and foreigners willing to absorb losses from their “strategic” investments. Agreed. This also fits into the overall need to prepare.  

3. Take your time. Many companies want to get on the ground quickly. In one case, the CEO told his head of strategy to get China operations going within six months. Time pressure of this sort can create problems later on. It tends to result in sloppy planning and analysis. It shifts the attention from finding the right partner to finding any partner, regardless of partner fit. Moreover, it weakens your hand in negotiations. Your Chinese counterpart will know how to use your time constraints against you, and you will walk away with a worse deal. Completely agree. In my experience, there is a direct correlation between speed and quantity of mistakes. Again though, this fits into the overall need to prepare.

4. Chinese society is collectivist.  Chinese society is collectivist in that individuals identify with an “in-group” consisting of family, clan, and friends. Within this, cooperation is the norm. Outside it, zero-sum competition is common. Zero-sum competition means that your Chinese counterpart may not believe in win-win solutions. One can observe this, for instance, in the tendency to re-open negotiations just as everything seems settled, especially if one seemed too ready to agree with the negotiated terms; one’s counterpart may interpret this as an indication that s/he has not bargained hard enough. Absolutely true, and foreign companies that ignore this do so at their peril.  For more on negotiating with Chinese companies, check out How To Handle Chinese Negotiating TacticsHow To Handle Chinese Negotiating Tactics. Part TwoHow To Handle Chinese Negotiating Tactics. Part Three.

5. Mistrust and opportunism are endemic. There are two opposite ways of extending trust. One is to trust until given reason not to; the other is not to trust until there is enough evidence of trustworthiness. China takes the latter approach. The zero-sum competition already noted creates an incentive to take advantage of people outside the in-group. As a consequence, the Chinese tend not to trust people outside their in-group. Take your cue from them. Completely agree. Foreign companies doing business in China should not be afraid to show a lack of trust.  For more on the need for conducting due diligence in China and how to conduct due diligence in China, check out the following:

6. Trust is interpersonal and takes time to build. A common safeguard against opportunism is to build relationships of trust with persons who matter for your business. Unlike in the West, the creation of personal friendship is a prerequisite of doing business. Building friendship takes time, which is another reason to avoid rushing into things. Besides numerous invitations to sports and other events, one key element in building trust is long dinners during which everything but business is discussed. In these, alcohol plays an important role. Learn to drink intelligently. Seasoned negotiators dispose of the alcohol into their water glasses or into the wet towels most good restaurants make available. This is true, but plenty of business with China gets done these days without these sorts of personal relationships.

7. Notions of “out-of-bounds” behaviour do not necessarily match. Chinese negotiators occasionally push beyond what their Western counterparts consider appropriate bounds. For example, the representatives of a large Western firm were negotiating the distribution rights for one of their products. Their Chinese counterparts closed their initial pitch by threatening to use their political connections to prevent distribution of their products if they did not receive the rights. In another case, the Chinese party got their Western guests drunk to prevent them from being effective in negotiations the following morning (which, on the Chinese side, involved a completely different set of people). These sort of things do sometimes happen but smart companies generally have little problem in dealing with them.  

8. Chinese society is hierarchical.  Company decisions are typically reached in a top-down manner, with only the very top of the pyramid involved in decision-making. Mistrust puts limits on delegation, and supervisory control at each level is high. Be aware in negotiations that the decision is ultimately made at the very top. If your counterpart is not part of that group, s/he is typically not authorised to make major decisions but must report back to the top for instructions. Completely true.  

9. Government in China is decentralised and in important respects, bottom-up.  Conventional wisdom holds that China’s governmental structure is highly centralised, with all key decisions made in Beijing. In reality, Beijing directs little of what happens throughout the country, especially in far-flung regions. To be sure, if Beijing truly wants something to happen, it will. Expect conditions to vary by location. In addition, to the extent you need to negotiate with government, it is crucial to involve the local government. Even if you have agreement from Beijing, if the local government wants to thwart you, it will. Generally, you want to be sure that both the applicable local government and Beijing are okay with your China business plans.  

10. Be conscious of the large picture. Most of the growth in China since 1978 has come from private small and medium-sized enterprises. Today, they make up about 65 percent of Chinese GDP. If so, fierce competitive battles seem likely for the future, and easy access to state money for these firms means the playing field will not be level. Government may be on your side as long as your technology is needed. Keep this in mind when selecting a partner for cooperation or considering market entry.  Sure.

