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Succinct "ground truth" on supplier entry and operation in China

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Refreshingly succinct "ground truth" for supplier entry to, and operation within, China was provided by a co-presenter, Charles Freeman of China Alliance, at a recent conference on automotive supplier investment in China.

His observations are pertinent to any firm envisioning entry into China or continuing its operations there. We second his comments on risks to supplier Intellectual Property (IP). Remediation of those risks are the focus of our IP protection efforts. Freeman commenced his points with the "three 'knows'":

1. Know the context. Laws are only one factor in understanding a Chinese landscape.

The Chinese treat law as a thing in flux.  It is important to note that there are no penalties in Chinese law. Law is more of a guide than a set of specifics such that an agreement is a mere starting point of a relationship. "China is a culture of shame not guilt" such that it is more critical to be caught than to feel remorse.

2. Know who you're dealing with.

It is essential to understand with whom you're dealing and not attempt to impute more to the relationship than is warranted. The Chinese prize stability over intimacy or friendship. You may be friendly, forming a working relationship, but don't make unwarranted assumptions of the reach of your presumed friendship.

3. Know what your supplier wants from the transaction.

Your view of sustainability and viability may not be what they want. Do not presume that your opposite wants what you want. The Chinese love us because we say too much; learn to practice silence. You have a far higher bar to climb in learning what your opposite prizes than the reverse.

4. Don't believe everything you hear.

Businesses will often tell you "yes," while government will often tell you "no." Neither is likely true. Take what you hear as a position, an opinion, without reaction on your part. Keep working the issue; firmer positions will emerge from which you can make advantage or avoid a fault.

5. Maintain your attitude.

Have a backbone; you're not a supplicant. The best that you can expect is mutual respect. Work for it. They can lie, but you can't. Do not confront if you're lied to.

6. Beware divide and conquer.

The Chinese are good at divide and conquer, often threatening that another firm or competitor will grant the terms that the Chinese request.

7. Chinese will hit you up for your technology.

Chinese are generally scored for the investment that they attract and/or the technology that they attract. Assume that your technology will be stolen at some time. Forget attempting to try an IP case in China. You won't have any better results back home as many US courts find IP cases far too complex.

8. The value of maintaining government relations.

Build government relations into your Chinese plans from the onset. Government relations contribute directly to your bottom line, either heading off or managing government relations. Don't let your joint venture partner, even if they are the larger partner, handle this for you. Relationships can unravel and you could be left without a viable working relationship.

9. The primacy of hiring your HR manager.

The HR manager is a prime hire that ranks with your most senior Chinese hires. All future Chinese hires will owe him their job.

10. Stay active, stay involved.

Things change rapidly in China. China is not a place that you can manage at arm's length or fail to be constantly attentive in changing commercial and governmental conditions.

Gordon Housworth


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Low cost is not low risk: Realistic IP Protection in China, 21 September , 2006

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Presentation given at GlobalAutoIndustry conference, "Key Strategies for Succeeding in China’s Booming Auto Industry," 21 September, 2006, Troy, Michigan, in PDF:


Low cost is not low risk: Realistic IP Protection in China,
21 Sept, 2006

Underpinning this presentation is ICG's Intellectual Property (IP) Protection Abstracts from April 2004 to July 2006. Click 'more' at the bottom of any abstract to jump to the full weblog article.

If you need IP support for either Greenfield or Brownfield installations, or supply chains combining your facilities and assets as well as your suppliers, please send feedback inquiry.

Gordon Housworth


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Snippets of IP theft close to home

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Martial extended the word for slave theft, plagium, to cover literary theft and was in turn plagiarized by others:

Plagiarism was so common in the churches by the time of King James that he had to order that at least one sermon a month be original. When, eventually, the practice was officially condemned, the practitioners merely aggravated the sin with an alloy of hypocrisy

Plagiarism remains with us in all disciplines; what was once a collegially understood, if annoying, appropriation has now taken on a fully fledged autonomous claim of original ownership. Kierkegaard has taken the next step in proclaiming "an entirely new art form: 'Plagiography' (and, for those who cannot do but merely desire to preach, its sister-muse, the detective science of 'Plagiology')."

The commercial world is always on the edge of plagiarism in its quest for new product:

Intellectual property is sacrosanct, but only to a certain degree [as] most car manufacturers would likely argue that the unique appearance of their car, such as the shape of the grille, is significant, and so if someone copies it that can become an issue of "trade dress" infringement, because the appearance of the product is something protected by trademark. "Generally, you can’t win unless the consumer is confused by what they see, so if you recognize a car is a Lexus and think it looks like a Mercedes, generally that’s not enough."

Part of the purpose of this note is to document the outright plagiarism of an article on mine so that the party may be identified and hopefully mend its ways. It does not rise to the level of 10 Downing Street plagerizing the work of Ibrahim al-Marashi on Iraqi security services in its Iraq - Its Infrastructure of Concealment, Deception and Intimidation, but it annoys me that they made not the slightest effort to change the text block while going on to offer a workshop that would purport to implement my intent.

That the firm is UK based and my US article is aging in web terms, 1997, are typical in cases of plagiarism where the plagiarist presumes that time and distance will make none the wiser. While I take the opportunity to whack the miscreant, I would like to take the opportunity to bring forward an idea originally floated by Michael Schrage, now at the MIT Media Lab's E-Markets Initiative, that of making "a service-flavored product or a product-spiced service" which he called serducts and provices.

Schrage got quite a lot of press at the time on the useful idea that you were in trouble if you thought that you were solely in the product or the service business, and conversely, that you could make new and niche products at low cost and relatively rapid turnaround times. I used the process in adapting US goods and services to Asian markets. It seemed that serduct had longer legs than provice, but then both began to drop out of currency but they shouldn't. I recommend commercial readers to look to his original 1996 article.

I mentioned the serduct in a 1997 Competitive Advantage article, The fall and rise of service in the 20th Century in this section:

"Serduct" - the merger of service + product

Buyers view their purchase event through one of three lenses:

  • Purchase as best price
  • Purchase as service
  • Purchase as theater

Service plays an essential role in all three purchases.

In purchase as best price, the service component must be extremely efficient and nearly invisible. In purchase as service, the care and pampering of the buyer is the defining component of the "product" because the buyer could have purchased it elsewhere for less but opted for the intangibles of service. In purchase as theater, the service component expands to include the overall event and the environment of the sale. The story that the buyer will tell, and retell, to others about the purchase becomes an integral part of the product.

Transcending the transaction - moving beyond the individual purchase

Most traditional businesses require some 50 to 60% repeat buyers to sufficiently lower the cost of sale for new buyers. If the percentage of new buyers rises significantly above 40 to 50%, the firm will suffer for operating cash and generally will see sales revenue stretch unacceptably beyond forecast.

Most firms find themselves in a Catch-22 position as they've neither the money nor the processes to build sufficient new sales by traditional means. Winning firms are breaking the mold by forming a relationship with their customers - a relationship that costs more in the short term but delivers long-term buyers that influence other potential buyers in their circle of acquaintances.

The essential element is building an inalienable trust between the buyer and seller. This trust can be built with a variety of tools, but some essentials emerge:

  • Give the buyer a pleasant and trusting experience.
  • Institutionalize a personal "culture of passion" among employees.
  • Get far in front of the purchase and well after it. Develop birth to grave buyers.
  • Put aside the traditional, adversarial relationship for a win-win.
  • Minimize employee turnover (and consequential training).
  • Create measurement standards and reasonable accountability.

This trusting bond created between buyer and seller permits seller to extend his/her franchise to a family of services and products for their customers.

Here is Vision 3000 & Associates' "Serduct" - the merger of service + product:

Buyers view their purchase event through one of three lenses:

  • Purchase as best price
  • Purchase as service
  • Purchase as theater

Service plays an essential role in all three purchases.
In purchase as best price, the service component must be extremely efficient and nearly invisible. In purchase as service, the care and pampering of the buyer is the defining component of the "product" because the buyer could have purchased it elsewhere for less but opted for the intangibles of service. In purchase as theater, the service component expands to include the overall event and the environment of the sale. The story that the buyer will tell, and retell, to others about the purchase becomes an integral part of the product.

Transcending the transaction - moving beyond the individual purchase
Most traditional businesses require some 50 to 60% repeat buyers to sufficiently lower the cost of sale for new buyers. If the percentage of new buyers rises significantly above 40 to 50%, the firm will suffer for operating cash and generally will see sales revenue stretch unacceptably beyond forecast.
Most firms find themselves in a Catch-22 position, as they've neither the money nor the processes to build sufficient new sales by traditional means. Winning firms are breaking the mold by forming a relationship with their customers - a relationship that costs more in the short term but delivers long-term buyers that influence other potential buyers in their circle of acquaintances.

The essential element is building an inalienable trust between the buyer and seller. This trust can be built with a variety of tools, but some essentials emerge:

  • Give the buyer a pleasant and trusting experience.
  • Institutionalize a personal "culture of passion" among employees.
  •  Get far in front of the purchase and well after it. Develop birth to grave buyers.
  • Put aside the traditional, adversarial relationship for a win-win.
  • Minimize employee turnover (and consequential training).
  • Create measurement standards and reasonable accountability.

Short of a few bits of clumsy punctuation, there is not the slightest chance of accident, of denial of provenance. The buggers didn't even change the "+" sign. 10 Downing Street did better than that. Vision 3000's impact of me was much the same as that of the UK dossier on Iraq. Despite whatever skills that they might otherwise have, it called into question their honesty, veracity and intelligence overall.

Are copycat cars a sincere form of flattery?
Automakers ‘borrow’ successful vehicle styling, outflank their rivals
By Roland Jones
MSNBC
Updated: 5:14 p.m. ET May 23, 2006

The plagiarism plague
BBC News
Friday, 7 February, 2003, 13:18 GMT

Iraq dossier 'solid' - Downing Street
BBC News
Friday, 7 February, 2003, 13:14 GMT

A piece of plagiarism?
BBC News
7 February, 2003, 11:11 GMT
Here are some examples of similarities between the government dossier and the work of Ibrahim al-Marashi.

