ReportBeyond the Great Wall Intellectual Property Strategies     for Chinese Companies
Since its founding in 1963, The Boston Consulting Group has focusedon helping clients achieve competitive advantage. Our f...
Beyondthe Great WallIntellectual Property Strategies    for Chinese Companies           David Michael            Collins Q...
© The Boston Consulting Group, Inc. 2007. All rights reserved.For information or permission to reprint, please contact BCG...
ContentsNote to the Reader	                                      4Executive Summary	                                      ...
Note to the ReaderThis research report is a joint product   For Further Contact          Acknowledgmentsof the Strategy pr...
Executive SummaryOver the past five years, a rapid rise in exports has       markets of the United States, Europe, and Jap...
Competing on the              World StageS            ince joining the World Trade Organiza-     Austria. (See Exhibit 1.)...
When challenged by Chinese competitors, incum-                                             to exclude the Chinese companie...
Understanding                                 the Five Phases of                                  IP DevelopmentA         ...
which develop, design, and market the products                                    their exports. Eventually, the young com...
RD spending by Chinese companies rose during                                                   Against the backdrop of Chi...
need to increase their investments in international                           appear on the radar screen of IP owners and,...
Sharks, Minnows, and Targets: Understanding IP StrategyBCG’s IP-strategy matrix allows a company to understand           F...
Targets are vulnerable to at least three types of                      Elevated Costs. The market for Chinese-manu-attacks...
nary, such high costs are common for countries in                                     the nine defendants agreed to pay Te...
The U.S. National Science Foundation reports that                        • What IP rights does the Chinese company retain ...
represented almost 30 percent of the combined                                                liquid. Small “IP shops” eage...
ping the IP landscape in an industry onto the ma-                            and litigation risk in the U.S. market tend t...
primary factors: the best technology, the strong-                                  When it comes to setting an internation...
mestic market. Many companies want to sell goods                                               what Chinese companies can ...
come sophisticated managers of intellectual prop-                                  ent of royalty payments for the first t...
Closing the IP GapT           he path through IP development will          Map your IP position and that of international ...
For Further ReadingThe Boston Consulting Group has            Looking Eastward: Tapping China            “Globalizing RD: ...
For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.c...
www.bcg.comAbu Dhabi      Chicago       Kuala Lumpur   Nagoya          SingaporeAmsterdam      Cologne       Lisbon       ...
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Beyond the Great Wall: Intellectual Property Strategies for Chinese Companies

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This was one of my favorite projects at BCG. Did some really neat research into the impact of IP on economic development and built a strategic framework for developing nations as they come to participate with the global IP marketplace.

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Transcript of "Beyond the Great Wall: Intellectual Property Strategies for Chinese Companies"

  1. 1. ReportBeyond the Great Wall Intellectual Property Strategies for Chinese Companies
  2. 2. Since its founding in 1963, The Boston Consulting Group has focusedon helping clients achieve competitive advantage. Our firm believesthat best practices or benchmarks are rarely enough to create lastingvalue and that positive change requires new insight into economicsand markets and the organizational dynamics to chart and deliver onwinning strategies. We consider every assignment to be a unique setof opportunities and constraints for which no standard solution willbe adequate. BCG has 63 offices in 37 countries and serves companiesin all industries and markets. For further information, please visit ourWeb site at www.bcg.com.
  3. 3. Beyondthe Great WallIntellectual Property Strategies for Chinese Companies David Michael Collins Qian Vladislav Boutenko Ralph Eckardt Mark Blaxill January 2007 www.bcg.com
  4. 4. © The Boston Consulting Group, Inc. 2007. All rights reserved.For information or permission to reprint, please contact BCG at:E-mail: bcg-info@bcg.comFax: +1 617 973 1339, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. Exchange Place Boston, MA 02109 USA
  5. 5. ContentsNote to the Reader 4Executive Summary 5Competing on the World Stage 6Understanding the Five Phases of IP Development 8Phase 1: Driving Growth Through Exports 8Phase 2: Climbing the Value Ladder 9Phase 3: Paying the Price 11Phase 4: Getting Serious About Intellectual Property 14Phase 5: Profiting from Intellectual Property 19Closing the IP Gap 21For Further Reading 22 Beyond the Great Wall
  6. 6. Note to the ReaderThis research report is a joint product For Further Contact Acknowledgmentsof the Strategy practice and the David Michael The authors acknowledge the BCG BeijingTechnology and Communications +86 10 6567 5755 contributions of BCG’s global expertspractice of The Boston Consulting michael.david@bcg.com in strategy and in technology andGroup. The authors welcome your communications. They extend specialquestions and feedback. Collins Qian thanks to David Dean, a senior vice BCG Shanghai +86 21 6375 8618 president and director in BCG’s Munich qian.collins@bcg.com office and the former global leader of the Technology and Communications Vladislav Boutenko practice, and to Michael Deimler, a BCG Moscow +7 495 258 34 34 senior vice president and director in boutenko.vladislav@bcg.com BCG’s Atlanta office and global leader of the Strategy practice. In addition, the authors would like to thank Amit Nisenbaum, project leader; Daniel Maloney, associate; and Laura Rees, associate. These colleagues formed the project team that supported this research. Finally, the authors express gratitude to the following members of the BCG editorial and production staff: Barry Adler, Katherine Andrews, Gary Callahan, Matthew Clark, Mary DeVience, Elyse Friedman, Kim Friedman, and Mark Voorhees. David Michael Senior Vice President and Director Collins Qian Vice President and Director Vladislav Boutenko Vice President and Director Ralph Eckardt Former Manager Mark Blaxill Former Senior Vice President