I think the above list is highly accurate, but as far as being helpful for conducting business in China, I prefer Hupert’s.  What do you think?

Got an email the other day from a China business consultant I know.  The email (modified a bit so as not to hide information) follows:

Hello Dan,

A quick question/insight into the Chinese business mind. We are set to go to China next month with a client and I suggested we hire a professional translator to go with us, but the Chinese company on the other side “blew a gasket,” citing confidential business information and claiming we should not bring a translator because they have a close relationship with the government. I suggested that they find a translator they trust and that seems to have been ignored.

Why the absolute insistence that no translators be allowed? Doesn’t this beg the obvious question. This Chinese company is generally doing what we want them to do overall but we would like some clarity in our discussions and we certainly want more clarity in our correspondence.

They translate for us what they think we need. Just a bit frustrating.

Any curbside thoughts?

Yes. Many. Someone is definitely being played here and there are the following markers of this just in your short email:

  • “Close relationship with the government.” This doesn’t have anything to do with your desire/need to have a translator and I am concerned this is their subtle way of threatening you. Seems they may be saying that if you do bring a translator, they will use their close relationship with the government to prevent your client from doing business in China.
  • Of what are they afraid? Why don’t they want a translator? Honest and legitimate Chinese companies tend to want clarity; dishonest and illegitimate Chinese companies tend to want obfuscation. Our China lawyers oftentimes tell our clients this when it comes to drafting contracts and it applies with even greater measure when all you are seeking is to use a translator.
  • It should be more than “a bit frustrating” that they translate for you only what theythink you need; it should scare the heck out of you.

I know I cannot turn back time, but what you really should have done was to have gone over there with someone to translate and then just introduce that person as someone there on behalf of the company. That person should not be Chinese and should not look Chinese and that person should never speak Chinese in the presence of the Chinese company. In other words, that person should be your stealth translator. It may be too late for you to pull that off, but that would have been my advice to you a few months ago. I can tell you story after story about the great stuff foreign companies doing business in China have been able to learn from stealth translators but I will save that for a later day.

What do you think?

Just came across an interesting post with a not so interesting title on the China IPR Blog: IP Developments in Beijing.  The post starts out discussing how “due to the rapid increase in IP cases in the Beijing Number 1 Intermediate Court, particularly IP cases involving patent and trademark validity, the Beijing Intermediate Court will split its Intellectual Property Tribunal in two” with the number one IP Tribunal hearing mostly trademark and unfair competition cases and the number two IP tribunal hearing mostly patent and copyright cases.

The post then notes that the Beijing court (which hears about 10% of all China IP cases) has seen its case load increase from “4,748 cases in 2008 to 11,305 in 2012, an increase of nearly 150%,” with copyright cases representing about half the total.

This is important for foreign companies doing business in China and here’s why.

  1. Rational human beings do not generally spend money on something that is not going to bring them any benefit.
  2. Bringing a lawsuit in China always costs money (China court filing fees tend to be fairly high), oftentimes a relatively large amount of money.
  3. Chinese businesses tend to be made up of rational human beings who understand the value of an RMB.
  4. Chinese businesses must believe that they can get the Beijing IP court to give them redress for alleged IP infringements or they would not pursue the lawsuits.
  5. Chinese businesses must, in increasingly large numbers, believe that they can get the Beijing IP court to give them redress for alleged IP infringements or they would not be increasing the number of IP lawsuits they are pursuing.
  6. Chinese businesses are almost certainly correct in their belief that suing before the Beijing IP court will give them redress.
  7. If Chinese businesses are correct in their belief (and they almost certainly are, see number 6 above), that means that IP enforcement, at least through China’s courts is improving.

Independently of the above, you would have a tough time finding a China lawyer who does not also believe that IP enforcement in China is improving, particularly with respect to trademarks.

IP enforcement/IP protection is improving in China for two main reasons.  First, Chinese companies and foreign companies alike are now realizing that it makes sense for them to register their trademarks, copyrights and patents in China so that they have an opportunity at being able to protect them (in the courts, among other places).  And two, China’s courts are increasingly realizing the importance of protecting IP in China, largely because Chinese companies increasingly want them to grant IP protections.