Iraq - Its Infrastructure of Concealment, Deception and Intimidation
Prime Minister
10 Downing Street
January 2003
PDF

IRAQ'S SECURITY AND INTELLIGENCE NETWORK: A GUIDE AND ANALYSIS
By Ibrahim al-Marashi
MERIA Journal
Volume 6, No. 3 - September 2002

The fall and rise of service in the 20th Century
Gordon Housworth
Intellectual Capital Group LLC
Copyright 1997 Intellectual Capital Group
Published in Competitive Advantage
American Society for Quality Services journal, 1997

Provices and Serducts
If you think you're either in the product or the service business, you're probably in trouble. Learn to wrap a service around your product or to 'productize' your service.
By Michael Schrage
Fast Company
Issue 04, page 48, August 1996

The Honest Man's Guide to Plagiarism
JOHN GREENWAY
NATIONAL REVIEW
DECEMBER 21, 1979
Mirror

Gordon Housworth



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The second industrialization model - powered by IP harvesting

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"Piracy" has become a very imprecise term in describing the risks and impacts to Intellectual Property (IP) in what we call the second industrialization model. We track a four tiered model of IP violation that is marking the progression of newly industrializing states:

  1. Simple piracy (copy with no effort to hide piracy - the audio/video model that applies to anything replicable from CD and DVD)
  2. "Badged" substitute (pirated or stolen Intellectual Property used to create a product masquerading as a legitimate offering by a legitimate supplier)
  3. Substitute product (pirated or stolen Intellectual Property used to create a "no name" or "new name" product competing with a legitimate offering, usually on price)
  4. Supplier substitution (original legitimate supplier is forced from the market, replaced by the copier)

While all four are IP theft, we have bowed to convention in the popular press to describe the first as piracy while reserving the other three as IP theft, especially as the theft is masked such that the sellers have distanced themselves from the theft.

As a heretofore internal working term, we call this the second industrialization model, the first being textile manufacturing. Although the French perfected large textile looms, their output was craftwork for a limited clientele. It was left to the English to turn looming into a mass production affair. The US purchased old, discarded looms, copying them down to their eccentrically worn bobbins to commence the colonial industrialization. Nation after nation subsequently followed suit for well over one hundred and fifty years.

We see the codification of a new industrial model in the postwar period based upon "commercial on commercial" Intellectual Property (IP) attack. While the earlier "military on military" or state on state espionage remains vibrant, a significant focus has shifted to advancing dual use technologies which bring both military advantage and domestic commercial industrialization.

Within this model, nations in a position of strength, specifically in innovation - part of which is acquired without royally, normally do not want IP protection laws as they are either independently innovating, thereby able to sell at a premium; producing more efficiently, thereby driving down costs over competitors; or imbedding surreptitiously acquired IP and thereby terminating the revenue streams of competitors. Nations tend to seek or support IP protection laws when they are in decline by some combination of an ebbing of innovation, emergence of lower cost producers, or new producers harvesting their IP and ending expected revenue streams.

The postwar Japanese model tracked this progression and is only now promoting IP protection laws in the face of Korean and Chinese successes in former Japanese core industries. The Chinese are expected to accelerate the model significantly. The downside for firms and industries affected is that China (and I started my commercial visits in 1980) is unique among developing nations in having a "first world" mentality even as it had a "third world" industrial capacity, i.e., from its "reopening" in the 1970s, it closed off industrial penetration and investment that it did not like (which most other industrializing nations could not or would not do) as it turned a benign eye on virtually any domestic industrial effort that nurtured growth, revenue and industrialization. How it achieved the IP required to do that was never questioned.

As is widely known among skilled China watchers, edicts on IP infractions, or anything else, often rarely leave Beijing as provincial, city and enterprise zone mangers do largely as they wish and are tolerated so long as they bring growth and revenue without significant embarrassment to the Party (CCP).

Firms that do not understand this landscape and industrial progression are ripe for IP harvesting. Moreover, legal remedies are largely ineffectual and the rewards moot as the IP is already lost and all expected downstream revenue is attenuated. Readers may wish to examine Low cost is not low risk: realities of IP Loss for realities on the ground.

Next step in pirating: Faking a company
By David Lague
International Herald Tribune
APRIL 28, 2006

FBI Sees Big Threat from Chinese Spies; Businesses Wonder
Bureau adds manpower, builds technology-theft cases
Jay Solomon
Wall Street Journal
12 August 2005
Mirror

Manufaketure
By TED C. FISHMAN
New York Times
January 9, 2005
Fee archive
Html miror
PDF mirror

"The China Price"
Business Week SPECIAL REPORT
DECEMBER 6, 2004

Why China Is Making The Valley Fret
U.S. chipmakers worry that a new Wi-Fi standard puts their businesses at risk
By Cliff Edwards, in San Mateo, Calif., with Jim Kerstetter in San Francisco, Bruce Einhorn in Hong Kong, and Paul Magnusson in Washington
Business Week
MARCH 29, 2004

Car-Parts Piracy Has Auto Makers Spinning Their Wheels
By MURRAY HIEBERT
WALL STREET JOURNAL
February 26, 2004

The grille looks familiar …
Western automakers are torn between the lure of the world's fast-growing market and the dismay of seeing their intellectual property 'borrowed' by the Chinese
By Tim Querengesser
The Ottawa Citizen
May 07, 2004
May have scrolled off
Mirror minus the images

Intellectual Property Rights in China: Face it or Face off
China High Tech PR (ChinaHighTechPR.com) monthly newsletter
The Hoffman Agency
December, 2003

Nissan ponders piracy suit vs China's Great Wall
Reuters/Forbes
Nov 28, 2003

Master of Innovation?
China aims to close its technology gap with Korea and Japan
By Bruce Einhorn in Shenzhen
Business Week
APRIL 14, 2003

When Spies Look Out For the Almighty Buck
By DAVID E. SANGER
New York Times
October 22, 1995

Gordon Housworth



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Double edged sword of optimizing China-based and US/EU-based supply chains

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Bleeding our China-monitoring interests over to logistics, I highly recommend two articles by George Stalk at BCG on the trade-offs between China-based and North American-based supply chains. The first is the HTML article from Supply Chain Management Review, Surviving the China Riptide, and the more developed PDF article from BCG, The China Rip Tide: Threat or Opportunity?

Stalk portrays the scope of the problem in trying to improve China-based chains as reaching epidemic proportions (Quotes below are from the HTML version):

[The] surface freight situation in North America and Europe is seriously challenged. Backlogs at ports and on railroads are at all-time highs. With freight volumes increasing faster than the ports can handle them, the situation will only worsen. Some Asian ships are too big to go through the Panama Canal to less busy ports on the Atlantic coast. Even some of those that can fit through the canal must offload and reload containers to meet the canal's pilot-visibility rules. The offloaded containers are sent by rail across the isthmus to be reloaded on the other side, adding even more transit time. And while shifting to East Coast ports might improve the predictability of shipping times, it certainly won't shorten them. Because of the problems on the North American West Coast and in Europe, the cycle times of the China supply chains are going up, not down... The cycle times of surface shipments (from China to Chicago, for example) are not only increasing - they are also becoming more variable. About 50 percent of the containers at one shipping company are offloaded within two weeks of their scheduled dates, and these are considered to be on time. The other 50 percent are even less predictable!

George was working on what became time-based competition (TBC) in the mid 80s, and released his seminal Time-The Next Source of Competitive Advantage in 1988. I had the opportunity to design integrated marketing and development programs around TBC as did a colleague at DEC. We can testify that TBC works. It's my opinion that Stalk has long had a subtle feel for the impact of timing and bullwhip effects, and it is evident here.

I submit that the 'Riptide pair' form the kernel of a "graduate survey course" for commercial supply chain and logistics managers. For those with chains in place, remedial protective measures are in order; for those designing chains, these mechanics should be factored into sourcing/siting decisions. Some of this has been known at the grassroots level, for example, while smaller part production left Mexico for Asia, assembly of "things larger than a breadbasket" stayed put. That feature will multiply if Ford goes ahead with leaked plans to site a new assembly plan in Mexico. (I admit to wondering if it was not leaked intentionally. The leak, if it was one, softened what could be an implied threat to nationalistic voters in the upcoming July Mexican presidential election as well as advising the UAW to 'roll over and play dead' in terms of its labor negotiations with the OEM.)

In their rush to source from China, many companies are blindly walking into a strategic trap. The trap is thinking that sourcing from China will result in lower product costs when, in reality, the supply chain dynamics will drive up overall costs and reduce profitability - thereby creating an opening for a competitor. Their only salvation is if all their competitors make the same mistake... The first company to see and correct the strategic error of sourcing from China without an appropriate investment in supply chain dynamics to minimize costs will seal the fate of its competitors.

There are many traps in going to China; the one that concerns us is Intellectual Property (IP) loss now at a hemorrhage level; in the automotive sector, the OEMs are comissive in stampeding their Tier Base to China based purely on piece part cost, a shortsighted practice that will come back to haunt both OEM and supplier. For those chains that can be retained here, the supply base has the opportunity - but not the guarantee (as an asset is at risk wherever it appears at any tier in the global supply chain) - of less predation upon strategic IP.

SwizStick at Third Paty Logistics captures Stalk's double edged sword, i.e., that US/EU suppliers can and should reoptimize their chains on total cost but that Chinese firms can again win the advantage by optimizing their chains with a built-in lower Unit Product Cost (UPC):

[Stalk analyzes] the hidden costs of a product that arise from fluctuations and challenges in the supply chain. His analysis is very technical and lengthy but is an excellent example of how companies who optimize their supply chain, integrating information flows and cutting cycle times, will have the advantage over their competitors. What I found extremely interesting and illuminating was the results of the analysis comparing a domestic supply chain to a China-based supply chain, clearly illustrating that a domestic supply chain that could optimize their information flows and cycle times would have a substantial operating margin advantage over the China-based supply chain. The author readily concedes that "...the competitive dynamic might continue with the China-based chain becoming integrated and also cutting its cycle time in half. In that case, the advantage returns to the China-based chain because of its lower UPC."

In a similar vein, Brian Sommer stated that Stalk had illuminated:

the true costs of using local, global and a mix of suppliers. The article takes the reader through a series of cost analyses assuming different combinations of US or China manufacturers and whether they possess non-integrated, semi-integrated or fully integrated supply chains. Stalk's analysis helps to understand why some firms:

  • move/keep much of their sourcing in-country
  • develop their own transportation solutions
  • rethink how much of each part should be made by country location
  • why some firms are re-routing offshore shipments to different, less congested ports
  • etc.

But more important, Stalk's analysis is great at understanding how Chinese firms may try to enter and win in the US market. His suggestions for US manufacturers/assemblers on how to win this competitive battle are a must read.