  7. 7. Executive SummaryOver the past five years, a rapid rise in exports has markets of the United States, Europe, and Japan.driven an unprecedented level of prosperity in As a result, Chinese companies are entering theseChina, fueling the nation’s emergence as an eco- markets unprotected.nomic powerhouse. To sustain its trajectory of im-pressive growth, China will become even more reli- • n their key export markets, Chinese companies Iant on exports. That means that Chinese companies are already facing a rapidly increasing number ofwill need to become ever more sophisticated about IP challenges.operating in global markets. • hinese companies and industries that seek to C• ntellectual property (IP) strategy is one of the ar- I compete globally should invest now to develop eas in which it is most critical that Chinese compa- their IP strategies and capabilities—or risk ceding nies boost their sophistication. Despite rapid and advantage to competitors that move more quickly well-documented improvements in the IP system and forcefully. within China, Chinese companies still lag behind competitors from developing and developed coun- China is not the first rapidly developing economy tries in securing international protection for their (RDE) to suffer growing pains in IP development. proprietary knowledge. In their evolution, all developing economies have followed a similar path.• ithout strong international IP rights, Chinese W companies may face exclusion from international • eveloping economies move through five phases D markets, have to pay onerous royalties, or find it of IP development. In this report, we examine necessary to enter into disadvantageous partner- those phases, placing China’s current position in ships with foreign companies that have stronger IP historical context. portfolios. These consequences could stall China’s economic growth and constrain the growth of its • e examine lessons from other countries and W emerging global companies. companies, and demonstrate how China can rapidly improve its IP position. We hope that, byChinese companies have dramatically ramped up drawing on these lessons, Chinese companies willRD spending, but they have not proportionately recognize the importance of developing superiorincreased their investment in securing international skills in IP management and learn how to prosperIP rights. beyond the Great Wall.• f Chinese companies are to match the standard I set by their competitors in developed countries, these businesses will need to invest 30 times more in international IP rights than they do today. The vast majority of the patents currently held by Chinese companies and inventors have been filed within China rather than in the major export Beyond the Great Wall
  8. 8. Competing on the World StageS ince joining the World Trade Organiza- Austria. (See Exhibit 1.) By any measurement of IP tion (WTO) in 2001, China has worked rights, China’s performance is significantly subpar mightily to improve its IP system, laws, while its growth over the past five years is unparal- and enforcement. To date, the govern- leled among large economies. ment has made great strides, and thecountry appears to be on a path toward meeting China’s rapid growth to the world’s sixth-largestthe world’s standards for IP protection. Perhaps economy has been powered largely by dramaticthe best evidence of this evolution is the dramatic increases in exports, an experience typical amongincrease in patent filings by Chinese companies RDEs. Asia’s “four little dragons”—Hong Kong,and inventors. In 2005 Chinese entities filed more Singapore, South Korea, and Taiwan—all rose tothan 93,000 patent applications—more than triple prominence on the shoulders of exports, as did Ja-the number filed in 2001—with the State Intellec- pan before them.tual Property Office. In fact, China is the world’s second-largest export-At the same time, however, overseas patent fil- ing nation, ranking behind only the United States.ings by Chinese companies and inventors remain Since joining the WTO, China’s exports have moreat negligible levels. In 2005, for example, Chinese than doubled to nearly $600 billion, with exportsentities submitted fewer than 2,200 patent appli- catapulting from 20 percent of gross domesticcations to the U.S. Patent and Trademark Office. product (GDP) in 2001 to 37 percent in 2005. (SeeThat number is a tiny fraction of the 17,219 patent Exhibit 2.) Amazingly, exports from Chinese com-applications filed there by South Korean inventors panies are growing at an annual rate that is sixand the 71,994 filed by Japanese investors. And the times as fast as that of global GDP.Chinese have been even less prolific in the exportmarkets of Japan and Europe. There is, however, a downside to export growth. As Chinese companies become increasingly depen-Although a patent count is an imprecise measure dent on overseas sales, the need for these compa-of value, the disparity between China’s economic nies to operate in the most highly developed IP re-stature and its global IP standing is nonetheless gimes in the world is also growing. During the firststriking. When patent applications worldwide are eight months of 2006, for example, nearly half ofclassified by the countries where the applicants re- China’s exports went to the United States, Europe,side, China accounts for only 0.5 percent of the ap- and Japan. In these attractive markets, Chineseplications filed by nonresidents in 2005. This per- companies face fierce competition and a sizable IPformance ranked China eighteenth, just behind disadvantage.
  9. 9. When challenged by Chinese competitors, incum- to exclude the Chinese companies from the mar-bent companies in developed countries can draw kets or to exact profit-draining royalty payments.on their well-established IP rights to constrain the These companies can avoid this continued perilgrowth and profitability of the new entrants. In only by cultivating world-class capabilities in ac-recent months, for example, Chinese companies quiring, developing, and managing intellectualfrom sectors as disparate as floor coverings and property.consumer electronics have faced patent infringe-ment claims in overseas markets. The claims aim Exhibit 1: China’s IP Development Lags Exhibit 2: Strong Growth in Exports Is Behind Its Economic Development Driving China’s Economic Success China ranks high in global demographic GDP minus exports Exports and economic standings Exports as a percentage of GDP Population $billions % Rank Country % of total 1 China 22.1 3,000 40 2 India 18.1 3 United States 5.0 Exports 35 Rank Country % of total 2,500 1 United States 9.1 2 China 6.6 30 3 Japan 6.3 GDP 2,000 Rank Country % of total 25 5 United Kingdom 4.1 6 China 4.0 7 Italy 4.0 1,500 20 15 1,000 Chinese ownership of international IP rights remains low 10 Patent applications filed by nonresidents 500 Rank Country % of total 5 17 Austria 0.6 18 China 0.5 19 Spain 0.4 0 0 Sources: Economist Intelligence Unit; OECD; World Intellectual Property 1995 2000 2005 Organization, WIPO Patent Report: Statistics on Worldwide Patent Activities, 2006 Edition. Sources: Economist Intelligence Unit; BCG analysis. Note: Export figures are from 2004; patent data are from 2005. Note: GDP and export figures are denominated in 1996 U.S. dollars. Beyond the Great Wall
