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 European Chamber of Commerce just came out with a massive report on innovation in China and its conclusion is that there’s not nearly enough of it.  The report is entitled, “Dulling the Cutting-Edge: How Patent-Related Policies and Practices Hamper Innovation in China,”[link no longer exists]  and its intent is not to “slam” China, but to prod the Chinese authorities into effecting change to encourage innovation.

The study focuses not on the quantity of China innovation, but on its quality and it is in that arena where it finds China “overhyped” and sorely lacking:

While patents are exploding in China and certain innovation is also on the rise, patent quality has not proportionately kept up and in fact the overall strength of China’s actual innovation appears overhyped. Statistical analysis in this study not only reveals concerning trends in the quality of China’s patents at present, but suggests that while patent filings in China will likely continue to notably grow in the future, patent quality may continue to lag these numbers. In fact, projections in this study indicate there might be over 2.6 million less-than-“highest-quality” patents filed in China in 2015 alone, which is substantially more than estimated “highest-quality” patents filings in that year. With this in mind, and objectively considering its performance on additional innovation metrics, it is clear that China’s innovation ecosystem deserves a new type of scrutiny.

The core of this study is devoted to investigating, through in-depth on-the-ground research and analysis, significant patent-related reasons for China’s patent quality and related innovation shortcomings. In an effort to hone this investigation, the study focuses on key unaddressed institutional and regulatory issues most closely related to patent quality that can be practically remedied in the near future.

This study uncovers how a network of patent-related policies, other measures, and practices in China collectively hamper both patent quality and innovation at large. These dulling devices are categorised in terms of certain government-set patent targets and indicators (Chapter 2); policies and other measures meant to promote patents (Chapter 3); and rules and procedures for reviewing patent applications and those for enforcing patents (Chapter 4). Although given their intertwined nature it is not always possible to clearly separate their impacts on patent quality as distinct from those on innovation at large, these dulling devices collectively create a vicious cycle: they hamper patent quality which then hampers innovation and vice versa, i.e. hamper components of innovation which then hampers patent quality, which then again further hampers innovation).

About a year ago, I became obsessed with whether China has what it takes to become a developed country.  I side with those who believe it is relatively easy to go from poverty to mid-level simply by deftly handling/managing cheap labor, but that it is incredibly difficult to go from a mid-level income country to a developed one.  This jump is difficult because it takes more than low wages and hard work, it takes innovation because that is what is required to become an innovation economy and becoming an innovation economy is what is typically required these days to become a developed country.  The sad truth is that those who live in China and know the country well have serious doubts about its ability to make that big leap.  They cite to an educational system that preaches following the pack,not blazing new trails and a business ethos that focuses more on minor incremental change over big breakthroughs.   Bill Dodson, who wrote the absolutely excellent book, China Inside Out: 10 Irreversible Trends Reshaping China and its Relationship with the World, in a post entitled, “America to Become the Next Paris: Dumb Innovation Predictions,” sees China’s changes of becoming truly innovative as about the same as America becoming the next Paris.

Does China have what it takes to become a front-line innovator?

Since we started this blog back in 2006, we wrote of how you should expect and prepare for China wages and other prices to rise. In our very first month, way back in January, 2006, in a post entitled, “China is Booming, Go There for Growth,” we warned of rising China prices:

This article discusses how “a majority of the world’s top chief executives plan to invest in China over the next three years to win customers” and to win market access, rather than just to reduce costs, which are expected to rise quickly over the next few years in any event.

SMEs should be thinking likewise.

For how much longer will China remain the world’s factory?

A month later, in, “Doing Everything Right in China — A Danfoss Primer,” we talked of the benefits of recognizing that “China has gone from being just a cheap place for OEM manufacturing to becoming a multi-tiered high growth market for goods.”  Then way back in April, 2006, in “China Is Expensive — NOT. Go Second Tier And Life Will Be Good,” we talked of how China’s rising prices were pushing foreign companies into China’s second tier cities.

And we have been writing of this ever since, most recently in a series of posts, we titled, “The End of Cheap China”:

The media has picked up on the whole “end of cheap China” meme and has been writing on it and its meanings frequently over the last few months. In “FDI in China: inland and at your service,” the Beyond Brics blog wrote of how China’s rising wages will push foreign direct investment (FDI) in manufacturing to China’s inland provinces, rather than outside the country.  Beyond Brics cites to an Economist Intelligence Unit (EIU) report predicting China’s inland provinces will be attracting “huge amounts of FDI in coming years.”