US/EU firms should investigate the implications of Stalk's analysis in concert with a realistic assessment of the financial impact of lost IP. The combination of the two would significantly modify existing supply chains. The institution of actionable and effective IP retention processes would then offer the suppliers

Rather than blindly bringing chains home or adding capacity to as yet uncongested ports, Stalk recommends that firms "need to be very aggressive in managing their China-based supply chains, looking for ways to squeeze time from them that competitors haven't identified. For companies that haven't yet sourced from China, [Stalk recommends] the following steps":

  • Reduce minimum-production-order quantities and reduce cycle times as quickly and as much as possible.
  • Don't source or manufacture in China until management fully understands the dynamics of the supply chains.
  • Create an integrated or a semi-integrated information flow within the company's existing supply chain.
  • Conduct in-depth examinations of buying practices and supplier relationships management at all levels of the supply chain. Then identify and prevent potential hidden costs.
  • Segment the demand chain on the basis of order predictability and demand volatility so that components with the highest gross margins and the most volatile demand get the fastest handling.
  • If a company does decide to source from or manufacture in China, it should explore alternatives that will minimize adverse supply chain effects. These alternatives may include options that appear costly but actually result in overall lower costs. For example:

  • Using air freight for products with the highest margins and volatility.
  • Insisting on point-to-point ocean shipping. To reduce costs, shipping companies build larger and larger container carriers, which must then be scheduled to call on multiple ports. Shipping products on a vessel that has your destination as its last port of call can add weeks - and great variability - to transit times.
  • Developing better relationships with transportation providers. This could mean paying the shipping company for preferential treatment. In "hot hatching," for example, you offer a premium to a shipping company that will load your goods onto its vessel last and unload them first. Another option is to work with the few shipping companies able to offload containers directly onto rail cars that are then expressed east - cutting days and sometimes weeks out of the supply chain.

Add IP risk mediation to this mix and firms operating in, or contemplating operations in, China would be well served; firms performing competitive analysis of potential Chinese competitors would have a new calculus for designing a competitive response.

Recommended read. While China is an especially difficult example of supply chain constraint, these guidelines can be generalized to any global supply chain.

"Surviving the China riptide."
by SwizStick @ 4:46 pm.
Third Paty Logistics
June 15, 2006

Ford to invest billions in Mexico: report
Reuters
June 14, 2006 01:17 PM ET

The China Riptide / Risky Supply Chains
Brian Sommer
Spend Matters
Posted At : June 6, 2006 1:13 PM

The China Rip Tide: Threat or Opportunity?
Profiting from the Growing Supply-Chain Bottleneck
By George Stalk Jr. and Kevin Waddell
Boston Consulting Group
June 2006

Surviving the China Riptide
By George Stalk Jr.
Supply Chain Management Review
May 1, 2006

The 10 Lives of George Stalk
By Jennifer Reingold
Fast Company
Issue 91, February 2005

It Is The Relative Speed That Counts
Roshni Jayakar
Interview with George Stalk
Business Today
July 1999

Time-The Next Source of Competitive Advantage
George Stalk, Jr
Harvard Business Review
66, July-August 1988
Full text mirror
HBR purchase link

Gordon Housworth



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Physicians, heal thyselves: The Big Four accountancies are setting up as targets for Intellectual Property (IP) theft

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If the Big Four are, as I believe, headed in the direction of becoming a lost cause, what is a corporate SEC-regulated IP-dependent client to do in the age of Sarbanes Oxley? Even when clients are independently building up a credible IP protection program, where do you draw the line on Big Four access to the IP upon which future revenue depends? There may be a remarkable opportunity for second tier accountancies not yet compromised, such as an IP-focused exposure or assessment program (which implies that they will per force have to have their own means of protection in place). With all of that in place, however, they could go in and assess Big Four clients, establish IP-driven carve-outs for business critical valuations and position themselves in a new market space. Even knowing what has been compromised, although painful for boards to face, can staunch an IP hemorrhage as well as evolve into a tool for the allocation of suitably-valued IP protective measures.

RSM McGladrey, Grant Thornton, and BDO Seidman, this is your moment. Where in the market are you?

Previous: Persistent limitations and deficiencies among the 'guardian class' of business advisors charged with protecting their clients' interests in China

And he said unto them, Ye will surely say unto me this proverb, Physician, heal thyself: whatsoever we have heard done in Capernaum, do also here in thy country. Luke 4.23

What was good for a small walled village in ancient Galilee, not to mention for Euripides, Aeschylus, Homer and Ovid, is good for businesses today, especially those who aspire to shepherd businesses for clients.

We predict that the Big Four accountancies, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG are now, and will continue to be, sustained targets for Intellectual Property (IP) harvesting by Chinese aspirants to this coveted market space - and they will be targets not just within the confines of China.

If a reader is taken aback, the questions he or she might ask are, "How can it not be?" "How could the highly profitable, strategic services sector be impervious to what is occurring in the manufacturing and R&D sectors?" By now, a client should be asking, "What happens to all the client data above and beyond the business processes of a Big Four member?" We suspect not.

The realization crystallized as three items crossed our desks, two from the FT's Barney Jopson, China to promote rivals to ‘big four’ and Big four firms plan boost to China staff, and China Business Services flagging the former FT item along with circulating an anti-monopoly draft, Draft Anti-Monopoly Law Approved. Frankly, we should have seen it sooner but coming on the heels of a renewed investigation of Intellectual Property (IP) threats, the implications leapt off the page.

Having previously discussed the difficulties that firms such as management consultancies and accountancies have in preventing IP loss under the best of circumstances, we then dug deeper into their lack of actionable processes for IP protective measures for their clients. I remembered earlier comments by partners at these firms over the near impossibility of rolling out a uniform policy to each office and partner. (The subject was not IP, just the generic process of gaining partner-wide agreement to promulgate a process, design it, approve it and test for compliance across a dispersed network.)

I realized that a historical advantage that many of these decentralized firms in what we may call the "guardian community" becomes a disadvantage in exercising a commitment to a global process rollout and, in fact, leaves them in a far worse condition than their commercial clients who have a more conventional hierarchical structure. Many accountancies, management services firms and multinational professional firms employ a Swiss Verein (or association) model of organization through which independent offices have limited liability in relation to the others. An advantage of the Verein structure is that local offices are "only bound by regulators in their country" and so have great sway over the practices that they elect to employ. Add to that the undeniable profit motive of each office to do 'what sells,' and you have a tenuous ability to roll out a globally effective IP protection plan.

I believe that the Chinese perceive finance and accounting as a strategic asset, at least on par with, say, automotive manufacturing. Just as in automotive, China is "determined also to promote the development of powerful domestic companies in strategic industries, ranging from manufacturing to finance, telling the local champions they should seek to "go global" as soon as they are strong enough."

The Big Four have commenced what amounts to unofficial, uncontrolled joint ventures with the Chinese state. The experience of US and EU automotive OEMs that pursued a far more controlled JV path is well known:

The big four have sought to curry favor with officials by providing consulting and training, and seconding people to bodies such as the finance ministry and the China Securities Regulatory Commission.

Just as in the automotive JVs, these de facto strategic advisory JVs will see virtually everything in the Big Four's inventory voluntarily surrendered without accountability. This is an Intellectual Property nightmare that will only be perceived after the damage is done. Given this state of affairs, I would as a Big Four client have to consider everything transferred to China, or made accessible in China, as compromised.

Substitute electronics, sensors, chip design, automotive and aircraft production for pharmaceuticals and accounting, then consider the following:

  • The big four "are proceeding with ambitious expansion plans in China" boosting "their staff in China by more than 20 pct this year" in the face of "official discomfort over the fact that China’s biggest companies depend on the services of foreign accountants to raise capital
  • The Chinese state is encouraging the rise of ‘national champions’ in accounting "to reduce the country’s reliance on the big four international firms that monopolise the auditing of Chinese companies listed overseas"
  • Domestic Chinese accounting firms "resent the kudos and influence" of the Big Four and service what amounts to financial table scraps of the listed Hong Kong firms
  • The Ministry of Finance has begun to "call for consolidation among China’s 5,600-odd accounting firms"
  • The Ministry of Finance has called for several national champions "able to prepare and certify accounts for such large flotations" as the IPO of Bank of China (BOC), which incidentally is now audited by PricewaterhouseCoopers

In Persistent limitations and deficiencies, I noted that "firms driven offshore in [a] "flight condition" are generally destabilized, plunged into a "catch-up mode" at any cost" and tend to be irrationally hopeful about, or at least inattentive, to their exposure to IP collection efforts. "They usually quickly become an easily harvestable asset." The "frantic China hirings" by the Big Four and the go-go atmosphere, problems with corruption notwithstanding, create just such an opened condition where the only focus is market position and profit. In such an environment, active collection efforts will not be noticed.

We depart from Jopson over comments that simply do not stand given Chinese practice and performance to date in other industries:

But the chances of a credible big-four rival emerging from present-day China look remote, as the country lacks experience of international disclosure requirements, accounting rules and audit procedures… the government would not give domestic firms "special privileges or preferential treatment" and stressed it was up to companies to decide which auditors they hired. Lack of direct government support could make it more difficult for local accounting firms to compete internationally.

Christopher Cassidy's Chinese Law: Smoke and Mirrors and Dan Harris' Chinese Law: Smoke And Mirrors And Who Really Wields The Influence. are far closer to reality on the ground. Reading them is recommended. Cassidy also noted that the "vice director of the Institute of Intellectual Property Law at China University of Politics and Law [could only point] to the pragmatism of Party leaders as the driving force behind what he hopes will be an effective system for IPR protection." That is not my definition of a transparent, legal framework for IP protection.

If the Big Four are, as I believe, headed in the direction of becoming a lost cause, what is a corporate SEC-regulated IP-dependent client to do in the age of Sarbanes Oxley? Even when clients are independently building up a credible IP protection program, where do you draw the line on Big Four access to the IP upon which future revenue depends? There may be a remarkable opportunity for second tier accountancies not yet compromised, such as an IP-focused exposure or assessment program (which implies that they will per force have to have their own means of protection in place). With all of that in place, however, they could go in and assess Big Four clients, establish IP-driven carve-outs for business critical valuations and position themselves in a new market space. (Even knowing what has been compromised, although painful, can staunch an IP hemorrhage as well as evolve into a tool for the allocation of suitably-valued IP protective measures.)

RSM McGladrey, Grant Thornton, and BDO Seidman, this is your moment. Where in the market are you?