  10. 10. Understanding the Five Phases of IP DevelopmentA lthough daunting, the challenges that Export-led growth serves as the economic engine China faces in IP development are during Phase 1, but the exported products—as hardly new. In addressing them, there- well as the methods employed to manufacture fore, Chinese companies do not need them—are decidedly low-tech. At this early stage, to reinvent the wheel. In recent dec- manufacturing typically entails either the final as-ades, Japan, Taiwan, and South Korea have trav- sembly of imported components or labor-intensiveeled down a similar path of IP development. In fact, production that requires low levels of capital. Theall developing economies make the same journey. garment industry offers an excellent example ofEven the United States, which in the 1800s relied this phenomenon.heavily on European technologies to build its in-dustrial base, has followed a similar evolutionary When developing economies are still nascent, theyroad. By learning the lessons of history, Chinese are “technology poor.” That is, they invest little incompanies can avoid many of the pitfalls that nor- RD and own virtually no intellectual property.mally confound RDEs. Furthermore, by mastering Since exports are basic rather than high-tech, com-IP strategy, they can transform a current weakness panies do not need—and rarely acquire—interna-into a source of enduring advantage. tional protection for intellectual property.Our research has found that developing econo- Less than 50 years ago, Japan was in Phase 1.mies and their leading companies move through Today it is hard to believe that the phrase “Madefive common phases of IP development: driving in Japan” once served as shorthand for low tech-growth through exports, climbing the value ladder, nology and poor quality. In the 1960s and 1970s,paying the price, getting serious about intellectual however, Japan’s leading companies quickly be-property, and profiting from intellectual property. came dissatisfied with this state of affairs and de-(See Exhibit 3.) veloped higher aspirations. In recent years, other developing countries have followed suit, investing heavily and reconfiguring their industrial policiesPhase 1: Driving Growth so that they could enter the next phase of IP de- velopment.Through Exports Even though the exports of developing economiesWhen they first begin to compete in world mar- may begin to grow rapidly during this phase, thesekets, developing economies rely heavily on their countries continue to capture only minimal value.abundant natural resources and low labor costs. Most of the gains flow either to foreign companies,
  11. 11. which develop, design, and market the products their exports. Eventually, the young companiesthat incorporate the sourced components, or to begin to invest in RD and may even begin to ac-customers, who benefit from lower prices. In Chi- quire some intellectual property. This type of evo-na, for example, more than half of the country’s ex- lution has been exemplified in South Korea overports are currently produced by enterprises at least the past several decades. Through the late 1970spartly owned by foreign interests, and less than 10 and throughout the 1980s, high-tech products aspercent are shipped under Chinese brands. B y learning a share of South Korea’s overall exports climbed, rising from the high single digits to 15 percent in 1989. Over the next decade, the mix of exportsPhase 2: Climbing the the lessons of shifted dramatically toward high-tech products, more than doubling to 32 percent by 1999.Value Ladder history, China can avoid Today China is beginning to exhibit exactly theAs companies in developing economies gain first- many of the same pattern. High-tech products as a percent-hand experience in exporting and manufacturing, pitfalls that age of exports rose from single digits in the 1990sthey invariably find ways to add and capture great- to 14 percent when China entered the WTOer value in the global marketplace. These players normally in 2001. By 2004 the share of high-tech prod-quickly learn that low labor costs alone cannot confound ucts doubled to about 28 percent of total exports,provide a solid foundation for sustainable success. and in 2005 China’s high-tech exports totaled developingInstead, they ascend the value ladder by mastering $195 billion. Given South Korea’s experiences, themore high-tech manufacturing methods; produc- economies. proportion of China’s products that are high-teching more complex components; and then develop- is likely to continue growing for at least the nexting, designing, and marketing their own products. five years.Companies often enter Phase 2 by copying the China has also seen domestic corporate investmentproducts and emulating manufacturing methods in RD rise more than fivefold from $19 billiondeployed by the foreign players that purchase in 1994 to $97 billion in 2004. As a share of GDP, Exhibit 3: In Their IP Development, RDEs Follow a Common Path Exports RD spending Net royalties paid IP strength Phase 1: Phase 2: Phase 3: Phase 4: Phase 5: Driving growth Climbing the Paying the price Getting serious about Profiting from through exports value ladder intellectual property intellectual property Exports of low-tech An increase in RD Companies suffer Companies in developing Companies in developing products drive growth, spending and acquired consequences when IP countries invest to countries achieve parity exploiting the low cost of knowledge drives growth owners from developed manage and protect their and may capture advan- labor and materials in the export of higher- nations defend their intellectual property tage through IP rights tech products markets Source: BCG analysis. Beyond the Great Wall
  12. 12. RD spending by Chinese companies rose during Against the backdrop of China’s rapid growth inthis ten-year period from 3 percent to 5 percent. exports and its increasingly high-tech product mix, the disparity between the number of domesticAlongside RD spending, patent applications have and overseas patents suggests that Chinese com-increased in China, but the vast majority of these panies have left themselves exposed to overseas IPapplications have been filed domestically. Even problems. First, Chinese companies have obtainedthough the number of overseas patent applica- fewer triadic patents—that is, patents that protecttions is growing rapidly, it is minuscule compared the same invention in the United States, Europe,with the number of domestic applications. and Japan—per dollar invested in RD than their counterparts in the developed world. (See ExhibitIn 2004, for example, the same year Chinese en- 4.) A triadic patent signals the importance of thetities filed nearly 66,000 patent applications in innovation: owners are unlikely to invest the timeChina, they filed fewer than 2,000 in the United and expense of filing in three jurisdictions unlessStates, just over 400 in the European Patent Of- they believe that an invention has commercial po-fice, and about 250 in Japan. As a result, China’s tential.increased RD spending over the past decade hasnot translated into a strategically relevant increase In context, this finding reveals that China’s in-in international protection of IP rights for Chinese vestment in triadic patents is so low relative to itscompanies. RD investment that Chinese companies would Exhibit 4: China Has Boosted Investments in RD, but IP Protection Has Not Kept Pace Developed countries Developing countries IP protection1 100,000 Investment in IP protection is higher than in RD U.S. Japan 10,000 Germany Switzerland Sweden France Netherlands Italy Belgium U.K. 1,000 Finland Australia South Korea Austria Canada Denmark Israel Norway Spain China 100 Singapore Taiwan Ireland Russian Federation New Zealand Hungary India Luxembourg Mexico South Africa Greece Czech Republic 10 Slovenia Poland Iceland Turkey Portugal Argentina Investment in IP protection Estonia Slovak Republic is lower than in RD Latvia Romania Lithuania 1 10 100 1,000 10,000 100,000 1,000,000 Innovation2 ($) Source: OECD, Compendium of Patent Statistics 2005. 1 IP protection, measured on a logarithmic scale, is based on the average number of triadic patents granted from 1996 to 2002 to residents in each country. 2 Innovation, measured on a logarithmic scale, is based on the average domestic corporate investment in RD from 1995 to 2001, denominated in 2000 U.S. dollars. 10
