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.