Chinese Law: Smoke And Mirrors And Who Really Wields The Influence.
Posted by Dan Harris
China Law Blog
June 13, 2006 at 04:03 PM

China set for investment revolution
Sundeep Tucker, London
The Australian - FT Business
June 13, 2006

Chinese Law: Smoke and Mirrors
by Christopher Cassidy at 8:10 PM
Asia Business Law
June 09, 2006

The Nexus of IPR and Culture in China
posted by Christopher Cassidy at 3:07 PM
Asia Business Law
June 09, 2006

China to promote rivals to ‘big four’
By Barney Jopson in Beijing
Financial Times
Published: June 8 2006 01:25 | Last updated: June 8 2006 01:25

Draft Anti-Monopoly Law Approved
China Business Services
June 8, 2006

China approves draft anti-monopoly law
By ELAINE KURTENBACH
AP
June 7, 2006 · Last updated 10:52 p.m. PT

China's bank corruption doesn't faze investors
The multi-million-dollar scandals are a footnote in the floats
Tom Mitchell and Justine Lau
The Australian-FT Business
June 05, 2006

Accounting firms plan to boost China staff by over 20 pct - report
AFX News Limited/Forbes
06.04.2006, 08:34 PM

Big four firms plan boost to China staff
By Barney Jopson in Shanghai
Financial Times
Published: June 4 2006 22:04 | Last updated: June 5 2006 05:19
Mirrored as
Big four accountants in frantic China hirings at The Australian - FT Business, June 06, 2006
Mirrored at China Daily/Foreign Media on China

Biggest law firm in China seeks help
By Clare Cheung
Bloomberg News/IHT
MAY 31, 2006

Around Asia's Markets: Bad loans dim ardor for China banks
By Michele Batchelor
Bloomberg News
APRIL 25, 2006

China, and the Story of the Malicious Foreign Takeovers
China Business Services
March 15, 2006

Gordon Housworth



InfoT Public  Intellectual Property Theft Public  Risk Containment and Pricing Public  Strategic Risk Public  

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Persistent limitations and deficiencies among the 'guardian class' of business advisors charged with protecting their clients' interests in China

  #

Previous: Low cost is not low risk: realities of IP Loss

Low cost is not low risk describes a global IP risk to both domestic and offshore facilities of both established industrial firms and venture capitalist (VC) startups in which:

  • Most firms do not know that they are at risk and, if they do become aware, do not know where to turn for valid assistance
  • Becoming aware of their target status but deprived of competent advice, firms employ non-solutions that lull themselves into a false sense of security
  • Firms silently surrender, fearful of negative consequences to business continuity or souring relationships with a host government (Too often a target firm mistakenly presumes that mitigation of IP loss demands a Rambo-style response.)
  • A firm's management may not confront a threat despite their awareness and even the periodic presence of internal champions for improved protection

We are now seeing firms that have prided themselves on US manufacturing being driven to China by simultaneous margin pressure and the recognition of rising Chinese reverse engineering of their products. Early indications are that these firms, not having sound guidance to the contrary, are operating under the odd assumption that it is better to "do something in China rather than to lose all" to reverse engineering.) Once in Asia, unprotected, more of the firm's assets can be at risk. (Experience has shown that firms driven offshore in such a "flight condition" are generally destabilized, plunged into a "catch-up mode" at any cost and inattentive to IP collection efforts; they usually quickly become an easily harvestable asset.)

How do firms, especially those global firms with broad skill sets, get into such a fix? Who are their advisors? Are they omissive? Answers differ between nascent Venture Capitalist (VC) funded firms and established firms. Venture Capitalist firms are usually small groups of former operators and entrepreneurs whose only external advisors are law firms and investment bankers (for the initial public offering. Established industrial firms are larger, employing tiers of professional managers that contract a broad spectrum of advisory agents, notably management consultancies, IT consultancies, banks, investment houses and law firms. We see three common characteristics among these advisory groups:

  1. Proper (actionable) IP protection guidelines are absent; in their place are ineffectual guidelines that confer a false sense of security among clients
  2. IP is frequently missing among the key characteristics that clients are urged to address when going offshore
  3. Fear of reprisal by a host government refusing them business restrains the level of advice offered to clients

The first two points are understandable as realistic IP protection practices, vulnerability assessments and mitigation practices are poorly understood by client and advisor alike. The third point is more troubling but I would prefer readers to understand it as the inevitable condition of a globally distributed services firm that has regional revenue targets independent of activities or events elsewhere in its network and is frequently beholden to one or more host governments for its ability to operate within their borders rather than a felonious act.

Proper (actionable) IP protection guidelines are absent:

While management consultancies often report what clients are doing as opposed to what the consultancy specifically recommends, their readership takes the implied leap that the related practices are recommended. As it is so infrequently reported, we should first state what does comprise competent threat analysis, what is "at the core of an interdiction process regardless of whether it is counterterrorism (CT) or Intellectual Property (IP) theft." From The danger of confusing terrorist interdiction with the consequences of terrorist action:

Defenders must be able to define a coherent view of their risk tolerance before they can craft a response strategy, a function the defense sector calls a Design Basis Threat (see simple overview.) For a more complex example, see Building Design for Homeland Security and look at the units: Asset Value Assessment, Threat/Hazard Assessment, Vulnerability Assessment, and Risk Assessment/Risk Management.

Unfortunately, the few that get this far attempt to solve the problem using scenario analysis which can never end, often results in analysis paralysis, and usually misses the scenario that delivers the payload or compromises the asset under protection:

Scenario-based responses are dangerously omissive. Witness the events now unfolding in London where the UK has had a thirty year history of dealing with a variety of terrorist attacks and bombings. The "scenario" and "lessons learned" of bombing mass transit (see Atocha’s Impact) in Madrid, Spain, was recent and well know yet it did the English little good in interdicting the London attack.

Moreover, scenario-spinning has no end since it has no scope-like business risk statement to bound it, and so efforts continue without end, usually crippling most well-intended protective efforts (paralysis by analysis)… The net is that the scenarios are very useful for estimating consequences (direct and indirect costs) should a similar event occur but that they are virtually ineffective for interdicting the adversary's preparation, surveillance and actual attack.

As noted in Acting upon knowledge is different from its gathering:

The alternative to scenario planning is to understand the key actors and processes at play, how they might interact (without locking into "the" prediction), especially in a region and culture so different from our own and one in which our own cultural assumptions could lead to under or overrating events, good and bad.

Some recommendations are astonishing. Peter Yu's From Pirates to Partners offers a good history and magnitude of the IP theft problem but then descends into a failed Twelve-Step Action Plan that is nothing short of an apologia for continuation of the current condition; Step 10, Be Patient with China During the Transitional Period, caught our eye. (We can support the first step, Abandon the Coercive Policy, only because US inaction has effectively made realistic enforcement moot. Individual firms must attend to the protection of their IP and that of critical suppliers in their development and manufacturing supply chain.)

McKinsey's Protecting intellectual property in China is slightly better than most in that it discredited reliance upon legal remedies:

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... we found that many executives think of protecting IP solely in legal termsand 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...

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.

Complete agreement on these comments but then the advisory dissolves into ineffectual remedies. Consider the implications of In a Scientist's Fall, China Feels Robbed of Glory, Atomised and Chip fraud in China becomes embarrassing setback, then review McKinsey's recommendations for "use of surveillance equipment or firewalls, to prevent large file transfers," "screen all job candidates for high ethical standards," "prefers employees with international work and educational experience, which it hopes will foster a healthy respect for IP," and "requiring non-compete clauses… in employment contracts for all positions." The article concludes with a "Pyramid of IP Protection" from "Must have" to "Nice to have" that is not in the correct order, and although desirable is not achievable with the tools on offer.

IP is missing key characteristic among client offshore guidelines:

No one firm was singled out for the following samples of IP omission; they were close to hand and our experience has shown them to be typical. It becomes easy to understand how otherwise competent suppliers can reach a vulnerable IP posture.

Booz Allen's The China Syndrome (and an earlier China's Gold Rush: Should You Make the Journey East?) cites "Five Factors to Examine": manufacturing cost, transportation efficiency, lead time and scheduling stability, product design and technical capabilities, concluding that:

By analyzing these five critical dimensions for each unique procurement initiative, companies can better understand their geographic sourcing options - which products are candidates to be sourced from low-cost countries and which need to be purchased from more developed markets.

IP is conspicuously absent.

Accenture's The Secrets of Successful Low-Cost-Country Sourcing states that "It’s absolutely essential that LCCS [low-cost-country sourcing] be made a core part of the overall corporate strategy" [but] successful LCCS is not a straightforward proposition [as it] involves a careful balancing of often competing interests within a company and demands great flexibility."

IP is apparently not part of this equation. It is certainly not sufficient to laud a client's "40-strong, largely Chinese procurement team in China. What’s more, the sourcing manager is a strong believer in working with local staff. It’s not just a question of culture and language, he explains: "These are people with a strong local network who are in tune with local market conditions.""

Ariba's Supply Base Localization: A Different Look at Low-cost Country Sourcing states that "Capturing the sourcing savings in a low-cost manufacturing strategy means weighing the risks and understanding total cost" but fails to mention IP. It's section When China Is Not the Answer is devoted solely to total cost piece part analysis: "As sourcing teams [are] getting a better handle on true total cost of ownership, a number of commodities are revealing themselves to be more costly when sourced from Asia versus from supply bases closer to home."

The Supply Chain Resource Consortium's Do Organizations Consider Strategic Cost Management When They Outsource To China? does not cite IP in its value equation nor does it mention IP in its 6-part China Series save for a brief mention of "laws to protect intellectual property."

I was surprised closer to home by an otherwise fine regional accounting and management firm, Plante & Moran, and its partner in the Strategic Planning and Global Services practice, Craig Fitzgerald. Having systematically tracked Fitzgerald's public materials since 2004, especially those having to do with China-related investments, I approached him in March 2006 about the seeming omission of Intellectual Property (IP) protection: "In comparison to your analyses of supplier tiers and recommendations for action, IP gets only a mention. A mantra around our shop for both outsourcing and offshoring is "Low cost is not low risk.""

I was saddened by his voicemail of 23 March, 2006:

I did get your voicemail and email messages, thank you very much. The nature of my consultation doesn't deal with IP protection whatsoever, so I really think us having a conversation would not be productive for you or for my clients as this is an area that I do not get into. I deal specifically with Customer relationship management and Enterprise strategy for auto suppliers. I do not go far afield or get into the tactics… [transcription of retained voicemail]

While Fitzgerald was very polite, all those who listened to his message agreed with my opinion that he closed with a second kind, but firm, attempt to convince me to not call again, all this from a fellow that states that he deals specifically with "Customer relationship management" and "Enterprise strategy for auto suppliers."

Fitzgerald is not alone. In dealings with a US tier one with Chinese operations, their headquarters staff were surprised to hear a key "advisor from Japan" shy away from any discussion of IP protection. I asked if the advisor was Japanese (yes) and if the individual was a long term contractor to this firm and other clients (yes). I noted that Chinese are not fond of Japanese on the best of days (decades ago my Chinese clients wanted, and paid for, tech support out of the US rather than rely on our Japanese distributor) and that the advisor could not raise sensitive issues lest it prejudice his ongoing consulting. Such an individual was not going to offer the US supplier any guidance beyond the mechanics of production and logistics.

