Protecting intellectual property in China

Litigation is no substitute for strategy.

Many multinational companies in China are losing the battle to protect their intellectual property, largely because they rely too heavily on legal tactics and fail to factor IP properly into their strategic and operational decisions. When we studied the Chinese operations of ten multinationals competing in IP-sensitive industries (including consumer electronics, medical equipment, pharmaceuticals, semiconductors, and software), we found that many executives think of protecting IP solely in legal terms—and sometimes only after property has been stolen. The most successful companies, however, take strategic and operational action to protect their IP before that happens, thus lowering their litigation costs and improving the odds that their IP will remain safe.

Companies should of course register their trademarks and patents with local authorities and prosecute violators with appropriate vigor (and prudence). The recent passage in China of a stronger statute on IP rights should better protect companies that take these measures. But litigation is no substitute for strategy. The best companies reduce the chance that competitors will steal their IP, by carefully selecting which products and technologies to sell and manufacture in China. For fear of IP theft, one pharmaceutical company we studied withholds its most innovative, high-margin drugs from the Chinese market altogether. The company is willing to introduce lower-margin products, such as mature, off-patent drugs that are sold over the counter.

One large equipment manufacturer designs and develops hardware in China but produces the related software (in this case, the most valuable IP) abroad. The software, with its source code hidden, is delivered to Chinese engineers ready to plug into the system. By separating functions and keeping technological details secret in this way, the manufacturer significantly reduces the possibility of an IP leak.

Developing software in a country with better IP protection and then transporting it to China adds time, costs, and complexity to the process. In the long term, however, the manufacturer estimates that the ability to protect its critical IP and to lower its litigation costs makes the trade-off worthwhile. In our experience, some executives are so caught up in the rush to reach the Chinese market that they share technological and business secrets too readily with partners, which subsequently use the information to become competitors.

Operational action is also critical. While most companies implement the necessary security measures, such as the use of surveillance equipment or firewalls, to prevent large file transfers, the best companies go further. Indeed, we found that these exceptional performers cultivate an awareness of IP and screen all job candidates for high ethical standards.

One global company, for example, prefers employees with international work and educational experience, which it hopes will foster a healthy respect for IP. A vast majority of the company's R&D scientists (who are, for the most part, Chinese nationals) have foreign PhDs and have worked outside China. The company reinforces IP awareness by requiring non-compete clauses (which prevent employees from serving competitors for up to three years after leaving) in employment contracts for all positions. Despite high attrition levels—the company is an excellent training ground, so its employees are often poached—it estimates that it has saved a good deal of money and market share by successfully minimizing IP leakage and theft. Poorly performing companies, by contrast, tend to neglect employment contracts, and even background checks, in their haste to hire.

Executives from the companies that best protect their IP frequently monitor the activities of their Chinese business partners—even long-term, trusted ones—for potential leaks. A leading high-tech components manufacturer, for instance, closely scrutinizes its business partners to ensure that parts aren't illegally copied and resold. It routinely verifies that the number of components delivered to its customers matches the number in products subsequently sold. This level of scrutiny is uncommon, however. Of the ten companies we studied, a majority fail to audit the compliance of their partners frequently or rigorously.

The law alone isn't enough to protect intellectual assets. A company should assign explicit responsibility for its IP to senior managers who are familiar with all aspects of the business and able to focus their energies on those elements of IP protection it can control. Achieving the right mix of legal, operational, and strategic considerations is difficult (exhibit), and companies certainly can't protect all of their IP all of the time. Yet those that get it right are more likely to build successful businesses in China.

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