Report
Beyond the Great Wall
Intellectual Property Strategies
for Chinese Companies
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Beyond
the Great Wall
Intellectual Property Strategies
for Chinese Companies
David Michael
Collins Qian
Vladislav Boutenko
Ralph Eckardt
Mark Blaxill
January 2007
www.bcg.com
© The Boston Consulting Group, Inc. 2007. All rights reserved.
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Contents
Note to the Reader
4
Executive Summary
5
Competing on the World Stage
6
Understanding the Five Phases of IP Development
8
Phase 1: Driving Growth Through Exports 8
Phase 2: Climbing the Value Ladder
9
Phase 3: Paying the Price
11
Phase 4: Getting Serious About Intellectual Property
14
Phase 5: Profiting from Intellectual Property 19
Closing the IP Gap
21
For Further Reading
22
Beyond the Great Wall
Note to the Reader
This research report is a joint product
of the Strategy practice and the
Technology and Communications
practice of The Boston Consulting
Group. The authors welcome your
questions and feedback.
For Further Contact
David Michael
BCG Beijing
+86 10 6567 5755
[email protected]
Collins Qian
BCG Shanghai
+86 21 6375 8618
[email protected]
Vladislav Boutenko
BCG Moscow
+7 495 258 34 34
[email protected]
Acknowledgments
The authors acknowledge the
contributions of BCG’s global experts
in strategy and in technology and
communications. They extend special
thanks to David Dean, a senior vice
president and director in BCG’s Munich
office and the former global leader of
the Technology and Communications
practice, and to Michael Deimler, a
senior vice president and director in
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
Executive Summary
Over the past five years, a rapid rise in exports has
driven an unprecedented level of prosperity in
China, fueling the nation’s emergence as an economic powerhouse. To sustain its trajectory of impressive growth, China will become even more reliant on exports. That means that Chinese companies
will need to become ever more sophisticated about
operating in global markets.
• Intellectual property (IP) strategy is one of the areas in which it is most critical that Chinese companies boost their sophistication. Despite rapid and
well-documented improvements in the IP system
within China, Chinese companies still lag behind
competitors from developing and developed countries in securing international protection for their
proprietary knowledge.
• Without strong international IP rights, Chinese
companies may face exclusion from international
markets, have to pay onerous royalties, or find it
necessary to enter into disadvantageous partnerships with foreign companies that have stronger IP
portfolios. These consequences could stall China’s
economic growth and constrain the growth of its
emerging global companies.
Chinese companies have dramatically ramped up
R&D spending, but they have not proportionately
increased their investment in securing international
IP rights.
markets of the United States, Europe, and Japan.
As a result, Chinese companies are entering these
markets unprotected.
• In their key export markets, Chinese companies
are already facing a rapidly increasing number of
IP challenges.
• Chinese companies and industries that seek to
compete globally should invest now to develop
their IP strategies and capabilities—or risk ceding
advantage to competitors that move more quickly
and forcefully.
China is not the first rapidly developing economy
(RDE) to suffer growing pains in IP development.
In their evolution, all developing economies have
followed a similar path.
• Developing economies move through five phases
of IP development. In this report, we examine
those phases, placing China’s current position in
historical context.
• We examine lessons from other countries and
companies, and demonstrate how China can
rapidly improve its IP position. We hope that, by
drawing on these lessons, Chinese companies will
recognize the importance of developing superior
skills in IP management and learn how to prosper
beyond the Great Wall.
• If Chinese companies are to match the standard
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
Competing on the
World Stage
S
ince joining the World Trade Organization (WTO) in 2001, China has worked
mightily to improve its IP system, laws,
and enforcement. To date, the government has made great strides, and the
country appears to be on a path toward meeting
the world’s standards for IP protection. Perhaps
the best evidence of this evolution is the dramatic
increase in patent filings by Chinese companies
and inventors. In 2005 Chinese entities filed more
than 93,000 patent applications—more than triple
the number filed in 2001—with the State Intellectual Property Office.
At the same time, however, overseas patent filings by Chinese companies and inventors remain
at negligible levels. In 2005, for example, Chinese
entities submitted fewer than 2,200 patent applications to the U.S. Patent and Trademark Office.
That number is a tiny fraction of the 17,219 patent
applications filed there by South Korean inventors
and the 71,994 filed by Japanese investors. And the
Chinese have been even less prolific in the export
markets of Japan and Europe.
Although a patent count is an imprecise measure
of value, the disparity between China’s economic
stature and its global IP standing is nonetheless
striking. When patent applications worldwide are
classified by the countries where the applicants reside, China accounts for only 0.5 percent of the applications filed by nonresidents in 2005. This performance ranked China eighteenth, just behind
Austria. (See Exhibit 1.) By any measurement of IP
rights, China’s performance is significantly subpar
while its growth over the past five years is unparalleled among large economies.
China’s rapid growth to the world’s sixth-largest
economy has been powered largely by dramatic
increases in exports, an experience typical among
RDEs. Asia’s “four little dragons”—Hong Kong,
Singapore, South Korea, and Taiwan—all rose to
prominence on the shoulders of exports, as did Japan before them.
In fact, China is the world’s second-largest exporting nation, ranking behind only the United States.
Since joining the WTO, China’s exports have more
than doubled to nearly $600 billion, with exports
catapulting from 20 percent of gross domestic
product (GDP) in 2001 to 37 percent in 2005. (See
Exhibit 2.) Amazingly, exports from Chinese companies are growing at an annual rate that is six
times as fast as that of global GDP.