Fear of reprisal by a host government:

While I've previously noted that the "established guardian community - major management consultancies, banks, investment houses and law firms - is restrained by fear of reprisal by a host government refusing them business in a designated country," few examples outshine the recent hasty scramble by a Big Four accounting firm, Ernst & Young, to grovelingly withdraw a and refreshingly frank May 3, 2006, assessment of Chinese bank non-performing loan (NPL) exposure. E&Y estimated total Chinese bank NPL at USD $911 billion with the NPL for the four major state-owned banks (the Big Four) spun off from the People's Bank of China (PBOC) in 1983-84 (Bank of China (BOC), Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), and Agricultural Bank of China (ABC)) at USD$358 billion - a figure three times greater than China's official estimate of USD$133 billion. More interestingly, E&Y audits ICBC, which is shortly to list).

China Business Services noted that E&Y's retraction "stated that the report "contained errors" requiring retraction of the study in toto. In doing so, E&Y has bowed lower than any western firm one can remember in recent times, offering in addition to the public shame of retraction, its profuse apology as well as sincere regrets.

Definitely read McGregor's China's banks still bedevilled by bad debts in which McGregor shows that E&Y's reporting was similar to that of PwC and McKinsey, and cited the frank comments of a managing director at E&Y, Jack Rodman:

AT first glance, Beijing would appear to have tackled head-on the mountain of bad debt in its state banking system - debt which has built up in the years since China began opening the economy in the late 1970s. In 1999, the Government established bad-debt disposal companies to sell off sour loans, used bank profits to wipe out more, and also pumped in cash from its foreign exchange reserves to recapitalise the institutions.

 In other words, US balance of payment debt paid, and continues to pay, down Chinese bad loans.

In all, China cleared about $US560 billion ($730 billion) of bad debts in a flurry, an amount equal to about half the country's gross domestic product at the time the funds were deployed. So after a period during which China enjoyed boisterous economic growth rates, it is surprising that a series of new reports say non-performing loans (NPLs) remain stubbornly high and may be getting worse.

A report issued on Wednesday by Ernst & Young, the accountancy firm, puts China's total liabilities for NPLs at just over $US900 billion, even higher than its $US875 billion stack of foreign reserves, the largest in the world. E&Y's findings are broadly in line with a report by professional services firm PwC issued last week, and similar in tone to another lengthy report released this week from McKinsey, the consultancy, on China's financial system.

"I think the numbers will be a big surprise because China has been giving the impression (with its banks listing overseas) that the problem is behind us," said Jack Rodman, a managing director with E&Y. "China has not really resolved the issue - they have just moved it from one state enterprise to another."

The three reports say the original stock of bad loans has not been dealt with and that a huge stack of new NPLs has been created. "While there have been improvements in the banking sectors, and the Government has sought to address NPLs, the core causes for the build-up have not been fully dealt with," said the McKinsey report.

"Until these problems are addressed, the problem is likely to persist, and the banking system will remain vulnerable to potential liquidity shocks." The "problems" are familiar - a lack of commercial mindset among banks and skills to assess credit risk, and a sprawling nationwide branch system over which the head office in Beijing has little control.

In other words, the Chinese banking system is insolvent, and investors may never see their money back, much less a profit.

Three of the big four state banks, which have either listed overseas or are preparing to, have an even better record, with their NPL ratio by December last year under 5 per cent, according to PwC. The fall was not due to NPL resolutions, but transfers to the bad debt disposal agencies, and a surge in new lending which made existing bad loans a smaller part of the expanding pie of banking assets.

"So while NPL ratios appear to be decreasing, in number NPLs are probably increasing," says Mike Harris, the PwC report's author. The bad debt disposal agencies, known as asset management companies (AMCs), have taken on $US330 billion in sour loans since 1999, but have only resolved about $US100 billion.

In other words, no substantive change has occurred in Chinese lending and banking practice.

Read Luo Jun's Bank of China's $9.9 Billion IPO Plan Vexed by Bad Loan Legacy for more on the mechanics. I recommend readers to Richard Kuslan's Asia Business Intelligence, Dan Harris' posts at China Law Blog, and byzantine_ruins' The Epic of the Fall:

Readers are referred to the many additional links on Chinese banking revelation are in the bibliography below. In lieu of the E&Y withdrawal, I recommend two reports by the IMF's Richard Podpiera. Read Does Compliance with Basel Core Principles Bring Any Measurable Benefits?, November 2004, for general banking sector performance and Progress in China’s Banking Sector Reform: Has Bank Behavior Changed?, March 2006, for analysis of Chinese lending growth, credit pricing, and regional lending patterns in search of "evidence of changing behavior of the large state-owned commercial banks (SCBs)." All the items by Minxin Pei offer readers a sound view of the structural issues contributing to China's economic and societal pressure.

This reprisal segment closes with the conflicts of interest facing investment bankers Lehman Brothers, Morgan Stanley and Goldman Sachs during the 2005 attempt of China's CNOOC to acquire Unocal:

Lehman Brothers, which has been aggressively wooing Chinese clients, also happens to be the banker for Chevron in the battle for control of Unocal, the American oil company. Chevron's strategy in seeking public support for a deal with Unocal has included denouncing Cnooc's offer not just on its economic merits, but also as a Chinese government-sponsored bid that threatens America's national security. Chevron's lobbying campaign in Washington all but compares China to Russia during the cold war. This has made for some awkward moments for Lehman Brothers in China. "Pitching business there at the moment is not the easiest thing to do," lamented a Lehman banker who just completed a trip to Hong Kong that he called "unsuccessful."...  

Morgan Stanley, which is also trying to create a franchise in China, is representing Unocal. Relying in part on Morgan Stanley's advice, Unocal's board has rejected Cnooc's bid - which is actually higher than Chrevron's offer - as too low, considering the political risks… "Conflict resolution is tremendously complex to start with for most big firms," said Steven Koch, co-chairman of global mergers and acquisitions at Credit Suisse First Boston. "It gets even more complicated when the client is associated with a country's national interests."…

Goldman Sachs… has spent the last several years zealously courting Chinese government officials… Goldman's decision to pursue working for Cnooc was a calculated one. It knew full well that Cnooc had a long shot of winning. As adviser to the losing side in the takeover fight, Goldman would make virtually no money for its months of strategizing...  

But for Goldman, it may have looked like a no-lose situation. If Cnooc won, it would be a watershed deal that would reap millions of dollars in fees for Goldman. But being on the losing side would offer rewards, too. The experience itself has already helped Goldman build deep relationships inside the Chinese government that may give it a leg up in the coming years... [S]ome people close to Cnooc have suggested that Goldman could be blamed if the Chinese company ends up losing the current takeover battle. Critics are already saying that Goldman has miscalculated the level of protectionist sentiment in Washington as well as Chevron's ability to stir up a firestorm of protest against the Chinese company.

The moral that I take from this section in particular and the full note in general is that if you are an investor in China in any fashion and are not performing your own independent, rigorous analysis from multiple sources, but rather relying on the advisory of your accountant, that you are in for a tenure marked by surprise and cost.

Next: Physicians, heal thyselves: The Big Four accountancies are setting up as targets for Intellectual Property (IP) theft

Chinese banks reap rewards of reform
(Asia Pulse/XIC)
Asia Times
Jun 7, 2006

Atomised
Beijing no longer commands instant obedience from China's local authorities
The Economist
Jun 1, 2006

China finance: Investors bet on BOC
ViewsWire
ECONOMIST INTELLIGENCE UNIT
May 26th 2006
Also here

Banking on Reform
Recent reforms have helped China avoid a banking collapse. But how will its banks hold up when the sector fully opens to foreign competition?
by Stephen Thomas and Chen Ji
China Business Review
CBR May-June 2006

Bank of China's $9.9 Billion IPO Plan Vexed by Bad Loan Legacy
Luo Jun
Bloomberg
May 16, 2006

In a Scientist's Fall, China Feels Robbed of Glory
By DAVID BARBOZA
New York Times
May 15, 2006

Chip fraud in China becomes embarrassing setback
Faked development of digital signal processors unravled
By Sumner Lemon, IDG News Service
May 15, 2006

Ernst & Young And China Banks -- Better Wrong Than Right?
Posted by Dan Harris
China Law Blog
May 15, 2006 at 09:35 AM

Non-Performing Accountants (and Loans)
China Business Services
May 15, 2006

Ernst and Young Retracts China Bad Loans Report
Posted by Richard Kuslan
Asia Business Intelligence
May 15, 2006 01:21 PM

China's Banks May Be Troubled, But Nobody Knows The Trouble Ernst & Young Has Seen
Posted by Dan Harris
China Law Blog
May 15, 2006 at 12:41 AM

Ernst & Young Bullied To Withdraw NPL Report By Chinese Authorities
By byzantine_ruins
The Epic of the Fall
May. 15th, 2006 @ 09:35 am

Ernst & Young withdraws NPL Report
E&Y Global headquarters
12 May, 2006

China central bank says report on extent of bank NPLs 'seriously distorted'
AFX/Forbes
05.11.2006, 08:00 AM

China's banks still bedevilled by bad debts
They've just passed the buck, writes Richard McGregor
Richard McGregor
The Australian-FT Business
May 05, 2006

China on Borrowed Time?
David Bosco
Foreign Policy
Wed, 05/03/2006 - 1:22pm.

Troubled Loan Trail Leads To China -- Do Not Try This At Home
Posted by Dan Harris
China Law Blog
May 3, 2006 at 11:16 PM

China bad loans may reach total of $900bn
By Richard McGregor in Beijing
Financial Times
Published: May 3 2006 07:46 | Last updated: May 3 2006 07:46

China Bad Loans May Reach Total of $900bn
China Business 2.0
May 3, 2006
MIRROR of much of the McGregor/FT article

Around Asia's Markets: Bad loans dim ardor for China banks
By Michele Batchelor
Bloomberg News
APRIL 25, 2006

The Chinese Conundrum: External financial strength, Domestic financial weakness
Brad Setser
Director of Research, Roubini Global Economics
Research Associate, Global Economic Governance
Produced for CESifo Conference: "Understanding the Chinese Economy"
Programme, University College, Oxford
This draft April 15, 2006

The Dark Side of China’s Rise
By Minxin Pei
Foreign Policy
March/April 2006
Scrolled to paid archive
Mirror here:
The Dark Side of China's Rise
By 
Minxin Pei Foreign Policy, March/April 2006
Carnegie Endowment for International Peace

Progress in China’s Banking Sector Reform: Has Bank Behavior Changed?
Richard Podpiera
International Monetary Fund Working Paper WP/06/71
Monetary and Financial Systems Department
Authorized for distribution by Abdessatar Ouanes
March 2006

Supply Base Localization: A Different Look at Low-cost Country Sourcing
By David Morgenstern
Supply & Demand Chain Executive
February/March 2006

China Is Stagnating in Its "Trapped Transition"
By Minxin Pei
Financial Times, February 24, 2006
Mirror at CEIP

Competition and trade in the U.S. auto parts sector
by Thomas H. Klier and James M. Rubenstein
Chicago Fed Letter
Research Department of the Federal Reserve Bank of Chicago
NUMBER 222
January 2006

China Is Paying the Price of Rising Social Unrest
By Minxin Pei
Financial Times, November 7, 2005
Mirror at CEIP

A Fresh Approach on China
By Minxin Pei
International Herald Tribune, September 9, 2005
Mirror at CEIP

Protecting intellectual property in China
Litigation is no substitute for strategy.
Meagan C. Dietz, Sarena Shao-Tin Lin, and Lei Yang
The McKinsey Quarterly, 2005 Number 3

There's a New China Syndrome on Wall Street
By ANDREW ROSS SORKIN
New York Times
July 24, 2005

The Secrets of Successful Low-Cost-Country Sourcing
By Kris Timmermans
Accenture
Outlook Journal, June 2005
PDF

The Economic Basis for Social Unrest in China
Albert Keidel
Carnegie Endowment for International Peace
for The Third European-American Dialogue on China
The George Washington University
May 26-27, 2005

OE Auto Parts Supplier Strategy for the Next Ten Years
Marc Santucci
eAutoPortal.com
2 May, 2005

Banking reform to continue despite scandals: official
Xinhua English
March 10, 2005 00:57:36

Sourcing in China not a sure bet
By strategy+business
Special to CNET News.com
February 7, 2005, 10:00 AM PST
[Recycling of content from 
China's Gold Rush: Should You Make the Journey East?]