What this all means for those of you doing business in China is that you too should be jumping on the IP registration bandwagon.  For more on protecting your IP in China, check out the following:

  • How To Protect Your IP From China. Part 2. What we, as China lawyers, look at in trying to protect our clients’ IP from China and what you, the company, should be looking at and doing to protect your own IP.

What are you seeing out there?

Just read a highly relevant post by Ben Shobert (it’s sheer coincidence that I am having lunch with him today) on The Ethical Challenges of Doing Business in China’s Healthcare Economy. Though Ben’s post focuses on health care companies, it applies to virtually all foreign companies doing business in China. Ben’s post stems from an MBA class he taught at the University of Washington.

At one point in the article, Ben states that the “larger question” is “whether the incrementally different standards they [foreign pharma companies in China] must hold themselves to represents what amounts to a tax — both because their host country will look first at foreign companies and hold them to higher standards, but also because the standards in their domestic markets (FCPA, UK Bribery Act, etc.) are applicable regardless of where they might do business.” That is not a question, it is a fact. Foreign companies doing business in China have always been and for the foreseeable future always will be held to a higher standard than Chinese domestic companies.

Back in 2011, we addressed this same question and emphatically came up with the same answer, in When Should You Deal With Your China Ethical Issues? Yesterday:

All but one of these are great questions. The only one I do not like is the next to the last one, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be “yes.” In that same post,

Similarly, In The Painted Veil On China Law, we talked of how China law enforcement differs between foreign and domestic companies:

There is one law in China for Chinese companies and that law has little or nothing to do with you as a foreign company. There is another law in China for foreign companies and that law does apply to you.  The laws that do apply to you are likely not all that different from the laws that apply to you in your home country and you are no doubt used to following the laws there.  You should view China similarly.

I cannot resist citing to one of my all time favorite comments, left here by one of the writers (Pipi) of the late great Sinocidal blog, on the differences between foreign companies doing business in China and domestic companies doing business in China:

When in China, do as the law says, not as the Chinese do. The laws are not intended to be enforced fairly – they’re their to be interpreted and enforced as local government sees fit to protect their clan, kin and cash-cows.

Does anyone really think that foreign companies (or at least Western companies) do not have to be just a little bit better than their domestic companies to survive in China? To the extent this “need to do better” can be called a tax (and I most definitely think that is what it is), foreign companies face higher “taxes” in China than domestic companies. And foreign companies that do not engage in bribery and corruption in China are likely at a disadvantage as compared with their Chinese competitors that are more likely to use such methods. And foreign companies that do engage in bribery and corruption are at a disadvantage as compared with their Chinese competitors because they are much more likely to be prosecuted (in China and at home).

Ben’s more interesting question, and one that was addressed by Ben and his MBA class, is “for life science companies like GSK, what really are their options?

Ben and the class saw the following five options (my comments are in italics):