There is, however, a downside to export growth.
As Chinese companies become increasingly dependent on overseas sales, the need for these companies to operate in the most highly developed IP regimes in the world is also growing. During the first
eight months of 2006, for example, nearly half of
China’s exports went to the United States, Europe,
and Japan. In these attractive markets, Chinese
companies face fierce competition and a sizable IP
disadvantage.
When challenged by Chinese competitors, incumbent companies in developed countries can draw
on their well-established IP rights to constrain the
growth and profitability of the new entrants. In
recent months, for example, Chinese companies
from sectors as disparate as floor coverings and
consumer electronics have faced patent infringement claims in overseas markets. The claims aim
Exhibit 1: China’s IP Development Lags
Behind Its Economic Development
to exclude the Chinese companies from the markets or to exact profit-draining royalty payments.
These companies can avoid this continued peril
only by cultivating world-class capabilities in acquiring, developing, and managing intellectual
property.
Exhibit 2: Strong Growth in Exports Is
Driving China’s Economic Success
GDP minus exports
China ranks high in global demographic
and economic standings
Population
Rank
Country
1
2
3
China
India
United States
Rank
Country
1
2
3
United States
China
Japan
Exports
Exports as a percentage of GDP
$billions
%
22.1
18.1
5.0
3,000
40
% of total
2,500
% of total
Exports
35
9.1
6.6
6.3
GDP
Rank
Country
5
6
7
United Kingdom
China
Italy
% of total
30
2,000
25
4.1
4.0
4.0
1,500
20
15
Chinese ownership of international
IP rights remains low
Patent applications filed
by nonresidents
1,000
10
500
Rank
Country
% of total
17
18
19
Austria
China
Spain
0.6
0.5
0.4
5
0
Sources: Economist Intelligence Unit; OECD; World Intellectual Property
Organization, WIPO Patent Report: Statistics on Worldwide Patent Activities,
2006 Edition.
Note: Export figures are from 2004; patent data are from 2005.
Beyond the Great Wall
0
1995
2000
2005
Sources: Economist Intelligence Unit; BCG analysis.
Note: GDP and export figures are denominated in 1996 U.S. dollars.
Understanding
the Five Phases of
IP Development
A
lthough daunting, the challenges that
China faces in IP development are
hardly new. In addressing them, therefore, Chinese companies do not need
to reinvent the wheel. In recent decades, Japan, Taiwan, and South Korea have traveled down a similar path of IP development. In fact,
all developing economies make the same journey.
Even the United States, which in the 1800s relied
heavily on European technologies to build its industrial base, has followed a similar evolutionary
road. By learning the lessons of history, Chinese
companies can avoid many of the pitfalls that normally confound RDEs. Furthermore, by mastering
IP strategy, they can transform a current weakness
into a source of enduring advantage.
Our research has found that developing economies and their leading companies move through
five common phases of IP development: driving
growth through exports, climbing the value ladder,
paying the price, getting serious about intellectual
property, and profiting from intellectual property.
(See Exhibit 3.)
Phase 1: Driving Growth
Through Exports
When they first begin to compete in world markets, developing economies rely heavily on their
abundant natural resources and low labor costs.
Export-led growth serves as the economic engine
during Phase 1, but the exported products—as
well as the methods employed to manufacture
them—are decidedly low-tech. At this early stage,
manufacturing typically entails either the final assembly of imported components or labor-intensive
production that requires low levels of capital. The
garment industry offers an excellent example of
this phenomenon.
When developing economies are still nascent, they
are “technology poor.” That is, they invest little in
R&D and own virtually no intellectual property.
Since exports are basic rather than high-tech, companies do not need—and rarely acquire—international protection for intellectual property.
Less than 50 years ago, Japan was in Phase 1.
Today it is hard to believe that the phrase “Made
in Japan” once served as shorthand for low technology and poor quality. In the 1960s and 1970s,
however, Japan’s leading companies quickly became dissatisfied with this state of affairs and developed higher aspirations. In recent years, other
developing countries have followed suit, investing
heavily and reconfiguring their industrial policies
so that they could enter the next phase of IP development.
Even though the exports of developing economies
may begin to grow rapidly during this phase, these
countries continue to capture only minimal value.
Most of the gains flow either to foreign companies,
which develop, design, and market the products
that incorporate the sourced components, or to
customers, who benefit from lower prices. In China, for example, more than half of the country’s exports are currently produced by enterprises at least
partly owned by foreign interests, and less than 10
percent are shipped under Chinese brands.
B
y learning
Phase 2: Climbing the
Value Ladder
the lessons of
history, China
can avoid
As companies in developing economies gain firsthand experience in exporting and manufacturing,
they invariably find ways to add and capture greater value in the global marketplace. These players
quickly learn that low labor costs alone cannot
provide a solid foundation for sustainable success.
Instead, they ascend the value ladder by mastering
more high-tech manufacturing methods; producing more complex components; and then developing, designing, and marketing their own products.
many of the
pitfalls that
normally
confound
developing
economies.
their exports. Eventually, the young companies
begin to invest in R&D and may even begin to acquire some intellectual property. This type of evolution has been exemplified in South Korea over
the past several decades. Through the late 1970s
and throughout the 1980s, high-tech products as
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 exports
shifted dramatically toward high-tech products,
more than doubling to 32 percent by 1999.