The China Syndrome
A five-dimension analytical model for deciding when (and when not) to purchase from the East
By Michell Quint & Dermot Shorten

strategy + business
01/18/05

Does Compliance with Basel Core Principles Bring Any Measurable Benefits?
Richard Podpiera
International Monetary Fund Working Paper WP/04/204
Monetary and Financial Systems Department
Authorized for distribution by Abdessatar Ouanes
November 2004

China's Gold Rush: Should You Make the Journey East?
Michell Quint & Dermot Shorten
Booz Allen
November 2004

Rural Financial Sector Reform in China
Thorsten Giehler
Asia Forum on Financial Sector Reforms in China, Frankfurt
26 Oct, 2004

Do Organizations Consider Strategic Cost Management When They Outsource To China?
by Rob Handfield, SCRC
Supply Chain Resource Consortium (SCRC)
4/8/04

China Series by Rob Handfield, SCRC:
Global Sourcing from China: Insights from a Recent Visit - China Series #1
5/3/05
Planning and Controld Systems in China (PLAN) - China Series #2
6/10/05
Identifying and Negotiation with Chinese Suppliers (SOURCE) - China Series #3
6/23/05
Manufacturing in China (MAKE) - China Series # 4
7/6/05
Logistics in China (DELIVER) - China Series # 5
7/20/05
Environmental Risks in China's Supply Chain - China Series # 6
8/22/05

Ch 3-Finance-Sec 2: Commercial banks: The big four state-owned banks
China Hand March 2004 Main Report
Economic Intelligence Unit
March 2004

China -Threat or Opportunity? You Decide
Craig Fitzgerald
Manufacturing Consulting Services, Plante & Moran
March 2003

Strategies for entering the Chinese Market
Craig Fitzgerald
OESA China Business Report
SAE 2003 World Congress
March 3, 2003

From Pirates to Partners: Protecting Intellectual Property in China in the Twenty-First Century
Peter K. Yu
American University Law Review, Vol. 50
Date Posted: December 7, 2000
Last Revised: April 21, 2003
Abstract

Gordon Housworth



InfoT Public  Intellectual Property Theft Public  Risk Containment and Pricing Public  Strategic Risk Public  

discussion

  discuss this article

Low cost is not low risk: realities of IP Loss

  #

Previous: Trends in Intellectual Property IP transfer to China

This note builds upon the Intellectual Property (IP) protection series. Readers are encouraged to review:

The US supply base is undeniably concerned about IP loss in China; trade issues, protection of intellectual property and the opening of China's market to foreign products were high on the US agenda during Chinese president Hu Jintao's recent visit to North America. While certain assets are likely targets inside China, the key is to think "asset" instead of "country". Risk cannot be based on countries or "risky areas" but rather wherever a sufficiently valuable asset is accessible at any tier in any country - as the collector will move to the least defended point that contains the IP. We currently see, for example, collection efforts on the US west coast against electronics assets long before they are transferred to a presumably risky country in Asia. Commercial and dual-use technologies are high on the collection list.

The idea of trying to isolate "risky countries" with respect to IP migration remains unworkable due to the revenue loss and market share erosion that occurs when IP is withheld plus the fact that nations such as China demand that you be there in order with competent products in order to do business.

The three key areas of vulnerabilities remain the same: Pricing model compromise (supplier outsourcing, subcontracting, etc.), Data citadel attack (R&D hives and data warehouses), and Human resources (HR) churn. All three are critical, yet we find that HR too often gets scant attention even though collection effectiveness is high while risk and cost are low.

Yes, all technology migrates over time but most firms assume risk by default in (a) not identifying what is already compromised, (b) identifying what assets need to be protected and (c) the amount of dollars and effort needed to realistically protect those assets - wherever they occur in the supply chain. If a collector obtains a critical IP asset, the owner's entire ROI justification collapses along with the expected revenue stream. And when the IP asset is the core of a system or subsystem that often contains more mature, less competitive technology, the entire system revenue stream truncates.

Many of the risks to suppliers as well as OEMs were inadvertently demonstrated in a recent 2006 SAE World seminar, Lessons Learned in China: The Automotive Supplier Perspective distilled from "more than 50 interviews and surveys with executives of global automotive suppliers located in the U.S."

A firm expert in supply chain analysis and logistics, PRTM, had surveyed these global suppliers, distilling the collective supplier wisdom on attempts at IP protection as "To protect critical IP, choose components wisely, break up assemblies, select partners carefully and exploit all legal options." Unfortunately, all are ineffective in protecting IP as none of the four offer protection against even modest collection efforts. They are even less effective against an Asian style method of collection.

It validated our assessment that commercial supply bases have no effective protection whatsoever and whatever attempts that are being made at a 'solution' to IP risk are only lulling the targets into a false sense of security. Following is the text of the original PRTM IP protection slide from their survey followed by our commentary pointing out the weaknesses of each approach. (I hasten to note that PRTM was only presenting a collated supplier response, but I fear that the longer those efforts are allowed to stand without challenge, the more likely it is that PRTM will be associated with these de facto "best practices.") PRTM text is in italics and was transcribed from PRTM handouts:

Choose components wisely

  • Only source components which have reached maturity in marketplace
  • Only source basic components with little "design know-how"
  • Make IP protection a priority of your make/buy strategy
  • Or build your own plant in China

COMMENT: The market value of an asset trends downward from high value design to low value commodity. Such progressive value loss can often be mitigated if mature IP is integrated into systems led by a high value asset. It is difficult if not impossible to isolate the newer asset(s) from the older in the production of integrated systems. (In the case of electronics, for example, the asset will appear in three overlapping tiers: logic design, embedment in firmware and test.)

The damage from IP loss moves progressively up the value chain, to newer and more vital IP, in terms of future growth, because collectors are re-tasked to target and acquire more valuable IP.

Compromise of the high value asset compromises both the value of the lead asset as well as the maturing and mature technology components in the system. When there is an IP loss, it is most likely that the discovery will show that the damage to the business is not isolated and broader than anticipated.

There is no "build your own plant" option. Regardless of whether your firm moves into an existing structure or contracts its own, someone else will erect the building, install HVAC, electricals, electronics and contract the security function, guards included.

A local option that delivers protective control is feasible only with a complete IP asset protection program (including asset vulnerability assessments), and significant preparation in selecting and developing local supply chain relationships.

Break up the puzzle

  • Do not source too many components from one supplier
  • Piece out assembly to multiple suppliers in different regions - protect integration IP
  • Avoid giving unnecessary specification & drawing details

COMMENT: Location-specific IP protection is a partial approach - and too often a red herring - that rarely if ever adds much protective value for a global asset. Conversely, location-specific approaches often creates a false sense of comfort on the protective side. The accessibility of the asset to hostile IP collectors at any tier, at any location, is the key question.

Asset-specific protection, by contrast, is global, or requires a comprehensive view of asset accessibility in the supply chain. It almost always becomes optimally effective on the basis of a complete asset (value chain) exposure assessment to be effective.

Choose integrity tested partners

  • Check integrity history with current customers
  • Choose strategic partner with a vested interest in protecting your IP - heavily dependent upon both yours and his business success

COMMENT: Even under ideal conditions, partnering merely shares the risk of IP loss but does not control it. Under typical conditions, partnering is not controlled and generates additional risk. (Note the levels of IP transfer that already occur in any joint venture.)

Education and a clear delineation of joint interests is usually required, but frequently hard to affect and enforce.

Customers may not pre-disposed to cooperate with supplier IP protection efforts.

Invest in legal protection of IP

  • Ensure strong legal contract and non-disclosure agreement… but still proceed with extreme caution
  • Use Chinese lawyers to write detailed "contracts" - jointly signed in person
  • Prosecute offenders relentlessly

COMMENT: Unfortunately, legal remedies come after the economic damage is done or is underway, i.e., the ROI and revenue loss are unrecoverable.

Legal remedies are ineffective outside the US, parts of the EU and Australia, and may in fact be damaging to the litigating party.

A legal strategy may be useful for asset sales or portfolio management (disposition), and will likely be a necessary part of US-based due-diligence for Sarbanes Oxley compliance. It will have limited deterrent value at best for clandestine IP asset collectors.

Above these risks to IP, PRTM found that "the majority of North American automotive suppliers sourcing from China are not realizing great savings," that "over half the participants in [the PRTM] study achieved less than 40% of their savings goals" for their Chinese operations:

PRTM concluded that China sourcing requires a minimum savings of 20% to outweigh such negatives as costs associated with logistics, quality and intellectual property (IP) risks… [PRTM cautioned] suppliers not to get too excited about the low price of a Chinese-made component. "Premium freight is the most basic risk" [of] the hidden costs of doing business in China… [Suppliers] wishing to save money by producing in China need to factor in the cost of insurance [and] the cost of lawyers and investigative teams to enforce IP rights and allocate funds to cover quality-related risks associated with doing business with one of the country’s relatively new suppliers… Suppliers should carefully select their business partner in China by doing local research and networking, not flipping open the Yellow Pages

Given the substantive IP transfers inherent in joint ventures, it was interesting to note the ebbing of JVs:

As far as suppliers wanting to establish a China strategy, PRTM finds joint ventures are becoming a thing of the past, with 21% of respondents in a JV with a Chinese company in 2005 but just 14% expected to be in one by 2010. The growth in China sourcing will come in the form of greenfield plants [with] 28% of respondents taking this approach last year and 44% expected to in 2010. "Joint ventures are out"

Even these brief comments does not do the problem justice. We see otherwise skilled firms adopting an IP protection posture involving amateurish methods and unimplementable good intentions, often buttressed by the erroneous belief that US legal remedies are applicable on a global basis. Other firms violate the rule of "Absence of evidence is not evidence of absence." When no legitimate Vulnerability Assessment has been carried out, it is tenuous at best to claim that no penetrations have been made, or that no threats of collection exist.