  13. 13. need to increase their investments in international appear on the radar screen of IP owners and, asIP protection by a factor of 30 in order to achieve outlined in BCG’s IP-strategy matrix, become vul-parity with companies in developed countries. Sec- nerable to attack. (See Exhibit 5, and for greaterond, China’s investments in international IP pro- detail about the matrix, see the sidebar “Sharks,tection fall well below even those of other develop- Minnows, and Targets: Understanding IP Strategy”ing countries. on page 12.)Other countries have been in this position. In the The IP strategy matrix helps explain how compa-mid-1980s, for example, South Korea found itself nies become exposed to IP risk. Early in their devel-in virtually the same position as China and India opment, companies in countries such as China findare in today. Yet even if their position seems un- themselves in the lower-left corner of the matrix.derstandable, Chinese companies should be taking They have little intellectual property and also verysteps to boost international IP protection if they low sales—in this case, export sales—at risk, andwant to minimize the time they spend in the next thus they are largely ignored by companies higherphase—one that history has shown to be trying in the food chain. As these companies develop andand difficult. move through Phase 2, their sales grow as a result, in part, of their low labor costs. Yet, as we have seen previously, their IP rights do not grow pro-Phase 3: Paying the Price portionately, and the companies find themselves in the upper-left corner of the matrix in the vul-During the third phase of IP development, the dis- nerable position we call the target. As the compa-parity between exports and IP holdings eventually nies grow, they capture market share and begin toensnares companies from less developed econo- threaten developed-country competitors, yet theymies. As their exports grow, these companies lack the IP rights they need to defend themselves. Exhibit 5: The IP Strategy Matrix Illustrates How Companies with IP Rights Grow Strong— and How Those Without IP Rights Become Vulnerable High The target The superpower With sizable revenues at risk—and insufficient Boasting a great deal of IP rights but also IP rights to defend themselves—these players risking a great deal of sales, these players are targets for sharks and superpowers must actively deploy IP rights to protect their strong, balanced position IP-dependent The minnow The shark revenues With few IP rights and low sales related to IP, With extensive IP rights and little revenue at these players are typically ignored risk, these players can aggressively pursue other competitors Low Low High Source: BCG analysis. IP protection Beyond the Great Wall 11
  14. 14. Sharks, Minnows, and Targets: Understanding IP StrategyBCG’s IP-strategy matrix allows a company to understand Finally, superpowers, in the upper right, enjoy strong and bal-and assess its relative IP position within a market or a tech- anced IP positions. In many industries, it is common fornology segment. At a conceptual level, it can help senior these leading companies to cross-license intellectual prop-managers make sense of the complexities inherent in an erty with key competitors. If two companies have propor-IP domain. tionately strong IP portfolios, neither can gain advantage by asserting its intellectual property. This balanced positionThe matrix consists of four quadrants. In the lower right, is reminiscent of the Cold War, when the vast stockpiles ofsharks have a strong IP position and little or no revenue at nuclear weapons held by the United States and the formerrisk to an IP challenge. Often, these players buy patents on Soviet Union fostered “mutually assured destruction” andan opportunistic basis and exploit them as assets, collect- kept an uneasy peace. In this same vein, when two compa-ing licensing fees rather than protecting a manufactured nies are capable of destroying each other through IP claims,product or invention. Because sharks can freely assert their a peace typically prevails on the patent front.IP rights without having to worry about counterassertions,they can be extremely aggressive. And because they make Companies can use these four simple categories to assessor sell no products of their own—or at least very few—they the IP landscape of competitors. By understanding the rela-are invulnerable to IP attacks. tive position of the various players in a sector, a company can quickly identify whether it or some other competitorIn the lower left, minnows (small fish) have low sales, as well is the most advantaged or the most vulnerable. Managersas a weak position in intellectual property. Because min- and IP professionals can also use the IP strategy matrix asnows typically don’t pose a competitive threat, it is rarely an analytical tool to assess risk, identify vulnerabilities, andworthwhile for an IP owner to attack them. find opportunities—and then set a course of action. The matrix can be useful in selecting attractive partners, iden-Some minnows, however, grow up to be targets (in the upper tifying IP assets to acquire, and determining the areas onleft of the matrix). Although these players have weak posi- which patenting activity should focus. BCG has developedtions in intellectual property just as the minnows do, more additional proprietary methods for assessing IP strength,of their sales are unprotected by intellectual property. Com- as well as methods for assessing how closely technologiespanies in this position are vulnerable to IP attacks because are related and the likelihood that infringement will occurtheir large size makes them worth pursuing. between any two patents or patent portfolios.12
  15. 15. Targets are vulnerable to at least three types of Elevated Costs. The market for Chinese-manu-attacks by competitors that have stronger IP po- factured DVD players vanished not because thesitions: market exclusion, elevated costs, and lost consortium denied Chinese companies a license toprofits. their intellectual property. Rather, Chinese manu- facturers chose not to license the technology: theMarket Exclusion. As developing countries move $20 cost per unit would have driven prices of theirfrom simply manufacturing under contract to products prohibitively high and made them un-companies from other countries to designing, pro- competitive in the marketplace.ducing, and marketing their own products, they in-variably imitate the products and manufacturing How is it that China, a “low-cost country,” foundmethods that they have seen and learned about that it could not produce competitively pricedfrom others. This “copying,” whether intentional DVD players? Manufacturers from other countriesor not, may infringe existing IP rights. When this were able to access the technology at a much lowerhappens, IP owners can exercise their fundamental cost. Specifically, because those manufacturersrights to preclude others