Today China is beginning to exhibit exactly the
same pattern. High-tech products as a percentage of exports rose from single digits in the 1990s
to 14 percent when China entered the WTO
in 2001. By 2004 the share of high-tech products doubled to about 28 percent of total exports,
and in 2005 China’s high-tech exports totaled
$195 billion. Given South Korea’s experiences, the
proportion of China’s products that are high-tech
is likely to continue growing for at least the next
five years.
China has also seen domestic corporate investment
in R&D rise more than fivefold from $19 billion
in 1994 to $97 billion in 2004. As a share of GDP,
Companies often enter Phase 2 by copying the
products and emulating manufacturing methods
deployed by the foreign players that purchase
Exhibit 3: In Their IP Development, RDEs Follow a Common Path
R&D spending
Exports
Net royalties paid
IP strength
Phase 1:
Driving growth
through exports
Exports of low-tech
products drive growth,
exploiting the low cost of
labor and materials
Phase 2:
Climbing the
value ladder
An increase in R&D
spending and acquired
knowledge drives growth
in the export of highertech products
Phase 3:
Paying the price
Companies suffer
consequences when IP
owners from developed
nations defend their
markets
Phase 4:
Getting serious about
intellectual property
Companies in developing
countries invest to
manage and protect their
intellectual property
Phase 5:
Profiting from
intellectual property
Companies in developing
countries achieve parity
and may capture advantage through IP rights
Source: BCG analysis.
Beyond the Great Wall
R&D spending by Chinese companies rose during
this ten-year period from 3 percent to 5 percent.
Against the backdrop of China’s rapid growth in
exports and its increasingly high-tech product mix,
the disparity between the number of domestic
and overseas patents suggests that Chinese companies have left themselves exposed to overseas IP
problems. First, Chinese companies have obtained
fewer triadic patents—that is, patents that protect
the same invention in the United States, Europe,
and Japan—per dollar invested in R&D than their
counterparts in the developed world. (See Exhibit
4.) A triadic patent signals the importance of the
innovation: owners are unlikely to invest the time
and expense of filing in three jurisdictions unless
they believe that an invention has commercial potential.
Alongside R&D spending, patent applications have
increased in China, but the vast majority of these
applications have been filed domestically. Even
though the number of overseas patent applications is growing rapidly, it is minuscule compared
with the number of domestic applications.
In 2004, for example, the same year Chinese entities filed nearly 66,000 patent applications in
China, they filed fewer than 2,000 in the United
States, just over 400 in the European Patent Office, and about 250 in Japan. As a result, China’s
increased R&D spending over the past decade has
not translated into a strategically relevant increase
in international protection of IP rights for Chinese
companies.
In context, this finding reveals that China’s investment in triadic patents is so low relative to its
R&D investment that Chinese companies would
Exhibit 4: China Has Boosted Investments in R&D, but IP Protection Has Not Kept Pace
Developed countries
IP protection1
100,000
Developing countries
Investment in IP protection
is higher than in R&D
Japan
10,000
Germany
Switzerland
Netherlands
Belgium
Finland
Australia
Austria
Denmark
Norway
Singapore
Ireland
1,000
100
10
1
U.S.
Sweden
Italy
France
U.K.
South Korea
Canada
Israel
Spain
China
Taiwan
Russian Federation
India
South Africa
New Zealand
Hungary
Mexico
Luxembourg
Greece
Czech Republic
Slovenia
Poland
Iceland
Turkey
Portugal
Argentina
Estonia
Slovak Republic
Romania
Latvia
Lithuania
10
100
1,000
Investment in IP protection
is lower than in R&D
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 R&D from 1995 to 2001, denominated in 2000 U.S.
dollars.
10
need to increase their investments in international
IP protection by a factor of 30 in order to achieve
parity with companies in developed countries. Second, China’s investments in international IP protection fall well below even those of other developing countries.
appear on the radar screen of IP owners and, as
outlined in BCG’s IP-strategy matrix, become vulnerable to attack. (See Exhibit 5, and for greater
detail about the matrix, see the sidebar “Sharks,
Minnows, and Targets: Understanding IP Strategy”
on page 12.)
Other countries have been in this position. In the
mid-1980s, for example, South Korea found itself
in virtually the same position as China and India
are in today. Yet even if their position seems understandable, Chinese companies should be taking
steps to boost international IP protection if they
want to minimize the time they spend in the next
phase—one that history has shown to be trying
and difficult.
The IP strategy matrix helps explain how companies become exposed to IP risk. Early in their development, companies in countries such as China find
themselves in the lower-left corner of the matrix.
They have little intellectual property and also very
low sales—in this case, export sales—at risk, and
thus they are largely ignored by companies higher
in the food chain. As these companies develop and
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 proportionately, and the companies find themselves
in the upper-left corner of the matrix in the vulnerable position we call the target. As the companies grow, they capture market share and begin to
threaten developed-country competitors, yet they
lack the IP rights they need to defend themselves.
Phase 3: Paying the Price
During the third phase of IP development, the disparity between exports and IP holdings eventually
ensnares companies from less developed economies. As their exports grow, these companies
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
IP rights to defend themselves—these players
are targets for sharks and superpowers
Boasting a great deal of IP rights but also
risking a great deal of sales, these players
must actively deploy IP rights to protect their
strong, balanced position
The minnow
The shark
With few IP rights and low sales related to IP,
these players are typically ignored
With extensive IP rights and little revenue at
risk, these players can aggressively pursue
other competitors
IP-dependent
revenues
Low
Low
Source: BCG analysis.