“The other big trend identified by the EIU is that services is attracting more investment than ever. FDI in both wholesale and retail has grown by nearly 40 per cent a year over the past five years.” Back in January, 2006, In part I of what became a twenty part series, called Service Sectors in China Will Reign, we predicted China’s service sector would boom.

We predicted all this (along with countless others) because it was all rather obvious. We knew that as foreign companies poured into China and hired Chinese employees, wages would have to increase and with that, spending. We knew that as foreign manufacturers poured into China or simply sourced their products to Chinese factories, the need for companies to service the manufacturers and those who profited from it would increase.

Earlier this year, in a post entitled, “The End of Cheap China, But Not China Manufacturing,” [link no longer exists] China Business Blog & Podcast wrote of how China’s rising prices would influence foreign investment into China. It too concluded that manufacturing would move inland.

In a recent article, “For Some U.S. Manufacturers, Time to Head Home: More companies are assessing the true cost of outsourcing,” Business Week too writes of rising costs in China and of how this is pushing low-end manufacturers to return home.

In Is the era of a ‘cheap China’ coming to an end, Week Magazine rightly views the end of cheap China as “an undeniable sign of economic growth and progress.”

In an oft-cited article from earlier this month, entitled, The End of Cheap China, the Economist Magazine seeks to answer the question of “What do soaring Chinese wages mean for global manufacturing?” Like China Business Blog & Podcast, it concludes that China manufacturing will shift inland and move up the value chain. The Economist concludes its article with the following statement that is actually THE big question:

The pace of change in China has been so startling that it is hard to keep up. The old stereotypes about low-wage sweatshops are as out-of-date as Mao suits. The next phase will be interesting: China must innovate or slow down.

Will China be able to innovate fast enough to make up for the fact that it is no longer cheap? What impact will China’s slowing economy have on all of this?

What do you think?

Very interesting Reuters article, entitled, “Special report: Can China’s billions spur the next big idea?” The thesis of the article is that China is doing well with incremental innovation but is still nowhere near competing with a country like the United States on “bold” innovations. In other words, China does just fine in slightly improving or reducing the cost of existing items, but it is not yet become creative in developing the new.  

The article posits the following as the cause:

China’s innovation shortcomings are not merely the product of a preference for central planning over entrepreneurship, of course. Barriers include poor enforcement of intellectual property rules, an educational system that stresses rote learning, and a relative lack of independent organizations that can evaluate scientific projects and help police instances of plagiarism.

 “There’s a political constraint, too,” said Arthur Kroeber, managing director of GaveKal-Dragonomics in Beijing. “In the long run, innovation arises in societies that are really open, where you can discuss anything. And China doesn’t have that kind of political culture yet.”

What do you think?

The Washington Post has an interesting article today on the lack of Chinese innovation, entitled, “In China, Dreams of Bright Ideas.”  The article’s subtitle, “From Top Down, A Push to Innovate,” is actually more telling, as it sums up China’s innovation problem: China is still a hierarchical country with an intrusive government.

China’s government has done a great job with China’s economy (much better than a free marketer like I would ever have predicted), but innovation does not come from “the top down” by government fiat; it typically bubbles up from below.  Governments encourage innovation by helping fund it, by setting up legal systems to protect it, and, most importantly, by just stepping away.

The Pinocchio Theory Blog, in its post, entitled, “The New,” does an excellent job describing the “bubbling up from below” theory of innovation:

The New always comes from the outside, from beyond, or from below; all a corporation [or a government] can do is internalize this outside, by channeling the flows, appropriating the innovations for itself.”

Innovation is, at least to some extent, a rebellious act.  China generally encourages conformity.

But, if recognizing a problem is the first step towards solving it, China has at least begun solving its innovation shortfall:

Although political dogma here seems stuck in the past, economic innovation has become a new Communist Party catchword. Even while they enforce political conformity, President Hu Jintao and Premier Wen Jiabao rarely let a speech go by these days without urging their countrymen to think up new products. Most recently, Hu told scientists and engineers they must make China “a nation of innovation.”