from making use of their held patents that they could cross-license with theprotected inventions. Patent holders can work members of the DVD consortium, their net licens-through the courts, the U.S. International TradeCommission (ITC), and the WTO to prohibit thesale of infringing products in the markets covered T he ing costs were lower. The surprising moral of this story is that when all costs are considered, devel- oping countries may not always be low-cost loca- surprisingby their patents. The outcome of such suits and tions after all.claims can be disastrous for a developing economy, moral of thiswith companies and even entire industry segments story is that Across a wide range of products, the costs to ac-effectively shut down. cess or license technology are consuming a grow- when all costs ing share of the total cost of goods sold. For theOver the past several years, the number of ITC are considered, DVD players cited in the example, license fees rep-complaints citing Chinese companies for patent in- developing resented 20 to 30 percent of production costs; thefringement has grown dramatically. Twenty years percentages can be even higher in other technol-ago, Japan was the most common target of IP countries ogy sectors. Analysts estimate, for example, thatcomplaints filed with the ITC; ten years ago, that may not always the total cost of IP licensing for third-generationdistinction fell to South Korea; and today, China’s mobile handsets may be as high as 25 to 35 per- be low-costexplosive growth places it in the bull’s-eye. Com- cent of the final selling price for those manufactur-plaints are not limited to high-tech products: Chi- locations ers that do not hold patents for 3G technologies.nese products such as pet foods, insect traps, and after all. Increasingly, corporations that lack an IP portfoliotoothbrushes have been subject to ITC actions. will be relegated to low-end commodity markets.It is interesting that formal and legal complaints Lost Profits. The outlay of large royalty paymentsare not the only route to market exclusion. Some- signals that a company or a country is in Phasetimes, patent holders can curtail infringing prod- 3 of the IP development process. Chinese compa-ucts in more subtle ways. Consider, for instance, nies are just beginning to foot the bill, but otherthe case of the disappearing market for DVD play- economies, such as South Korea and Japan, haveers manufactured in China. In this well-publicized already experienced this phenomenon.example, more than 300 Chinese manufacturersof DVD players exited the business after purchas- In 2005 South Korea made royalty payments ofing patterns shifted. Chinese manufacturers found about $4.5 billion on exports of about $250 bil-themselves essentially locked out of their largest lion. (See Exhibit 6, page 14.) Assuming an aver-export market when a consortium of patent hold- age profit margin of 10 percent of sales, we caners successfully pressured retailers in the United see that South Korea paid around 20 percent ofStates and Europe to purchase DVD players only its total profits from exports as royalties to foreignfrom manufacturers that held IP licenses. companies. Although this figure sounds extraordi- Beyond the Great Wall 13
  16. 16. nary, such high costs are common for countries in the nine defendants agreed to pay Texas Instru-Phase 3. ments more than $1 billion over five years. This experience motivated many Japanese and SouthOur analysis of several developing economies re- Korean companies to advance to the next phase inveals that royalty payments typically peak at be- IP development.tween 2 and 3 percent of revenues from exportsales. Assuming the same 10 percent profit marginthat we have calculated for South Korea, we can Phase 4: Getting Serious Aboutsee that developing countries pay up to 30 percentof their total export profits to access foreign-owned Intellectual Propertyintellectual property. If they want to move beyond Phase 3, developing-The semiconductor industry provides a powerful market companies quickly realize that competingexample of how companies in developing econo- successfully in world markets will require thatmies can escape this kind of IP checkmate. During they dramatically enhance their IP position. Thethe 1980s, in a market flooded with lower-priced question is, How?chips from Japanese and South Korean manufac-turers, U.S. manufacturers of DRAM chips strug- It takes a long time to reverse an IP deficit. Lead-gled to make money. The pain was so great that ing technology companies have built their IP posi-several U.S. manufacturers decided to exit the tions over decades and mastered the art of patentmarket. filing, and it is not easy for still- Exhibit 6: Companies in South Korea emerging companies to over-Like other U.S. chipmakers, Have Already Seen Their Royalty come the barrier to entry thatTexas Instruments struggled, Payments Soar legacy patents pose. Significantbut unlike its peers, the com- Royalty payments made by investment and dogged perse-pany also held a trump card. South Korean companies 1 verance are required to escape ($millions)Texas Instruments owned sev- 5,000 the IP trap.eral fundamental patents onDRAM technology. Historically, Although we cannot providethe company had used the IP all the possible solutions in this 4,000rights only passively, as barter report, we highlight four criti-in cross-licensing deals. cal levers that companies can deploy to overcome their IPRather than abandon the mar- 3,000 deficits: partnering, acquiringket, Texas Instruments decided intellectual property, building ato turn these patents into com- focused IP portfolio, and play-petitive weapons. The company ing the standard-setting game. 2,000simultaneously sued nine Japa-nese and South Korean compa- Partnering. Given the longnies for patent infringement. lead-time required to build aThe legal assault was unprec- 1,000 powerful patent portfolio, aedented in the semiconductor quicker way to forestall mar-industry, with the court battle ket exclusion is to collaborateoccurring against a backdrop with IP-rich corporations. This 0of political and diplomatic in- 1980 1985 1990 1995 2000 2005 approach holds down the coststrigue. Sources: Bank of Korea; Economist Intelligence Unit CountryData; associated with gaining access BCG analysis. 1 to technology, although it also Data for years prior to 1998 are estimated on the basis of derivedEventually, the accused compa- growth rates. presents significant drawbacksnies began to settle. Altogether, in other areas. 14