Beyond the Great Wall
High
IP protection
11
Sharks, Minnows, and Targets: Understanding IP Strategy
BCG’s IP-strategy matrix allows a company to understand
and assess its relative IP position within a market or a technology segment. At a conceptual level, it can help senior
managers make sense of the complexities inherent in an
IP domain.
The matrix consists of four quadrants. In the lower right,
sharks have a strong IP position and little or no revenue at
risk to an IP challenge. Often, these players buy patents on
an opportunistic basis and exploit them as assets, collecting licensing fees rather than protecting a manufactured
product or invention. Because sharks can freely assert their
IP rights without having to worry about counterassertions,
they can be extremely aggressive. And because they make
or sell no products of their own—or at least very few—they
are invulnerable to IP attacks.
In the lower left, minnows (small fish) have low sales, as well
as a weak position in intellectual property. Because minnows typically don’t pose a competitive threat, it is rarely
worthwhile for an IP owner to attack them.
Some minnows, however, grow up to be targets (in the upper
left of the matrix). Although these players have weak positions in intellectual property just as the minnows do, more
of their sales are unprotected by intellectual property. Companies in this position are vulnerable to IP attacks because
their large size makes them worth pursuing.
12
Finally, superpowers, in the upper right, enjoy strong and balanced IP positions. In many industries, it is common for
these leading companies to cross-license intellectual property with key competitors. If two companies have proportionately strong IP portfolios, neither can gain advantage
by asserting its intellectual property. This balanced position
is reminiscent of the Cold War, when the vast stockpiles of
nuclear weapons held by the United States and the former
Soviet Union fostered “mutually assured destruction” and
kept an uneasy peace. In this same vein, when two companies are capable of destroying each other through IP claims,
a peace typically prevails on the patent front.
Companies can use these four simple categories to assess
the IP landscape of competitors. By understanding the relative position of the various players in a sector, a company
can quickly identify whether it or some other competitor
is the most advantaged or the most vulnerable. Managers
and IP professionals can also use the IP strategy matrix as
an analytical tool to assess risk, identify vulnerabilities, and
find opportunities—and then set a course of action. The
matrix can be useful in selecting attractive partners, identifying IP assets to acquire, and determining the areas on
which patenting activity should focus. BCG has developed
additional proprietary methods for assessing IP strength,
as well as methods for assessing how closely technologies
are related and the likelihood that infringement will occur
between any two patents or patent portfolios.
Elevated Costs. The market for Chinese-manufactured DVD players vanished not because the
consortium denied Chinese companies a license to
their intellectual property. Rather, Chinese manufacturers chose not to license the technology: the
$20 cost per unit would have driven prices of their
products prohibitively high and made them uncompetitive in the marketplace.
Targets are vulnerable to at least three types of
attacks by competitors that have stronger IP positions: market exclusion, elevated costs, and lost
profits.
Market Exclusion. As developing countries move
from simply manufacturing under contract to
companies from other countries to designing, producing, and marketing their own products, they invariably imitate the products and manufacturing
methods that they have seen and learned about
from others. This “copying,” whether intentional
or not, may infringe existing IP rights. When this
happens, IP owners can exercise their fundamental
rights to preclude others from making use of their
protected inventions. Patent holders can work
through the courts, the U.S. International Trade
Commission (ITC), and the WTO to prohibit the
sale of infringing products in the markets covered
by their patents. The outcome of such suits and
claims can be disastrous for a developing economy,
with companies and even entire industry segments
effectively shut down.
T
he
surprising
moral of this
story is that
when all costs
Over the past several years, the number of ITC are considered,
complaints citing Chinese companies for patent indeveloping
fringement has grown dramatically. Twenty years
countries
ago, Japan was the most common target of IP
complaints filed with the ITC; ten years ago, that may not always
distinction fell to South Korea; and today, China’s
be low-cost
explosive growth places it in the bull’s-eye. Comlocations
plaints are not limited to high-tech products: Chinese products such as pet foods, insect traps, and
after all.
toothbrushes have been subject to ITC actions.
It is interesting that formal and legal complaints
are not the only route to market exclusion. Sometimes, patent holders can curtail infringing products in more subtle ways. Consider, for instance,
the case of the disappearing market for DVD players manufactured in China. In this well-publicized
example, more than 300 Chinese manufacturers
of DVD players exited the business after purchasing patterns shifted. Chinese manufacturers found
themselves essentially locked out of their largest
export market when a consortium of patent holders successfully pressured retailers in the United
States and Europe to purchase DVD players only
from manufacturers that held IP licenses.
Beyond the Great Wall
How is it that China, a “low-cost country,” found
that it could not produce competitively priced
DVD players? Manufacturers from other countries
were able to access the technology at a much lower
cost. Specifically, because those manufacturers
held patents that they could cross-license with the
members of the DVD consortium, their net licensing costs were lower. The surprising moral of this
story is that when all costs are considered, developing countries may not always be low-cost locations after all.
Across a wide range of products, the costs to access or license technology are consuming a growing share of the total cost of goods sold. For the
DVD players cited in the example, license fees represented 20 to 30 percent of production costs; the
percentages can be even higher in other technology sectors. Analysts estimate, for example, that
the total cost of IP licensing for third-generation
mobile handsets may be as high as 25 to 35 percent of the final selling price for those manufacturers that do not hold patents for 3G technologies.