  1. You can choose to maintain western standards of compliance. “The implications of this are that your domestic competitors, and, it should be noted some of your less scrupulous foreign ones as well, will not hold to this approach. So, you cannot simply hold to a high standard, you have to put in place strong sales and marketing tactics that work to stay front of mind in the consumer and healthcare professional.  But, in an emerging economy such as China’s, is this even a realistic strategy? Do consumers have enough discretionary income that they can realistically value the intangibles your therapy is going to offer, or is the decision the consumer will make no different than that the doctor or hospital administrator is going to? If your product is positioned based on an economic rationale that is inconsistent with that of your market, can you compete?”  Right, but you have failed to address a much bigger question: are you willing to risk jail time and public humiliation and reputational damage by engaging in bribery/corruption?
  2. Hold to the status quo. “Here’s what that means:  essentially, you assume the crack down is short-term, and inherently political in nature. ‘This too shall pass’ becomes the phrase you hear executives saying just under their breath as they count rosary beads during weekly management calls. If you believe that the crackdown on GSK was largely a political move by Beijing to accomplish two goals – lower prices and divert the public’s attention away from the government’s own culpability in the dismal state of China’s healthcare system – then you might take the slap on the wrist and move on. Companies that make this bet likely believe that the rules in China are not really in flux; that in twelve months practices in China’s sales channel will look basically like they did twelve months before the GSK scandal. Implicit in this conclusion is that China’s decision is inherently political, and companies who hold to this view would do well to remember that future responses to crises along lines of affordability and access are going to result in similar actions towards foreign companies.”
  3. Fundamentally change your sales strategy.  “This assumes the sort of tactical re-arrangement of how you sell and market like was mentioned earlier, but it also forces companies to bring newer drugs to China earlier than they had originally planned.  For most of the last three decades, products brought into China from all sorts of sectors have tended to be more mature. Much of this has to do with the China market’s inherent IP issues, but also the sense that Chinese consumers were not ready for the more current products. Pharma has been no different, but this approach might have to change for companies that now feel they have no choice but to accelerate their product life cycle plans that originally called for more mature products to migrate to China in an effort to hold off the anticipated IP and price pressures more sophisticated therapies would encounter.”
  4. Exit China. “Don’t laugh. The world’s second largest generic pharmaceutical company, Actavis, just did. My most recent Forbes column touched on this, and made an effort to remind people that there are multiple reasons for Actavis to have left, and that the company’s timing may be designed to take advantage of a moment when they could leave China without questions being asked about why they were not further into the Chinese market versus their competitors. GSK threatened to leave China if the fine from the Chinese authorities was too large, a threat the CEO quickly rescinded. But, neither company would be the first to come to the conclusion that they could not operate successfully in China and that they needed to deploy capital elsewhere.”
  5. Mitigate compliance risk through a very strategic use of distributors. “At its worst, this approach is designed to hide non-compliant behaviors from auditors; at its best, using good distributors is a strategy that forces compliant behaviors into parts of the supply chain that previously were not visible to manufacturers. Typically this involves competent distributors taking over, or managing, the efforts of small dealer networks around China that had previously little to no supervision, simply because of the highly fragmented nature of the dealer networks that service China’s hospitals.”

This is one of those situations where being a China lawyer is much easier than being a manager of a foreign company doing business in China. When my clients ask about how they should handle corruption in China, I tell them that they must never engage in it and that they need clear policies and training sessions to make crystal clear to their own people that corruption simply will not be tolerated. I then tell them that if they do not have a corruption plan AND a corruption policy in place, they have increased their chances of being in a world of pain at some point. I then usually put it to them directly: which of the following do you want to be able to say to the Chinese authorities/US federal prosecutors if your company is ever accused of having engaged in corruption?

  • Oh, sorry, I didn’t realize that corruption might be a problem.
  • We did everything we could to try to prevent this. Here is our policy manual which we require our employees to sign when they join our company and re-sign to acknowledge every year thereafter. And here is a record of the full day mandatory anti-corruption training we give to our employees every six months and the written materials we provide to them each time.  As you can see, the employees implicated in this case each attended x number of these sessions. I really do think we did everything we could do as a company to try to stop this sort of thing and I think you will find that we do take stopping corruption very seriously.
I then tell them about the compliance attorneys at my law firm who can help them sort out their FCPA and China corruption issues and the costs that will entail. They then usually call us back a few days later….
Corruption and bribery?
Don’t worry about the taxes.
Just don’t do it.

Many months ago, co-blogger Steve Dickinson was interviewed regarding the Legal Representative’s role in Chinese companies.  I was cc’ed on one of the emails regarding that interview and I am running that now because much of what was discused is helpful to foreign companies doing business in China.

Question:  What are the biggest myths regarding the China legal representative?

Answer:  The legal representative is a concept that comes from China’s company law. The only meaning is that this person has the power to bind the company in contracts and this person also represents the company in submitting reports to regulators. It has no meaning regarding management of the company. The company is managed by the board of directors, the general manager and the senior management. Thus, liability does not accrue to the legal representative simply from his or her status as the legal representative.  Though many beleive that the legal representative is responsible for all the liabilities of the company, this is simply not true.

Directors and management are also not liable for the liabilities of the company unless they directly participated in the improper acts. Take the first big melamine milk scandal as an example. In that case, directors and officers were held criminally liable because they directly participated in the adulteration of milk program. In that case, the crimes/torts  were their own acts and they were therefore held liable. None of this liability was incurred because they were were the legal representative. The liabilities were incurred because they were involved in actively managing the company and the illegal acts were directed by them personally.


Question:  What are the legal responsibilities of a legal rep?

Answer:  See the above.


Question:  What are the legal responsibilities of shareholders?

Answer:  See the above. No liability or responsibility as shareholder. However, everyone is responsible for his/her own affirmative acts.