Leave it to the English to be candid:

There is an almost suicidal rush now to transfer research and development operations to China lock, stock and barrel. Financial consultants have advised firms about the tax advantages of relocating R&D to China; you can hire researchers with PhDs very cheaply compared to the more advanced countries. All this raises the risk of loss and abuse of intellectual assets in a country where copycatting and intellectual property piracy have long been a national sport.

US and EU IP is being harvested at an intense rate by a hierarchy of collectors. In the case of China, Chinese firms are being pressured for increased margins while Chinese scientists and researchers are being pressured for national breakthroughs that create native Chinese advances not subject to foreign control and/or royalty payments.

Edward Tse's China's Five Surprises offers a fine structural analysis of points that most, if not a wide majority, of US and EU firms are not taking into account in planning their response to China. Even this aggressive posture as outlined by Tse is not enough to satisfy CCP goals for growth, thus the pressure on Chinese scientists to acquire foreign technology as part of their research.

In heated competitive atmospheres such as this, it is all too easy to view foreign IP as harvestable assets. Changes in Chinese law are reducing even the modest IP protection for foreign firms save for the efforts offered up to redress audio and film piracy. We have reason to believe that there is also an assumed feeling of impunity on the part of collectors in the face of feeble or ineffectual responses from targets.

We expect visibility of offshoring, outsourcing and IP theft to rise in the US 2006 and 2008 elections. It is a basic tenet of attack strategy that the attacker (collector) will step up activities in progress if they feel that a heightened security posture is imminent. What is belated good practice and awareness on the target side will be met with accelerated collection on the adversary side.

We recommend early adoption of prudent, non-adversarial business practices now to identify current exposure and to combat the forthcoming surge in collection efforts. Beware ineffectual IP protection tools and processes such as the mechanisms flagged above or IP protection pyramids that, while desirable, are fuzzy and leave the client without the tools to achieve its IP goals. We have achieved success with strategies drawn from proven Counterterrorism (CT) practices applied to Intellectual Property risk evaluation and remediation. We know from experience that these processes can be taught and that they are easy to embed as company best practices performed by its employees instead of an outside consultant. Properly done, IP protection becomes a crucial business attribute, like quality, lean manufacturing or robustness.

Next: Persistent limitations and deficiencies among the 'guardian class' of business advisors charged with protecting their clients' interests in China

Piracy in China Remains Concern For U.S. Firms
Cui Rong
Wall Street Journal
May 16, 2006

Bank of China's $9.9 Billion IPO Plan Vexed by Bad Loan Legacy
Luo Jun
Bloomberg
May 16, 2006

In a Scientist's Fall, China Feels Robbed of Glory
By DAVID BARBOZA
New York Times
May 15, 2006

Chip fraud in China becomes embarrassing setback
Faked development of digital signal processors unravled
By Sumner Lemon
IDG News Service
May 15, 2006

Automotive Sourcing in China & Cost Savings [Title from weblog - may not be the paid subscriber title]
From wardsauto.com
By Christie Schweinsberg
April 6, 2006
Mirror from
Manufacturing Forum, Practical Machinist

Study Reveals: Auto Suppliers Find No Cost Guarantee in China Sourcing
MEMA
April 3, 2006
Mirror at China Supply Chain Council

Study Reveals: Auto Suppliers Find No Cost Guarantee in China Sourcing; OESA and PRTM Management Consultants' Survey: More Than Half of Companies Studied Achieved Less Than 40 Percent of China Sourcing Targets
Business Wire
April 3, 2006

Enter the Dragon? - Lessons Learned in China Sourcing
Executive summary [Handout obtained at SAE session presentation]
Andreas Mai and Stephen Pillsbury, PRTM Management Consultants
Findings from a study based on more than 50 automotive supplier executive team interviews and surveys of supplier experiences and best practices in China
Lessons Learned in China: The Automotive Supplier Perspective
SAE 2006 World Congress, Detroit, MI
April 3, 2006
NOTE: Best online summaries immediately above

Competition and trade in the U.S. auto parts sector
by Thomas H. Klier, senior economist, and James M. Rubenstein, Miami University of Ohio
Chicago Fed Letter
Research Department of the Federal Reserve Bank of Chicago
NUMBER 222
January 2006

Don't jump in without testing the water
Peter Humphrey, ChinaWhys
China-Britain Business Council (CBBC)
2005

China’s Five Surprises
by Edward Tse
Strategy + Business
Winter 2005
PDF

GM Eyes Asia for Cost Cuts
Asian suppliers could help automaker trim costs
by Joseph Szczesny
Car Connection
Sept 12, 2005

INTELLECTUAL PROPERTY THEFT IN CHINA AND RUSSIA
HEARING BEFORE THE SUBCOMMITTEE ON COURTS, THE INTERNET, AND INTELLECTUAL PROPERTY OF THE COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES, ONE HUNDRED NINTH CONGRESS, FIRST SESSION
Serial No. 109–34
MAY 17, 2005
PDF
Mildly indexable HTLM version

OE Auto Parts Supplier Strategy for the Next Ten Years
Marc Santucci
eAutoPortal.com
May 2, 2005

A "China Price" For Toyota
The auto giant is taking its cost-slashing drive to a new level. Can its suppliers match China's cheaper parts?
By Chester Dawson in Toyota City, with Karen Nickel Anhalt in Berlin
Business Week Online
FEBRUARY 21, 2005

Sourcing in China not a sure bet
By strategy + business
Special to CNET News.com
February 7, 2005, 10:00 AM PST

Gordon Housworth



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Trends in Intellectual Property (IP) transfer to China

  #

Trends outlined in the 1999 Bureau of Industry and Security's U.S. Commercial Technology Transfers to the People’s Republic of China have accelerated to the present day:

China’s laws, regulations, and policies with regard to foreign investment and trade include numerous provisions and mandates for foreign technology transfer. These policies are clearly intended to support domestic reform and modernization efforts toward self-sufficiency in high-tech sectors. Furthermore, many of the provisions included in China's existing industrial policies appear to raise questions as to their consistency with international trade practices and bilateral agreements... Despite these policies, however, many foreign corporations continue to invest in China, including US high-tech companies. In doing so, these companies often must transfer commercial technology in various forms in order to accommodate Chinese foreign investment and import regulations, which have become increasingly selective in terms of the level and type of technologies allowed. Thus, it is clear that foreign firms are being coerced into transferring technology (which they probably would not otherwise do) as the price to be paid for access to China's market.

The more difficult question to answer, however, is the degree to which these transfers are "forced" [as the] degree to which US technology is being transferred to China is a combination of Chinese law and strategic decision-making on the part of US corporations. That is, technology transfer is both mandated in Chinese regulations or industrial policies (with which US companies wishing to invest in China must comply) and used as a deal-maker by US firms seeking joint venture contracts in China…

[F]oreign investors face a difficult dilemma: to invest early and accept the risks involved in doing so in hopes of minimizing potential losses while creating a market presence and goodwill in China, or to wait and see how China's market and policies develop, investing when the time is ripe and investment policies less discriminatory. The leading high-tech companies — American, European, and increasingly also the Japanese — seem to have decided on the former strategy…

[Part 1 shows that] China’s foreign investment policies have followed a clear pattern characterized by an increasingly targeted focus on hightechnology investment and imports. These policies are intended to bolster China’s modernization efforts in both the civilian and military sectors. The most significant finding of this study, however, is the degree to which US high-tech firms are collaborating on R&D with leading Chinese universities and research institutions in China, an offset agreement frequently accompanying joint venture contracts. Although there is as yet no clear cause and effect as much of the evidence is circumstantial, Part 2 of the study demonstrates that trends in Sino-US trade are worrisome in that hightechnology sector exports (such as electronics) are increasing from China to the United States and elsewhere while at the same time the US trade deficit with China is climbing.

Long past the period of sending "outdated factory equipment to China to produce older models no longer salable in the West, the 2006 landscape shows a continuing foreign competition in China:

so fierce [that] Honda is about to introduce its latest version of the Civic only several months after it went on sale in Europe, Japan and the United States. Toyota, meanwhile, is assembling its Prius gasoline-electric sedan only in Japan and China. [In 2005-6] Ford opened a second production line next door that is practically identical to one of its most advanced factories, the Saarlouis operation in southwestern Germany. The new line produces the Focus, the same small car it builds in Germany (but different from the Focus sold in the United States). And with continuing improvements to the first line, it will bring total capacity here to 200,000 cars a year by June [2006]…

American and European carmakers, including Ford, General Motors, DaimlerChrysler and Volkswagen, as well as Toyota, Honda and Nissan of Japan are introducing their best technology to their plants in China, and not only to compete against one another. They also face rapidly growing competition in the Chinese market from purely local companies like Geely, Chery and Lifan.

That technology infusion is now reversing the acquisition direction. Shanghai Automotive Industry Corporation (SAIC) "acquired a controlling stake in Korean car maker Ssangyong Motor Co." in 2004. Nanjing Automobile Corporation bested SAIC to acquire the UK's MG Rover Group in 2005, dismantling its factories for shipment to China (although SAIC gained rights to two Rover designs). Chinese suppliers such as Wanxiang continue to acquire automotive suppliers, many of whom "needed cash because Chinese manufacturers like Wanxiang were eroding their business." To solve its shortfall in efficient engine manufacture, the Lifan Group in partnership with the CCP is attempting to purchase the highly advanced Chrysler-BMW joint venture Campo Largo engine plant, which if successful, would see the plant dismantled and moved to China to seed indigenous engine manufacture. [Russian AvtoVAZ and GAZ has also evinced interest.]

SAIC is now using expertise gained from its joint ventures with GM and Volkswagen to produce its own upscale luxury sedans in 2006, occupying both partner and competitor roles to its foreign partners. Foreign OEMs have no avenue of redress:

Under Chinese regulations, to make cars in China, foreign companies must form joint ventures in which their Chinese partners own no less than 50%. The major multinationals have already teamed up with the biggest and most promising local firms. [They] have little choice but to keep making their cars and encourage their partners not to compete too directly with them.