Increasingly, corporations that lack an IP portfolio
will be relegated to low-end commodity markets.
Lost Profits. The outlay of large royalty payments
signals that a company or a country is in Phase
3 of the IP development process. Chinese companies are just beginning to foot the bill, but other
economies, such as South Korea and Japan, have
already experienced this phenomenon.
In 2005 South Korea made royalty payments of
about $4.5 billion on exports of about $250 billion. (See Exhibit 6, page 14.) Assuming an average profit margin of 10 percent of sales, we can
see that South Korea paid around 20 percent of
its total profits from exports as royalties to foreign
companies. Although this figure sounds extraordi-
13
nary, such high costs are common for countries in
Phase 3.
the nine defendants agreed to pay Texas Instruments more than $1 billion over five years. This
experience motivated many Japanese and South
Korean companies to advance to the next phase in
IP development.
Our analysis of several developing economies reveals that royalty payments typically peak at between 2 and 3 percent of revenues from export
sales. Assuming the same 10 percent profit margin
that we have calculated for South Korea, we can
see that developing countries pay up to 30 percent
of their total export profits to access foreign-owned
intellectual property.
Phase 4: Getting Serious About
Intellectual Property
If they want to move beyond Phase 3, developingmarket companies quickly realize that competing
successfully in world markets will require that
they dramatically enhance their IP position. The
question is, How?
The semiconductor industry provides a powerful
example of how companies in developing economies can escape this kind of IP checkmate. During
the 1980s, in a market flooded with lower-priced
chips from Japanese and South Korean manufacturers, U.S. manufacturers of DRAM chips struggled to make money. The pain was so great that
several U.S. manufacturers decided to exit the
market.
Like other U.S. chipmakers,
Texas Instruments struggled,
but unlike its peers, the company also held a trump card.
Texas Instruments owned several fundamental patents on
DRAM technology. Historically,
the company had used the IP
rights only passively, as barter
in cross-licensing deals.
Rather than abandon the market, Texas Instruments decided
to turn these patents into competitive weapons. The company
simultaneously sued nine Japanese and South Korean companies for patent infringement.
The legal assault was unprecedented in the semiconductor
industry, with the court battle
occurring against a backdrop
of political and diplomatic intrigue.
Eventually, the accused companies began to settle. Altogether,
14
It takes a long time to reverse an IP deficit. Leading technology companies have built their IP positions over decades and mastered the art of patent
filing, and it is not easy for stillExhibit 6: Companies in South Korea
emerging companies to overHave Already Seen Their Royalty
come the barrier to entry that
Payments Soar
legacy patents pose. Significant
investment and dogged perseRoyalty payments made by
South Korean companies
verance
are required to escape
1
($millions)
the
IP
trap.
5,000
Although we cannot provide
all the possible solutions in this
report, we highlight four critical levers that companies can
deploy to overcome their IP
deficits: partnering, acquiring
intellectual property, building a
focused IP portfolio, and playing the standard-setting game.
4,000
3,000
2,000
1,000
0
1980
1985
1990
1995
2000
2005
Sources: Bank of Korea; Economist Intelligence Unit CountryData;
BCG analysis.
1
Data for years prior to 1998 are estimated on the basis of derived
growth rates.
Partnering. Given the long
lead-time required to build a
powerful patent portfolio, a
quicker way to forestall market exclusion is to collaborate
with IP-rich corporations. This
approach holds down the costs
associated with gaining access
to technology, although it also
presents significant drawbacks
in other areas.
The U.S. National Science Foundation reports that
between 1985 and 2000, Japanese corporations
created more than 820 joint ventures with U.S.
companies in industries in which intellectual property was important—namely, information technology, biotechnology, new materials, aerospace
and defense, automotive, and chemicals. These
partnerships provided an IP shield that allowed
Japanese firms to compete successfully in markets
and technology domains from which they might
otherwise have been excluded.
Over the past decade, and increasingly over the
past five years, Chinese companies also have been
joining forces with non-Chinese companies in IPoriented joint ventures. To these relationships,
Chinese companies typically bring a low-cost labor
pool, manufacturing capabilities, and the promise
of access to the domestic Chinese market. Their
joint-venture partners typically bring technology,
intellectual property, investment capital, global
distribution channels, and management expertise.
Unfortunately, the junior members of many of
these partnerships run the risk that their IP-owning partners will capture most of the value. Consequently, IP-oriented partnerships are not a
long-term solution. Nonetheless, they can provide
significant short-term advantages and can put
companies on a path toward IP development. Ultimately, the success of a partnership depends on its
structure. As they negotiate a partnership, emerging Chinese companies should carefully consider
IP issues, among them:
•D
oes the joint venture own the intellectual
property, or is the partner merely providing a
license?
• Does the Chinese company have full access to the
technology contributed by its partner? Or, for example, does the partnership agreement severely
limit the use or application of the technology?
• Who owns the intellectual property created within the joint venture? Who has the right to license
the joint venture’s intellectual property or enforce its patents? What forms of redress does the
Chinese company have if the parties disagree?
Beyond the Great Wall
•W
hat IP rights does the Chinese company retain
if the joint venture dissolves?
Acquiring Intellectual Property. Frequently, acquiring an IP position is the fastest way to
build a portfolio. Remember those Japanese and
South Korean companies that were forced to pay
huge royalties to Texas Instruments for access
to semiconductor technology? There is more to
the story.