  17. 17. The U.S. National Science Foundation reports that • What IP rights does the Chinese company retain between 1985 and 2000, Japanese corporations if the joint venture dissolves?created more than 820 joint ventures with U.S.companies in industries in which intellectual prop- Acquiring Intellectual Property. Frequent-erty was important—namely, information tech- ly, acquiring an IP position is the fastest way tonology, biotechnology, new materials, aerospace build a portfolio. Remember those Japanese andand defense, automotive, and chemicals. These South Korean companies that were forced to paypartnerships provided an IP shield that allowed huge royalties to Texas Instruments for accessJapanese firms to compete successfully in markets to semiconductor technology? There is more toand technology domains from which they might the story.otherwise have been excluded. Recognizing that Texas Instruments would want toOver the past decade, and increasingly over the extend the initial five-year licenses, several of thepast five years, Chinese companies also have been Japanese and South Korean licensees spent the fivejoining forces with non-Chinese companies in IP- years building up their own IP portfolios. Achiev-oriented joint ventures. To these relationships, ing IP parity within five years through internal pat-Chinese companies typically bring a low-cost labor ent filings alone would have been impossible, how-pool, manufacturing capabilities, and the promise ever, so the Asian competitors took advantage ofof access to the domestic Chinese market. Theirjoint-venture partners typically bring technology,intellectual property, investment capital, global C hinese the sorry state of the U.S. DRAM industry to pur- chase struggling U.S. companies that held strong intellectual property. When the time came to companiesdistribution channels, and management expertise. renegotiate with Texas Instruments, the licensees also have found themselves in a much stronger negotiatingUnfortunately, the junior members of many of been joining position.these partnerships run the risk that their IP-own- forces withing partners will capture most of the value. Con- This strategy has not been limited to the DRAMsequently, IP-oriented partnerships are not a non-Chinese market. During their rise to IP sophistication, Japa-long-term solution. Nonetheless, they can provide companies nese companies completed at least 450 acquisitionssignificant short-term advantages and can put of U.S. companies that held valuable intellectualcompanies on a path toward IP development. Ulti- in IP-oriented property, including more than 90 such acquisitionsmately, the success of a partnership depends on its joint ventures. in the semiconductor and semiconductor-manu-structure. As they negotiate a partnership, emerg- facturing industries alone. Certainly, many factorsing Chinese companies should carefully consider motivated Japanese companies to take these steps,IP issues, among them: but IP considerations no doubt played an impor- tant part.• Does the joint venture own the intellectual property, or is the partner merely providing a Other nations have learned this lesson, too. In a license? recent study of Chinese outbound mergers and acquisitions, The Boston Consulting Group found• oes the Chinese company have full access to the D that between 2000 and 2004, the companies in 13 technology contributed by its partner? Or, for ex- RDEs consummated 776 acquisitions of companies ample, does the partnership agreement severely in developed countries. limit the use or application of the technology? It is interesting to note that nations such as In-• ho owns the intellectual property created with- W dia, South Africa, and Malaysia used this strategy in the joint venture? Who has the right to license more aggressively than China. Although China the joint venture’s intellectual property or en- force its patents? What forms of redress does the . China’s Global Challengers: The Strategic Implications of Chi- Chinese company have if the parties disagree? nese Outbound MA, BCG report, May 2006. Beyond the Great Wall 15
  18. 18. represented almost 30 percent of the combined liquid. Small “IP shops” eager to amass attractiveGDP of all countries studied, it accounted for only patent portfolios are forming. Public IP auctions82 transactions—less than 11 percent of the total. and merchant banks specializing in IP assets are(See Exhibit 7.) Intellectual property played a sig- beginning to emerge.nificant role in a number of these deals, most no-tably the Lenovo Group’s acquisition of IBM’s PC These developments are helping an increasingbusiness and the acquisition of Thomson’s televi- number of corporate players commercialize theirsion division by the Chinese electronics player TCL patents. Many universities and research-orientedInternational Holdings. Both acquisitions not only companies also engage in these sales, hoping tohelped pave the way for significant global expan- maximize returns on their investments in innova-sion but also dramatically shifted the IP landscape tion. Moreover, because a truly liquid market forin their markets. intellectual property does not yet exist, and be- cause the same intellectual property holds differ-Not all IP-oriented acquisitions need to be large. ent value for different buyers, Chinese companiesIn fact, acquisitions of small technology-focused may be able to acquire desirable portfolios at at-companies with strong IP positions are becoming tractive prices.more common. While it was once rare for compa-nies to acquire IP assets—a patent portfolio, for The challenge for would-be acquirers is to identifyexample—this market is becoming increasingly the right targets. A good way to start is by map- Exhibit 7: China Lags Behind Other RDEs in Acquiring Companies from Developed Countries Number of 250 Chinese companies accounted for nearly one-third of the acquisitions GDP of RDEs in 2003 but only about one-tenth of RDEs’ that companies foreign acquisitions in developed countries in RDEs made in developed 201 countries 200 (2000–2004) 169 150 100 88 82 65 56 50 25 20 20 16 14 11 9 0 India Malaysia Russia Brazil Turkey Thailand Indonesia South Africa China Mexico Poland Hungary Czech Republic Percentage of 12.5 3.3 2.2 29.4 9.0 13.1 10.3 4.4 5.0 1.7 3.0 1.8 4.3 RDE GDP (2003) Percentage of RDE 25.9 21.8 11.3 10.6 8.4 7.2 3.2 2.6 2.6 2.1 1.8 1.4 1.2 MA transactions Source: Thomson Financial. Note: Because of rounding, percentages may not total 100. 16
  19. 19. ping the IP landscape in an industry onto the ma- and litigation risk in the U.S. market tend to betrix highlighted in Exhibit 5. After this quick cut higher than in many European countries, but so ishas identified the most attractive players, deeper the reward. The U.S. economy is larger than anyanalytical techniques can help determine exactly European economy, and hence the revenue up-which IP assets would be most effective in over- side in the United States is greater.coming an IP deficit. Historically, when companies in developing coun-Two types of acquisitions are possible. First, com- tries have gotten more serious about protectingpanies should acquire intellectual property to their intellectual property in export markets, theyprotect their existing or soon-to-be-introduced have exponentially increased their patent filingsproducts. Second, they might want to consider overseas. Samsung, one of the South Korean com-acquiring patents that competitors are most likely panies that settled with Texas Instruments whento infringe. The latter assets could prove to be a the DRAM patents were litigated, serves as per-valuable trading commodity when competitors at- haps the best example.tempt to exclude emerging companies from keymarkets or to constrain their profits through roy- In addition to the settlement, Samsung has paidalty payments. billions of dollars in royalty payments to foreign IP holders in recent years. Today, however, SamsungBuilding a Focused IP Portfolio. The third criti-cal lever for overcoming an IP deficit is achievedby honing one’s own IP portfolio. This kind of tar- T he real key is using all available levers to minimize royalty payments and generate a higher return on its IP investments. Patents