GM and Volkswagen have no choice but to acquiesce even though they know that all the IP they contributed, and will contribute, to their joint ventures will increasingly be used against them:

In a prepared statement, GM said it "understands" Shanghai Automotive's "desire for further growth" and that it is confident "SAIC recognizes that the success of both companies in the China market is closely linked to the success of our joint ventures."

In a prepared statement, Volkswagen said, "Volkswagen and SAIC keep a close and long-lasting partnership. We understand SAIC's wish to build up an own Chinese car brand. We offered our support in the past and still do at present."

While foreign OEMs have enjoyed rapidly rising production of "family vehicles" (cars, SUVs and minivans) in China in the 2000-2005 period, indigenous Chinese manufacture has grown at much higher rate. (It is an axiom of technology maturation that each generation takes half the time of its predecessor; Japanese car manufacturers took 20 years to establish themselves in the US market, the Koreans 10 years, and short of import limitations, I expect the Chinese to half that, all at lower cost.)

SAIC's vertical integration will drive other Chinese auto firms to follow suit, thereby increasing the pressure and demands on foreign OEMs for more and better technology even as it narrows their options. Foreign OEMs will become collateral damage in the competition between Chinese OEMs and Tier One suppliers.

I predict that Chinese firms will move instead to replace foreign firms or absorb their Chinese operations when the foreign OEMs have nothing else to offer, ultimately buying into increasingly ailing foreign OEMs so as to create sales channels for Chinese vehicles.

What happens when even the current level of JV supplied technology is no longer sufficient, when the desired technology is not within the hands of foreign OEMs?

Next: Low cost is not low risk: realities of IP Loss

China's Car Sector Gears Up for Big Change
At Shanghai Auto, Foreign Partners Now Find A Rival
By GORDON FAIRCLOUGH
Wall Street Journal
April 5, 2006

AvtoVAZ Goes Brazilian To Secure New Engine Supplies
By Anna Smolchenko
The St. Petersburg Times
Issue #1154(20), March 21, 2006

Thanks to Detroit, China Is Poised to Lead
By KEITH BRADSHER
New York Times
March 12, 2006

Cutting U.S. jobs while prospering in China
A struggling U.S. auto parts maker faces a dilemma that's increasingly common as more products are made in China
By Craig Simons
Austin Statesman
March 05, 2006

China Seeking Auto Industry, Piece by Piece
By KEITH BRADSHER
New York Times
February 17, 2006

China takes aim at U.S. auto industry
By Michael Oneal
Chicago Tribune
Published January 29, 2006

GM Eyes Asia for Cost Cuts
Asian suppliers could help automaker trim costs
by Joseph Szczesny
Car Connection
Sept 12, 2005

China Investing in Rust-Belt Companies
Auto-Parts Maker Wanxiang Invests in U.S. Partners As Its Ambitions Expand
By PETER WONACOTT
Wall Street Journal
November 26, 2004
Fee archive
Mirror

U.S. Commercial Technology Transfers to the People’s Republic of China
Bureau of Industry and Security
US Department of Commerce
1999
Key findings:

Full text by section: Part 1, Part 2, Part 3, Appendix A, Appendix B, Appendix C, Appendix D, Appendix E

Gordon Housworth



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US intellectual property protection: the targets are asleep or unarmed, the advising guardians are AWOL and the police are offering placebos

  #

To paraphrase the misattributed quote of Everett Dirksen, a billion to India, a billion to China, and pretty soon you're taking about serious outsourcing - and along with it an uncontrolled and unprotected intellectual property (IP) stream. The unremitting drumbeat of each InfoWorld RSS feed item that crosses my desk (see link list below) on yet another offshore investment reminds me of the laxity of US administrations to address strategic shortfalls in things so essential as K-16+ education, promoting advanced technologies - genetics and biologics included, and what I call the "sleeping princess" vulnerability of irreplaceable IP.

David Berlind's The United States of India notes:

In less than two months time it has become clear that, between Cisco, Intel, and now Microsoft, India will get injected with at least $3.8 billion. China is getting similar injections. According to a report in InfoWorld, Intel chairman Craig Barrett talked about why education is making China more competitive while he was cutting the ribbon on a new $200 million test and assembly center his company built in the western Chinese city of Chengdu.

The landscape for global IP protection (and that includes both domestic and offshore locations) is not a pretty one. Worse, I see no improvement since penning A tipping point in intellectual property protection? in January 2005. (I submit the predictions in Emerging Information Technology (IT) themes in India and China and Refining a China forecast as well.)

I wager that the majority of firms do not know that they are at risk and that, if they do become aware, do not know where to turn for assistance. Fearful of alienating one or more factions with unknown consequences, firms silently capitulate. Targets that are waking seem mostly to feel disarmed despite the presence of heroic individuals. Their leadership does seem to be engaging despite every indicator that they are aware, an equally fatal condition. Consider our current view of global IP risk:

  • Venture Capitalists (VCs) hire management for their nascent firms to produce and deliver a product stream leading to an initial public offering (IPO), not for risk management and risk remediation.
  • VCs are herding their stables to Asia to "save costs," often housing their charges into a single R&D hive that creates a target rich environment that will only culminate in local firms producing similar products before the US startups get to their rev one product.
  • Established industrial firms continue offshoring (see Multisourcing, parts 1 and 2) for lower cost, global 24X7 reach for their firm and their clients, richer talent pool, emerging market base, some of all of the above depending upon the locale. Such firms continue to confuse low cost with low risk.
  • Industrial firms confuse IT approaches such as network packet sniffing and hardware control mechanisms as remedies to IP theft which they are not. Hardware remedies have their place but form only a minority of an effective protective envelope.
  • The established guardian community - major management consultancies, banks, investment houses and law firms - is restrained by fear of reprisal by a host government refusing them business in a designated country. (Witness the concern of repercussions of even advising Unocal and its suitor Chevron against acquisition by CNOOC where those advising firms were exposed across sectors in seeking other Chinese business.)
  • The guardian community is itself a source of IP hemorrhage as aggressive 'up or out' programs flush talent out their back door, taking with them IP on both their prior employer as well as the employer's clients.
  • Those guardians not cowed (a microscopic group) are no better prepared that their benighted brethren in their operational knowledge of truly effective, non-confrontational means to affect IP protection, i.e., should one of these firms make recommendations, the client will only be lulled into a false sense of security that will put more of their IP at risk.
  • The compliance, policy, and legal instruments being floated by DoJ and the FBI are effectively non-remedies as they do nothing to instill competent cost effective IP protection in the target firms, offer no recourse for overseas infractions outside US jurisdiction, save for very limited areas, and do nothing to remediate the direct and drag-along loss of the IP theft.
  • Avoiding reprisal is so strong that the guardian community will often refer their clients to pursue the ineffective DoJ/FBI compliance, policy, and legal instruments.

In short, the targets are asleep or unarmed, the advising guardians are AWOL and the police are offering placebos. Not an comfortable condition as my predictions from January 2005 still stand:

  • Emerging Asian suppliers will displace less efficient US suppliers in US supply chains
  • US OEMs will continue their pursuit of lowest cost suppliers, abandoning historic ‘domestic’ suppliers in favor of new Asian suppliers

And if it is not too late:

  • After enduring growing losses, US OEMs and major manufacturers will use IP security as a key selector for suppliers in the critical path of their supply chains
  • Protective IP programs will be essential to a supply chain’s critical path, and so the health of the supply chain. (The trajectory of IP protection will mimic that of the rise of part quality as a mandatory selection criterion.)

The United States of India
Posted by David Berlind @ 7:10 am
December 7, 2005

China surpasses U.S. as top IT goods supplier, OECD says
China exported $180 billion in ICT goods last year compared to U.S. exports of $149 billion
By Nancy Gohring, IDG News Service
December 12, 2005

Europe's IT industry losing ground
Survey shows U.S. and Asian firms offer better pricing, greater flexibility in contracts
By Jeremy Kirk, IDG News Service
December 12, 2005

India's outsourcing valued at $60 billion by 2010
Industry could face a shortage of half a million workers
By John Ribeiro, IDG News Service
December 12, 2005

Aviva to expand outsourcing in India
British insurance company to double the staff offering BPO and call center services
By John Ribeiro, IDG News Service
December 12, 2005

Lenovo wants to take on new markets in 2006
Lenovo to focus on SMB customers in the U.S. and Europe
By Sumner Lemon, IDG News Service
December 09, 2005

Microsoft to invest $1.7 billion in India
Microsoft is latest technology company making large investment in anticipation of a boom in India's IT market
By John Ribeiro, IDG News Service
December 07, 2005

Intel will invest over $1 billion in India
Intel to expand its business in India, invest to help stimulate technological innovation
By John Ribeiro, IDG News Service
December 05, 2005

EDS likely to double Chinese, Indian workforces
The company currently has up to 20,000 employees in those regions
By China Martens, IDG News Service
November 30, 2005

Juniper to double technical staff in India
Center in Bangalore works on software and hardware development
By John Ribeiro, IDG News Service
November 23, 2005

HP opens research lab in China
Beijing lab will be HP's sixth research facility
By China Martens, IDG News Service
November 15, 2005

Amazon.com sets up second development center in India
Center will focus on developing new features for Amazon's sites
By John Ribeiro, IDG News Service
October 21, 2005

Cisco to invest $1.1 billion in India
Company will triple the number of staff it employs in India
By John Ribeiro, IDG News Service
October 19, 2005

Intel lauds Chinese CPU development
Intel exec says the Godson-2 chip shows fast uptake in design prowess by the Chinese
By Dan Nystedt, IDG News Service
October 18, 2005

Gartner: China's tech industry needs government support
Analyst firm says China's goal of becoming tech leader by 2010 will demand policies across several areas
By Sumner Lemon, IDG News Service
September 01, 2005

India's Infosys plans huge expansion in China
Outsourcer to grow its staff in China from 250 to 6,000 during next five years
By John Ribeiro, IDG News Service
August 04, 2005

CNOOC Throws In Towel
Shu-Ching Jean Chen and Claire Poole
Law.com
Aug-04-2005

There's a New China Syndrome on Wall Street
By ANDREW ROSS SORKIN
New York Times
July 24, 2005

The Big Tug of War Over Unocal
By STEVE LOHR
New York Times
July 6, 2005
Fee
archive
Mirror, Mirror

China throws down gauntlet to USA Inc
Frank Kane
The Observer (UK)
Sunday June 26, 2005

Uncle Sam's CNOOC dilemma
Chinese oil company makes trump bid for Unocal. But will the US block it as it did with Hutch bid for Global Crossing?
By Steven Irvine
Finance Asia
24 June 2005

Goldman goes 'unsolicited'
Investment bank and J.P. Morgan would provide financing
By David Weidner, MarketWatch
23 June 2005

Gordon Housworth



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