Question:  What’s your advice to foreign company representatives regarding exit strategies from China?

Answer:  This confuses the concepts of director, general manager, and legal representative and so I really cannot answer the question. Basically, however, do not allow the company to commit a crime if you are in a management position. This sounds simple but it is not. It is notuncommon for your Chinese staff to recommend that you commit a crime. They will tell you that “everyone does this” in China and they will make you out to be naive if you are not willing to do the same. Don’t’ do it. If you have issues along these lines, seek outside advice. Fast.  And if your staff insists, terminate them. Ask yourself whether what you are doing is worth spending time in a Chinese jail.


Question:  Is there a checklist worth following?

Answer:  See above. The other point is: if that if you are accused of a crime, without regard to whether the accusation has merit or not, leave China immediately, if possible. Do not wait for your family. Just leave. It is better for your family to follow behind in a week or two than to have your wife/husband visit you in a Chinese criminal detention facility.

Just came across an interesting post on the Cha Shao Bao blog, entitled, The Nature of China’s Business Press. [link no longer exists] The post is based on a lecture by Arthur Kroeber, the managing director and head of research for Dragonomics and editor-in-chief of the China Economic Quarterly. Kroeber spoke of the dynamism of China’s business press (particularly Caijing) and how the business press has influenced the non-business press and how it has itself sometimes pushed over into non-business reporting. Kroeber notes how the Chinese government early on in its experiment with capitalism recognized the importance for China’s expanding economy and its business community (both domestic companies and foreign companies doing business in China) to have a somewhat vigorous discussion of business matters in China’s media.

I am skeptical economic growth necessarily leads to an opening up in the political arena, but it seems an expanding business press may play a role in the opening up of the media, which in turn, ….

Just the other day, in part 15 of these series, I expressed skepticism at the ability of Chinese companies to become big time international powerhouses any time soon. And today, I came across a Business Week article by Bruce Einhorn saying pretty much the same thing, but focusing on the technology sector. Einhorn’s article is entitled, The Tech Dragon Stumbles: China’s upstarts are finding life in the big leagues tougher than they reckoned, and it nicely sets out why Chinese technology companies are having a tough time becoming world beaters. 

The article talks about how Chinese technology companies generally are not adjusting well to international competition, and it cites the following to support this:

  • Nokia and Motorola are taking cell-phone market share in China from TCL and Ningbo Bird
  • Declining profit margins at telecom equipment makers Huawei Technologies and ZTE
  • China’s biggest maker of liquid-crystal displays (LCDs), BOE Technology Group, is seeking a government bailout
  • Chipmakers Semiconductor Manufacturing International Corp. (SMIC) and Grace Semiconductor Manufacturing Corp. “are limping”
  • Computer maker Lenovo Group is “struggling overseas.”

Though Einhorn attributes these Chinese companies’ failings to market forces and mismanagement, he also sees them stemming from Chinese government interference:

What was supposed to be a major advantage for Chinese tech companies — the backing they receive from Beijing — has in many cases turned into a liability. In exchange for preferential loans, tax breaks, and sweetheart property deals, Communist Party bosses often get to influence key business decisions.

Take SMIC. The chipmaker will soon operate plants in five cities across China. By contrast, SMIC’s Taiwanese rivals, United Microelectronics Corp. and Taiwan Semiconductor Manufacturing Co., have built most of their factories in two science parks just a few hours drive from one another in Taiwan, making it easier to manage the plants. So why has SMIC spread out so much? Every [local] government wants to go into high tech, says Pranab Kumar Samar, an analyst in Hong Kong with Daiwa Institute of Research. That might make for good politics, but it’s not exactly smart business. Many Chinese companies are also paying the price of a government effort to spur the development of homegrown technologies. State-owned Datang Telecom Technology & Industry Group, for instance, has squandered hundreds of millions of dollars and almost a decade on a Chinese standard for so-called third-generation (3G) mobile telephony when it could have easily adopted one of the international standards already in use. This has also hobbled Huawei, ZTE, and the country’s dozens of cellular handset makers. Chinese companies “don’t have a [3G] market in which to cut their teeth,” says Mark Natkin of Marbridge Consulting Ltd. in Beijing.

Once it again, it appears that as difficult as it may be for foreign companies doing business in China, the reverse is proving even tougher.