provide one key measure of is to focusgeted and mindful approach differs radically from this activity. In 1990 Samsung was granted only 60the more passive one many companies pursue. on securing U.S. patents, but by 2005, Samsung had becomeToday many firms invest in RD and file patent those patents the fifth most-prolific grantee, with 1,641 U.S. pat-applications on the basis of what inventors think ents. In public statements, Samsung officials have that strategistsmight be patentable. But the real key is to focus said that the company wants to attain a third-placeon securing those patents that strategists know will know will ranking by 2007. In contrast, no Chinese companybring both access and differentiation. bring both has broken into the top 100.Because securing global protection for intellectual access and Playing the Standard-Setting Game. Although aproperty is expensive, setting priorities is essential. differentiation. detailed examination of the highly complex waysFor emerging companies in developing countries, in which international standards for technologythe critical goal should be gaining affordable ac- are set transcends the scope of this report, no dis-cess to export markets by avoiding crippling roy- cussion of IP strategy would be complete withoutalty payments. Ownership of directly relevant in- at least a brief mention of the practice. Leadingtellectual property is important, but sophisticated companies excel at using the international stan-IP owners also seek patents in areas of their com- dard-setting process to execute their IP strategy.petitors’ vulnerability. They can use such patentsas leverage during negotiations. Through the standard-setting process, competitors reach agreement about common interoperabilityTo begin, companies must identify the competi- protocols. This ritual is rife with politics and in-tors that represent the most significant threats and trigue, as industry competitors try to balance thethen determine the specific technology domains need for cooperation with their drive for advan-critical to those players. Holding a few key patents tage. In these complex multilateral negotiations,can make a major difference when it comes time companies’ power and influence depend on threeto negotiate with these companies. Moreover, dif-ferent markets represent varying levels of threat . In this report, we use the term international standards to refer only to negotiated multilateral standards and notand opportunity, and companies must invest ac- to de facto standards created through consumer or user ac-cordingly. For instance, patent protection costs ceptance. Beyond the Great Wall 17
  20. 20. primary factors: the best technology, the strong- When it comes to setting an international stan-est intellectual property, and the largest mar- dard, companies in RDEs have three choices. Theyket share. can adopt the dominant international standard and make sizable royalty payments, as SouthIn terms of these factors, most companies from Korea did; attempt to influence the direction of thedeveloping economies are relatively weak, so stan- international standard by relying on the strengthdards are often set without their input. When a of either their market or a powerful ally; or createdeveloping economy adopts an international stan- their own domestic standard.dard, therefore, companies in that country canwind up paying hefty royalties to foreign competi- If these companies don’t command a strong posi-tors that hold patents essential to the standard. tion in technology and intellectual property, how- ever, their influence and ultimate success will beSouth Korea, the first country to adopt the Code Di- severely limited in their pursuit of the latter op-vision Multiple Access (CDMA) standard for wire- tions. All the strategies call for companies in devel-less telecommunications, provides a window into oping economies to collaborate in varying degreesthis phenomenon. Because South Korean compa- with standard-setting activities supported by thenies held virtually no relevant IP rights when the leading players. (See Exhibit 8.)CDMA standard was adopted, they found them-selves having to pay billions of dollars to CDMA Fortunately, China boasts a major advantage overpatent holders. South Korea and most other nations: a large do- Exhibit 8: Standard-Setting Strategies Should Vary Depending on Market, Technology, and Other Factors Participating in Drawing strength Working with a Going it alone the normal process from the market powerful ally Participating in Using the weight of Working with a partner Using Chinese Description normal discussions on China’s market to set a to build a China- technology and IP to set setting a standard winning standard favorable standard an alternate standard Factors Technology and IP • Strong technology • Strong technology • An ally with strong • A strong technol- strength and IP are required and IP are helpful technology and IP ogy and IP position to exert significant but may not be may be able to help is required influence necessary secure favorable treatment Coordination of the • Coordination among • Coordination, • A coordinated • A coordinated response from Chinese Chinese companies perhaps led by the response will be effort by Chinese companies will increase government, will more likely to attract players is more influence be necessary potential allies likely to succeed Fragmentation of • Fragmentation • Chinese influence • Given fragmentation, • Strategy is likely to existing efforts in affords Chinese may be high it may be easier to work only if setting a standard companies greater attract an ally existing efforts are influence highly fragmented Size of the relevant • Large market size • If China’s market • A large relevant • A large local market affords China a is large, its market is an market is required stronger voice support may set attractive lure for a for a go-it-alone the winning potential ally effort to succeed standard Collaboration with High Low dominant players Source: BCG analysis. 18
  21. 21. mestic market. Many companies want to sell goods what Chinese companies can expect and hope forand services in China, and in some instances—for in their future.example, in order to gain market access—theymay be willing to compromise and adopt stan- South Korea, which of course started down thedards that are more favorable to Chinese compa- IP development path more recently than Japannies. Until Chinese companies can bolster their did, is about to turn the corner and enter Phasepositions in technology and intellectual property, 5. Several of South Korea’s leading companies, forthe size of their domestic market may be their best example, Samsung, have already made this tran-bargaining chip. sition, and they are now acquiring state-of-the-art skills in IP management.Phase 5: Profiting from We highlighted South Korea’s rising royalty pay- ments in Exhibit 6; it is equally important toIntellectual Property note that South Korea’s royalty proceeds are also growing rapidly—an indicator of the country’sThroughout this report, we have cited South Ko- progress. (See Exhibit 9.) In fact, the country’s roy-rea and Japan as examples of countries that are alty proceeds are growing so quickly that net royal-making successful transitions from weakness to ty payments by South Korean companies are nowstrength in intellectual property. The current ex- flat. If the current trends continue, we expect thatperiences of both of these countries exemplify over the next several years, as these companies be- Exhibit 9: Companies in South Korea Are Beginning to Offset Royalty Payments with Royalty Receipts Payments Receipts Net royalty payments Royalty 5,000 payments and receipts of South Korean 4,000 companies 1 ($millions) 3,000 2,000 1,000 0 1,000 2,000 3,000 4,000 5,000 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Sources: Bank of Korea; Economist Intelligence Unit CountryData; BCG analysis. 1 For 1980 to 1997, royalty receipts were derived from compound annual growth rates for 1998 to 2001, and royalty payments were calculated as the diffe- rence between net royalties and the derived royalty receipts. Beyond the Great Wall 19