C
hinese
companies
also have
been joining
forces with
non-Chinese
companies
in IP-oriented
joint ventures.
Recognizing that Texas Instruments would want to
extend the initial five-year licenses, several of the
Japanese and South Korean licensees spent the five
years building up their own IP portfolios. Achieving IP parity within five years through internal patent filings alone would have been impossible, however, so the Asian competitors took advantage of
the sorry state of the U.S. DRAM industry to purchase struggling U.S. companies that held strong
intellectual property. When the time came to
renegotiate with Texas Instruments, the licensees
found themselves in a much stronger negotiating
position.
This strategy has not been limited to the DRAM
market. During their rise to IP sophistication, Japanese companies completed at least 450 acquisitions
of U.S. companies that held valuable intellectual
property, including more than 90 such acquisitions
in the semiconductor and semiconductor-manufacturing industries alone. Certainly, many factors
motivated Japanese companies to take these steps,
but IP considerations no doubt played an important part.
Other nations have learned this lesson, too. In a
recent study of Chinese outbound mergers and
acquisitions, The Boston Consulting Group found
that between 2000 and 2004, the companies in 13
RDEs consummated 776 acquisitions of companies
in developed countries.
It is interesting to note that nations such as India, South Africa, and Malaysia used this strategy
more aggressively than China. Although China
. China’s Global Challengers: The Strategic Implications of Chinese Outbound M&A, BCG report, May 2006.
15
liquid. Small “IP shops” eager to amass attractive
patent portfolios are forming. Public IP auctions
and merchant banks specializing in IP assets are
beginning to emerge.
represented almost 30 percent of the combined
GDP of all countries studied, it accounted for only
82 transactions—less than 11 percent of the total.
(See Exhibit 7.) Intellectual property played a significant role in a number of these deals, most notably the Lenovo Group’s acquisition of IBM’s PC
business and the acquisition of Thomson’s television division by the Chinese electronics player TCL
International Holdings. Both acquisitions not only
helped pave the way for significant global expansion but also dramatically shifted the IP landscape
in their markets.
These developments are helping an increasing
number of corporate players commercialize their
patents. Many universities and research-oriented
companies also engage in these sales, hoping to
maximize returns on their investments in innovation. Moreover, because a truly liquid market for
intellectual property does not yet exist, and because the same intellectual property holds different value for different buyers, Chinese companies
may be able to acquire desirable portfolios at attractive prices.
Not all IP-oriented acquisitions need to be large.
In fact, acquisitions of small technology-focused
companies with strong IP positions are becoming
more common. While it was once rare for companies to acquire IP assets—a patent portfolio, for
example—this market is becoming increasingly
The challenge for would-be acquirers is to identify
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
acquisitions
that companies
in RDEs made
in developed
countries
(2000–2004)
Chinese companies accounted for nearly one-third of the
GDP of RDEs in 2003 but only about one-tenth of RDEs’
foreign acquisitions in developed countries
250
200
201
169
150
100
88
82
65
50
56
25
0
India
Malaysia
South Africa
Russia
China
20
Brazil
Mexico
20
16
Turkey
Poland
14
11
Thailand
Hungary
9
Indonesia
Czech Republic
Percentage of
RDE GDP (2003)
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
Percentage of RDE
M&A transactions
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
Source: Thomson Financial.
Note: Because of rounding, percentages may not total 100.
16
and litigation risk in the U.S. market tend to be
higher than in many European countries, but so is
the reward. The U.S. economy is larger than any
European economy, and hence the revenue upside in the United States is greater.
ping the IP landscape in an industry onto the matrix highlighted in Exhibit 5. After this quick cut
has identified the most attractive players, deeper
analytical techniques can help determine exactly
which IP assets would be most effective in overcoming an IP deficit.
Historically, when companies in developing countries have gotten more serious about protecting
their intellectual property in export markets, they
have exponentially increased their patent filings
overseas. Samsung, one of the South Korean companies that settled with Texas Instruments when
the DRAM patents were litigated, serves as perhaps the best example.
Two types of acquisitions are possible. First, companies should acquire intellectual property to
protect their existing or soon-to-be-introduced
products. Second, they might want to consider
acquiring patents that competitors are most likely
to infringe. The latter assets could prove to be a
valuable trading commodity when competitors attempt to exclude emerging companies from key
markets or to constrain their profits through royalty payments.
Building a Focused IP Portfolio. The third critical lever for overcoming an IP deficit is achieved
by honing one’s own IP portfolio. This kind of targeted and mindful approach differs radically from
the more passive one many companies pursue.
Today many firms invest in R&D and file patent
applications on the basis of what inventors think
might be patentable. But the real key is to focus
on securing those patents that strategists know will
bring both access and differentiation.
Because securing global protection for intellectual
property is expensive, setting priorities is essential.
For emerging companies in developing countries,
the critical goal should be gaining affordable access to export markets by avoiding crippling royalty payments. Ownership of directly relevant intellectual property is important, but sophisticated
IP owners also seek patents in areas of their competitors’ vulnerability. They can use such patents
as leverage during negotiations.
To begin, companies must identify the competitors that represent the most significant threats and
then determine the specific technology domains
critical to those players. Holding a few key patents
can make a major difference when it comes time
to negotiate with these companies. Moreover, different markets represent varying levels of threat
and opportunity, and companies must invest accordingly. For instance, patent protection costs
Beyond the Great Wall
T
he real key
is to focus
on securing
those patents
that strategists
know will
bring both
access and
differentiation.
