How to prevent a Chinese copycat and protect your technology?

The Chinese market is huge. With around 1,5 billion people China has an enormous market for practically any type of technology. China has for example almost 200 cities with more than 1 million inhabitants, over 20 cities with metro systems and builds 30 million apartments every year. But China is also the country know for copying new technology. How to prevent copycatting?

Setting up your own subsidiary won’t work

Setting up your own wholly owned subsidiary in China is a strategy that many companies have tried out, and many of them failed. China is a country where you need to have the right contacts and where ‘foreign’ approaches don’t always fit. So in order to be successful you’ll have to collaborate with the Chinese.

Contracts are hard to enforce

As almost everything in China is at a large scale, also the production and distribution companies that you might want to deal with will be relatively big and have access to a lot of resources. They will be acting in their home market, so in case anything in the relationship will go wrong, any litigation will be exhausting (not to mention costly). This is regardless of the neutrality and competence of the court. A contract is a good way to outline processes and expectations, but will hardly be a tool to enforce payments.

Options in doing business with the Chinese

Let’s have a look at various options in doing business with the Chinese:

1. Sell your products to China and have a local partner as distributor
When it comes to small quantities this might work, but bear in mind that your product would probably have a higher cost price and that there will be transportation fees and import duties. This can make your product 2 to 3 times more expensive as the competitors’. For heavily branded products this may work, for machinery and equipment the purchasing price or in the best case the Total Costs of Ownership will be the decisive factor for the Chinese buyers.

As the equipment with your technology is probably more expensive, you have the risk of reverse engineering: the Chinese have been known to disassemble your machine and copy all the pieces bit by bit. Unless your technology is hidden in an algorithm or in the production process, or there is no necessity to constantly update the technology in your machine, you’ll run the risk of obsolescence in China.

2. Collaborate with a Chinese company and bring in your technology
Land, labour and capital is available in abundance in China. So why not set up a production plant in China that puts your technology in its products? This way the products can be competitively priced. Your Chinese partner can do all the local investment of capital and effort, as well as source the vast local market and arrange distribution.

The deal can be structured in various ways: either you can license your technology to your Chinese partner and receive a fee per product sold or you can set up a joint venture. In a joint venture you will share in the company’s profits, which can bring both risks and upsides. You will have access to more information and have more influence, however never total control.

Although your Chinese partner may shield you from patent infringements of other Chinese companies, monitoring him would now become a concern. For example, measures need to be in place to ensure the right quantities or profits are reported, and that you will receive your rightful share of the revenues. Where a joint venture is formed, you may also need “non-compete” clauses in the contract to prevent the partner from forming separate entities to compete in the same markets in China.

Keep control of your (latest) technology

This means that you’ll have to stay in control of your assets. Non-contractual controls are the way forward. This means that you will have to look at the following aspects:

  • Which part of your technology is the most crucial? Anything that can be bought elsewhere is not of interest to the Chinese.
  • Is your technology protected by a patent or by confidentiality? Patents can be looked up and the technology reproduced, whereas confidential information cannot
  • Is it possible to keep a part of the production out of China? If you have a specific production technology that makes the difference then you might consider keeping it in your home country.
  • Is your technology constantly improving and can you keep the technology development in your homeland?
  • Can you control the technology from out of your homeland, e.g. in the case of software applications or software controlled equipment?

What you need is a compelling and sustainable reason for your Chinese counterpart to keep the relationship healthy. They may slightly manipulate the number of products sold, or the profits coming out of the joint venture, but that’s something you may have to accept. As long as the net effect for your company is convincingly positive, then you may consider reluctant acceptance (although for a Westerner, this may not feel comfortable).

Chinese investors may want to take a stake in your company

As the Western world is spending beyond its means, whilst China is consuming much less than it produces, there is plenty of investment capital available in China. Instead of haggling with you on the conditions for licensing your technology, the Chinese may prefer to own the technology, and if that comes with buying your company, this may be a viable consideration.

It is a prudent position that simply being a shareholder (depending on equity holding) doesn’t entitle you to get access to all proprietary information. On the other hand, having a Chinese shareholder can bring a number of non-financial benefits in entering the Chinese market and can make market access through both distribution and licensing easier and safer.

Prepare a strategy for your meeting

If you are going to meet Chinese parties, make sure you have considered all three options above: (1) Chinese distributor; (2) Licensing or Joint Venture; (3) Offering equity to Chinese party. Practically any business person can act as a distributor, joint venture partner or investor, even if the first intention is just to buy your product or service.

Any strategy needs clear value assessments of your China market entry, which includes detailed and realistic assumptions of costs and income, as well as the risks to realizing that value. Do discuss your strategy with other China entrepreneurs to help you embark on this project with mitigation strategies to counter these risks.

The next step would be to learn more about the partner. This should also involve a trip to China to get a better impression of the potential partner(s) and of the vastness of China. Have yourself supported by a local intermediary, who can also do the translations, as these mostly will be necessary. Take your time, stay in control, and eventually profit from the opportunities in the country that soon will be the biggest economic power in the world.

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