With the recent U.S. filing in the WTO accusing China of failing to provide adequate protection of foreign Intellectual Property Rights, we are headed for another China/U.S. disinformation campaign on an important issue. Many foreign companies doing business in China get caught up in the confusion of the political rhetoric and conclude there is no hope for protection of their IP rights in China.

This is a mistake because China actually provides effective intellectual property protection in the patent, trademark and trade secrecy areas. These are the areas that are relevant to the vast majority of foreign businesses in China. The problem addressed by the U.S. WTO filing concerns pirated DVDs and media downloads. This is still a major problem in China, but it is not relevant to the IP issues that confront most foreign businesses in the country.

Many foreign businesses mistakenly conclude IP protection is hopeless in China. As a result, many do not come to China, and others who do fail to take any measures to protect themselves because they feel the process is futile and a waste of time and money.

I have been arguing for years that the IPR protection situation in China has substantially improved. However, when I make these statements, I am often challenged. In addition to the negative press and government reports, my clients often point to the situation on the ground. Take Shanghai for example. Within five minutes of the door to my apartment there are five pushcarts doing a brisk business in pirated DVDs and software. When I get off the subway on Nan Jing Road to walk to my office, I am immediately accosted by vendors selling pirated watches, bags and pens. My clients say: Isn’t this proof that China is ‘flooded with pirated products’ as the U.S. reports state? If giant foreign companies cannot protect their product from such pirating, what hope is there for a small or medium size foreign firm? Isn’t despair at a solution the only reasonable conclusion?

These surface impressions are completely irrelevant and misleading to the vast majority of foreign businesses operating in China. China has done an excellent job in establishing laws and creating an enforcement system for IPR protection. Largely for reasons of market structure and the technology of distribution, in the areas of patent, trademark and trade secret protection, the protection system has made substantial progress. Though there is substantial infringement in these areas in China, much progress is being made in combating such infringement and the registration, court and enforcement system has been reasonably effective.

On the other hand, in the area of protection of media distributed on DVDs and downloadable on the internet, progress in China has not been good at all. Again, largely for reasons of market structure and the technology of distribution, there has been little measurable impact on reducing infringement in this area.

Now, let’s go back to our scene on the streets of Shanghai. Why do I say that this obvious IPR piracy is not an issue for the vast majority of foreign businesses? What about all those folks who are selling pirated foreign brands (other than DVDs) on the street. First of all, these pirates have been driven from the retail outlets and are forced to sell their products on the street. They are not even permitted to operate pushcarts. Second, look carefully at to whom they are selling. They never approach a Chinese citizen. They only approach foreigners. This is because only foreigners are willing to purchase their inferior products. Chinese consumers are not that gullible. If you travel to Qingdao or Guangzhou or other cities with a low number of Western expats and tourists, you will find that street vendors selling pirated goods do not exist. This is because there are not enough foreign customers who want the product. It simply is not true that China is “awash in pirated goods.” In fact, this is a problem unique to cities with large foreign and expat populations. It therefore is simply irrelevant to foreign businesses operating in China.

Pirated DVDs, however, are available all over China and are purchased regularly by Chinese consumers who would never knowingly purchase a pirated luxury product like a coat or bag. The same stigma concerning prestige and quality simply does not apply to entertainment and software DVDs. Very little progress has been made in preventing the sales of such items over the past several years, in spite of major campaigns by the Chinese government. In this respect, the U.S. presentation of the situation on the ground is actually quite accurate. However, the vast majority of foreign companies are not selling a product in China that can be reduced to a DVD or internet download. Therefore, even though this issue is a major problem, it is simply not relevant to most companies doing business in China. It is a mistake to assume that China’s poor record in preventing infringement of media and software DVDs extends to the more common IPR areas of patent, trademark and trade secrecy.

For most foreign businesses, their important intellectual property rights (IPR) fall in the areas of patent, trademark and trade secrets. These IP rights can be quite effectively protected in China. However, the Chinese system, like the U.S. system, is a self-help program. Do not expect either the Chinese government or a foreign embassy to do the job for you.  You must do it yourself. This means making the proper filings and entering into the required agreements. It also means investing the time and money to locate infringers and then prosecute them aggressively. This process is a tough one. Unlike many other developing countries, however, aggressive protection of IP rights can succeed in China.

The greatest mistake is to do nothing.