In addition to the settlement, Samsung has paid
billions of dollars in royalty payments to foreign IP
holders in recent years. Today, however, Samsung
is using all available levers to minimize royalty
payments and generate a higher return on its IP
investments. Patents provide one key measure of
this activity. In 1990 Samsung was granted only 60
U.S. patents, but by 2005, Samsung had become
the fifth most-prolific grantee, with 1,641 U.S. patents. In public statements, Samsung officials have
said that the company wants to attain a third-place
ranking by 2007. In contrast, no Chinese company
has broken into the top 100.
Playing the Standard-Setting Game. Although a
detailed examination of the highly complex ways
in which international standards for technology
are set transcends the scope of this report, no discussion of IP strategy would be complete without
at least a brief mention of the practice. Leading
companies excel at using the international standard-setting process to execute their IP strategy.
Through the standard-setting process, competitors
reach agreement about common interoperability
protocols. This ritual is rife with politics and intrigue, as industry competitors try to balance the
need for cooperation with their drive for advantage. In these complex multilateral negotiations,
companies’ power and influence depend on three
. In this report, we use the term international standards
to refer only to negotiated multilateral standards and not
to de facto standards created through consumer or user acceptance.
17
When it comes to setting an international standard, companies in RDEs have three choices. They
can adopt the dominant international standard
and make sizable royalty payments, as South
Korea did; attempt to influence the direction of the
international standard by relying on the strength
of either their market or a powerful ally; or create
their own domestic standard.
primary factors: the best technology, the strongest intellectual property, and the largest market share.
In terms of these factors, most companies from
developing economies are relatively weak, so standards are often set without their input. When a
developing economy adopts an international standard, therefore, companies in that country can
wind up paying hefty royalties to foreign competitors that hold patents essential to the standard.
If these companies don’t command a strong position in technology and intellectual property, however, their influence and ultimate success will be
severely limited in their pursuit of the latter options. All the strategies call for companies in developing economies to collaborate in varying degrees
with standard-setting activities supported by the
leading players. (See Exhibit 8.)
South Korea, the first country to adopt the Code Division Multiple Access (CDMA) standard for wireless telecommunications, provides a window into
this phenomenon. Because South Korean companies held virtually no relevant IP rights when the
CDMA standard was adopted, they found themselves having to pay billions of dollars to CDMA
patent holders.
Fortunately, China boasts a major advantage over
South Korea and most other nations: a large do-
Exhibit 8: Standard-Setting Strategies Should Vary Depending on Market, Technology,
and Other Factors
Description
Factors
Drawing strength
from the market
Working with a
powerful ally
Participating in
normal discussions on
setting a standard
Using the weight of
China’s market to set a
winning standard
Working with a partner
to build a Chinafavorable standard
Going it alone
Using Chinese
technology and IP to set
an alternate standard
Technology and IP
strength
• Strong technology
and IP are required
to exert significant
influence
• Strong technology
and IP are helpful
but may not be
necessary
• An ally with strong
technology and IP
may be able to help
secure favorable
treatment
• A strong technology and IP position
is required
Coordination of the
response from Chinese
companies
• Coordination among
Chinese companies
will increase
influence
• Coordination,
perhaps led by the
government, will
be necessary
• A coordinated
response will be
more likely to attract
potential allies
• A coordinated
effort by Chinese
players is more
likely to succeed
Fragmentation of
existing efforts in
setting a standard
• Fragmentation
affords Chinese
companies greater
influence
• Chinese influence
may be high
• Given fragmentation,
it may be easier to
attract an ally
• Strategy is likely to
work only if
existing efforts are
highly fragmented
Size of the relevant
market
• Large market size
affords China a
stronger voice
• If China’s market
is large, its
support may set
the winning
standard
• A large relevant
market is an
attractive lure for a
potential ally
• A large local
market is required
for a go-it-alone
effort to succeed
Collaboration with
dominant players
Source: BCG analysis.
18
Participating in
the normal process
High
Low
what Chinese companies can expect and hope for
in their future.
mestic market. Many companies want to sell goods
and services in China, and in some instances—for
example, in order to gain market access—they
may be willing to compromise and adopt standards that are more favorable to Chinese companies. Until Chinese companies can bolster their
positions in technology and intellectual property,
the size of their domestic market may be their best
bargaining chip.
South Korea, which of course started down the
IP development path more recently than Japan
did, is about to turn the corner and enter Phase
5. Several of South Korea’s leading companies, for
example, Samsung, have already made this transition, and they are now acquiring state-of-the-art
skills in IP management.
Phase 5: Profiting from
Intellectual Property
We highlighted South Korea’s rising royalty payments in Exhibit 6; it is equally important to
note that South Korea’s royalty proceeds are also
growing rapidly—an indicator of the country’s
progress. (See Exhibit 9.) In fact, the country’s royalty proceeds are growing so quickly that net royalty payments by South Korean companies are now
flat. If the current trends continue, we expect that
over the next several years, as these companies be-
Throughout this report, we have cited South Korea and Japan as examples of countries that are
making successful transitions from weakness to
strength in intellectual property. The current experiences of both of these countries exemplify
Exhibit 9: Companies in South Korea Are Beginning to Offset Royalty Payments
with Royalty Receipts
Payments
Royalty
payments and
receipts of
South Korean
companies
1
($millions)
Receipts
Net royalty payments
5,000
4,000
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 difference between net royalties and the derived royalty receipts.