“Innovation is an overall strategy for maintaining China’s economic security,” said Hu Shuhua, who heads the Product Innovation Management Center at Wuhan University of Technology. “Now should be the time for us to innovate,” he added, pointing out that China has been importing other countries’ know-how for the last 20 years. “Now we have the economic and technical base to do it.”

The lag in technological innovation has troubled China’s leaders most. A cartoon in the government-controlled China Daily newspaper last week depicted the Chinese economy as a Formula One racer all ready to speed off but handicapped at the starting line by one wooden wheel, labeled “technology.”

The Washington Post article does a nice job in setting forth some of the obstacles China faces in moving towards becoming an innovation economy:

China’s traditional culture may be an obstacle. For centuries, schoolchildren here have been taught to conform and belong. “The bird that flies out of its flock is the first one targeted by hunters,” goes the Chinese proverb.

Schools still emphasize group activities and discipline over individualism. Class performances mostly involve synchronized banner-waving by rows of identically dressed students. Children are traditionally trained to learn by rote, memorizing material without questioning the teacher and parroting it back at exam time. The method produces high test scores but little innovation.

“Chinese people are educated to be the same,” complained Zhang Da, 38, another Shanghai fashion designer, whose dresses hang in the trendy boutique Younik. “If they are the same as others, they feel safer. That’s a problem.”

I would add China’s lack of IP protection, particularly for patents, as a less entrenched, but still important, additional obstacle slowing China’s evolution to becoming an innovation economy.

China’s lack of innovation is pervasive in business to the point that it impacts nearly all Western companies that do business in or with China.  I am constantly hearing complaints of China’s lack of innovation from Westerners doing business in China. Though these complaints rarely include the word “innovation,” I am told the following:

1.  Companies in China are not capable of doing anything beyond exactly what we tell them to do.

2.  We are not getting any help from our Chinese manufacturers in blending our production techniques with their factory. We have to do all of this ourselves.

3.  We partnered with this company because they had substantial experience selling similar products within China.  And yet, they have not made even one suggestion (good or bad) as to how we can make our product better suited for the Chinese market.  We ended up having to learn about the market entirely on our own and we suggested the changes.

4.  My Chinese employees are unwilling to do anything beyond what I specifically tell them to do.  I feel like they do not even try to fill in the blanks in the instructions I give them.

Now I fully realize that the problems enumerated above are due, at least in part, to cultural differences and misunderstandings and that the Western businesspeople bear some responsibility.  I also realize that much of what is described above may not really constitute innovation.  Nonetheless, there is no escaping that China is not yet an innovative country.

I recently did a post on China’s education system, entitled “Chinese Education System gets an F,” dealing mostly with the system’s tendency to crush student creativity.  I expected a torrent of feedback accusing me of unfairness or of a lack of knowledge of an educational system in which I have never been a participant.  Instead, the exact opposite occurred.  I received all sorts of comments and e-mails essentially saying I was right and, if anything, I had been too soft.  China’s education system will clearly play a large role in determining its path towards becoming an innovation economy.

China’s government recognizes China’s innovation problem, but I have seen little evidence indicting it understands the role its education system must play in solving that problem.  I have seen even less evidence of a willingness to encourage the free thought necessary for innovation.  The Chinese government has proven its adeptness at driving economic change, but it remains to be seen whether it can step far enough out of the way to allow innovation to develop and to flourish.

For those interested in reading more, Business Week blogger, Bruce Nussbaum, has an interesting take on this article, in his post, “Innovation in China.”

What do you think?

I have watched with only mild interest the debate about the number of engineering graduates in China as compared to the United States, because, in the end, it is the quality of the graduates that really matters, not the quantity.

When it comes to a quality education — the kind that drives innovation — China is lacking.

The Australian just did a long and thoughtful article on this, entitled “Chinese Fail.”  [link no longer exists] This article was spurred on by a 26 year old computer engineering PhD candidate at Tsinghua University (often called, “China’s MIT“) who quit school and then posted on his blog his reasons why. The blog post, which has become hugely popular in China, “accused the university of being obsessed with the production of meaningless research papers, rather than focusing on practical training, and said the teaching was not creative enough.”

As this article indicates, admittance into China’s best universities is very much based on rote memorization and, to a large extent, that is what goes on behind the university walls as well.  China must change this if it is to reduce the innovation gap.

Will that happen? If so, when? What do you think?