  22. 22. come sophisticated managers of intellectual prop- ent of royalty payments for the first time. (See Ex-erty, they will see their net royalty payments begin hibit 10.)to decline. Historically, Japanese companies have been re-Farther down the path, Japan has already begun luctant to use their intellectual property in aggres-to benefit from its long and patient investments sive ways or as a competitive weapon. Today thatin intellectual property, making it an even more reluctance has begun to wane. Over the last twopowerful exemplar of the type of opportunities years, for example, the number of patent-relatedthat lie ahead for Chinese companies. Today, Jap- suits filed by Japanese companies has doubled.anese companies hold 40 percent of the world’s Although Japan’s new attitude about intellectualpatents—more than any other country. Although property elicits immediate concern among Chi-Japanese patenting practices skew that percentage nese and other companies around the world, itupward, the measure nonetheless highlights the also should inspire hope. Japan’s shift proves thatremarkable turnaround that can be achieved by countries and companies can make progress in IPa country determined to turn intellectual property development. Certainly, Japan could not afford tointo strength. In 2003 Japan became a net recipi- take its new stance if companies there had not in- vested significantly to secure greater international. Japanese patent laws—which limit the number of claims IP protection over the past two decades.that can be filed under one patent—and the patent-filingpractices of Japanese companies result in a large number oftypically narrow patents. Exhibit 10: Japanese Companies Have Made the Leap from Paying High Royalty Fees to Collecting Them Payments Receipts Net royalty payments 2003 marked Japan’s first year with positive cash flow from royalties Royalty 1,500 payments and receipts for Japanese 1,200 companies (�billions) 900 600 300 0 300 600 900 1,200 1,500 1960 1965 1970 1975 1980 1985 1990 1995 2000 Sources: Bank of Japan; BCG analysis. 20
  23. 23. Closing the IP GapT he path through IP development will Map your IP position and that of international be long for China as a nation, but competitors in your key technologies and markets. that’s not necessarily the case for lead- ing Chinese companies. Each Chinese • How vulnerable are you to financial or market- company can set its own pace and place penalties?milestones for moving through the IP develop-ment process. • Which competitors could most easily expose your IP vulnerabilities?Through targeted acquisitions, increased patentfilings, and an emphasis on IP management, some Learn how leading international companies man-leading Chinese companies are already beginning age their intellectual property.to accelerate their IP development. Pioneers inChina, these players are following a trail blazed by • How do leading companies in your industry man- others, and their knowledge of history is helping age intellectual property?them shape a more competitive future. • ow do leading companies in other sectors or- HWe encourage all Chinese players to examine and ganize, prioritize, and manage their intellectualembrace these time-tested approaches. By devel- property?oping world-class IP management skills, they canmove beyond the Great Wall to compete success- Develop a plan for turning intellectual propertyfully in the global marketplace. from a weakness into a strength.For Chinese companies that want to move aggres- • How can you develop an IP strategy that is close- sively in developing their intellectual property, we ly linked with your corporate strategy?provide a checklist of the steps to consider. • Can you build a world-class IP organization? Determine your company’s position within thefive phases of IP development. • Can you articulate all your IP vulnerabilities and risks?• ow important are exports for the success of H your business? • an you evaluate and execute partnership and C acquisition opportunities in order to change your• re your exported products high- or low-tech? A position?• re you appropriately balancing your investment A • Where can you invest to secure international pro- in IP protection with your investment in RD? tection for your intellectual property?• ow strong is your IP position relative to that of H your international competitors? Beyond the Great Wall 21
  24. 24. For Further ReadingThe Boston Consulting Group has Looking Eastward: Tapping China “Globalizing RD: Building a Pathwaypublished other reports and articles on and India to Reinvigorate the Global to Profits” Biopharmaceutical Industry Opportunities for Action in Operations,global expansion, intellectual property, A report by The Boston Consulting Group, May 2005and related areas. Recent examples August 2006include: “Globalizing RD: Knocking Down the China’s Global Challengers: The Barriers” Strategic Implications of Chinese Opportunities for Action in Operations, Outbound MA May 2005 A report by The Boston Consulting Group, Navigating the Five Currents of May 2006 Globalization: How Leading Companies Are Capturing Global Advantage The New Global Challengers: How A Focus by The Boston Consulting Group, 100 Top Companies from Rapidly January 2005 Developing Economies Are Changing the World Facing the China Challenge: Using A report by The Boston Consulting Group, an Intellectual Property Strategy to May 2006 Capture Global Advantage A report by The Boston Consulting Group, Organizing for Global Advantage September 2004 in China, India, and Other Rapidly Developing Economies Capturing Global Advantage: How A report by The Boston Consulting Group, Leading Industrial Companies Are March 2006 Transforming Their Industries by Sourcing and Selling in China, India, A Game Plan for China: Rising to and Other Low-Cost Countries the Productivity Challenge in A report by The Boston Consulting Group, Biopharma RD April 2004 A Focus by The Boston Consulting Group, December 2005 “What Is Globalization Doing to Your Business?” “Spurring Innovation Productivity” Opportunities for Action in Industrial Opportunities for Action in Industrial Goods, February 2004 Goods, November 2005 “The New Economics of Global Advantage: Not Just Lower Costs but Higher Returns on Capital” Opportunities for Action in Operations, July 2005 22
  25. 25. For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.com.To receive future publications in electronic form about this topic or others, please visit our subscription Web site atwww.bcg.com/subscribe. 1/07
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