Beyond the Great Wall
19
ent of royalty payments for the first time. (See Exhibit 10.)
come sophisticated managers of intellectual property, they will see their net royalty payments begin
to decline.
Historically, Japanese companies have been reluctant to use their intellectual property in aggressive ways or as a competitive weapon. Today that
reluctance has begun to wane. Over the last two
years, for example, the number of patent-related
suits filed by Japanese companies has doubled.
Although Japan’s new attitude about intellectual
property elicits immediate concern among Chinese and other companies around the world, it
also should inspire hope. Japan’s shift proves that
countries and companies can make progress in IP
development. Certainly, Japan could not afford to
take its new stance if companies there had not invested significantly to secure greater international
IP protection over the past two decades.
Farther down the path, Japan has already begun
to benefit from its long and patient investments
in intellectual property, making it an even more
powerful exemplar of the type of opportunities
that lie ahead for Chinese companies. Today, Japanese companies hold 40 percent of the world’s
patents—more than any other country. Although
Japanese patenting practices skew that percentage
upward, the measure nonetheless highlights the
remarkable turnaround that can be achieved by
a country determined to turn intellectual property
into strength. In 2003 Japan became a net recipi. Japanese patent laws—which limit the number of claims
that can be filed under one patent—and the patent-filing
practices of Japanese companies result in a large number of
typically narrow patents.
Exhibit 10: Japanese Companies Have Made the Leap from Paying High Royalty Fees
to Collecting Them
Payments
Royalty
payments
and receipts
for Japanese
companies
(�billions)
Receipts
Net royalty payments
1,500
2003 marked Japan’s first year with
positive cash flow from royalties
1,200
900
600
300
0
300
600
900
1,200
1,500
1960
Sources: Bank of Japan; BCG analysis.
20
1965
1970
1975
1980
1985
1990
1995
2000
Closing the IP Gap
T
he path through IP development will
be long for China as a nation, but
that’s not necessarily the case for leading Chinese companies. Each Chinese
company can set its own pace and
milestones for moving through the IP development process.
Through targeted acquisitions, increased patent
filings, and an emphasis on IP management, some
leading Chinese companies are already beginning
to accelerate their IP development. Pioneers in
China, these players are following a trail blazed by
others, and their knowledge of history is helping
them shape a more competitive future.
We encourage all Chinese players to examine and
embrace these time-tested approaches. By developing world-class IP management skills, they can
move beyond the Great Wall to compete successfully in the global marketplace.
For Chinese companies that want to move aggressively in developing their intellectual property, we
provide a checklist of the steps to consider.
Map your IP position and that of international
competitors in your key technologies and markets.
•H
ow vulnerable are you to financial or marketplace penalties?
•W
hich competitors could most easily expose your
IP vulnerabilities?
Learn how leading international companies manage their intellectual property.
•H
ow do leading companies in your industry manage intellectual property?
• How do leading companies in other sectors organize, prioritize, and manage their intellectual
property?
Develop a plan for turning intellectual property
from a weakness into a strength.
•H
ow can you develop an IP strategy that is closely linked with your corporate strategy?
•C
an you build a world-class IP organization?
Determine your company’s position within the
five phases of IP development.
• How important are exports for the success of
your business?
•C
an you articulate all your IP vulnerabilities
and risks?
• Are your exported products high- or low-tech?
• Can you evaluate and execute partnership and
acquisition opportunities in order to change your
position?
• Are you appropriately balancing your investment
in IP protection with your investment in R&D?
•W
here can you invest to secure international protection for your intellectual property?
• How strong is your IP position relative to that of
your international competitors?
Beyond the Great Wall
21
For Further Reading
The Boston Consulting Group has
published other reports and articles on
global expansion, intellectual property,
and related areas. Recent examples
include:
Looking Eastward: Tapping China
and India to Reinvigorate the Global
Biopharmaceutical Industry
A report by The Boston Consulting Group,
August 2006
China’s Global Challengers: The
Strategic Implications of Chinese
Outbound M&A
A report by The Boston Consulting Group,
May 2006
The New Global Challengers: How
100 Top Companies from Rapidly
Developing Economies Are Changing
the World
A report by The Boston Consulting Group,
May 2006
Organizing for Global Advantage
in China, India, and Other Rapidly
Developing Economies
A report by The Boston Consulting Group,
March 2006
A Game Plan for China: Rising to
the Productivity Challenge in
Biopharma R&D
A Focus by The Boston Consulting Group,
December 2005
“Spurring Innovation Productivity”
Opportunities for Action in Industrial
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
“Globalizing R&D: Building a Pathway
to Profits”
Opportunities for Action in Operations,
May 2005
“Globalizing R&D: Knocking Down the
Barriers”
Opportunities for Action in Operations,
May 2005
Navigating the Five Currents of
Globalization: How Leading Companies
Are Capturing Global Advantage
A Focus by The Boston Consulting Group,
January 2005
Facing the China Challenge: Using
an Intellectual Property Strategy to
Capture Global Advantage
A report by The Boston Consulting Group,
September 2004
Capturing Global Advantage: How
Leading Industrial Companies Are
Transforming Their Industries by
Sourcing and Selling in China, India,
and Other Low-Cost Countries
A report by The Boston Consulting Group,
April 2004
“What Is Globalization Doing to Your
Business?”
Opportunities for Action in Industrial
Goods, February 2004
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 at
www.bcg.com/subscribe.
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