Signs
of China embracing global market rules abound, from Beijing's decision
to loosen its currency's peg to the dollar to the willingness of
Chinese companies to pursue acquisitions abroad. But one thing never
seems to change, and it's as obvious on street corners today as it was
six years ago. In 1999, when "Star Wars Episode 1 - The Phantom Menace"
debuted, it was quickly pirated on DVDs that sold throughout China for
next to nothing. Fast forward to May 2005 - four years after China
joined the World Trade Organization and embraced its stringent rules on
intellectual property rights. When "Star Wars: Episode III - Revenge of
the Sith," opened in U.S. theaters, copies again hit the streets of
Beijing within days. Sold out of bicycle baskets by roving vendors,
available in mom-and-pop retail stores everywhere, the counterfeit DVDs
retailed for about 75 cents each.
For movie executives, those DVDs drove home the fact that their
ongoing fight against counterfeiters has basically made no headway.
Frustrated, Motion Picture Association of America president Dan
Glickman recently raised the prospect of a push for action at the World
Trade Organization. Indeed, the MPAA is part of a Washington,
D.C.-based coalition of copyright companies now working with the U.S.
Trade Representative to study the possibility of taking China before
the WTO to compel a genuine crackdown. Given the tough sanctions
provided by the WTO's Trade-Related Intellectual Property Rights
agreement, such a move would have major diplomatic implications - at a
time when the U.S. urgently needs Chinese help on North Korea and other
issues.
The new, harder line says much about the level of exasperation among
foreign companies in China. They can't afford to stay out of such a
large and potentially lucrative market. They're well aware they face IP
theft there. But the extent of piracy - which continues to escalate,
according to a 2004 white paper by the American Chamber of Commerce in
China - still catches many off guard. The problem affects virtually
every industry, from films to software to drugs to auto parts. What's
more, as China's exports have surged in recent years, so have
counterfeit exports. About two-thirds of pirated goods seized by U.S.
Customs come from China. Though it's difficult to place a value on
financial losses, the U.S. Trade Representative estimates that
counterfeiting worldwide costs American companies around $200 billion
to $250 billion per year, with China likely responsible for the
majority of those losses.
What's standing in the way of better intellectual property rights
enforcement? "It's not a plot," says Bruce Lehman, former commissioner
of the U.S. Patent and Trademark Office and the chairman of the
International Intellectual Property Institute. "It's the result of a
system in transition." Lehman, who's also senior counsel at Akin Gump
Strauss Hauer and Feld LLP, points out the contradictions: On the one
hand, senior officials are earnestly discussing business-method
patents. On the other, there are events such as the decision last year
by the State Intellectual Property Office to invalidate Pfizer Inc.'s
2001 patent on Viagra after Chinese drugmakers had challenged it. "That
was kind of mysterious," says Lehman.
There isn't a shortage of laws, or of high-level promises. The
latest: in a visit to China in July, U.S. Commerce Secretary Carlos
Gutierrez won a pledge from government officials to increase criminal
prosecutions in cases of IP theft. But while the laws on the books in
Beijing exceed WTO obligations, local authorities in this sprawling
country usually lack the resources and motivation to enforce them.
"China is very fragmented, so even if there was a lot of political will
behind this, you would see local protectionism get in the way," says
Clement Ngai, legal counsel in Asia-Pacific for software maker Autodesk.
The enforcement organizations are a bewildering hodgepodge of
agencies and their divisions, some with overlapping authority. Among
those involved are the Administrations for Industry and Commerce, with
its Trademark Division and Economic Supervision Division; the Technical
Supervision Bureau; Copyright Administration offices; the customs
authorities; and the Public Security Bureau, with its Social Order
Divisions and Economic Crimes Investigation Divisions.
There are cultural issues as well. Many Chinese see strict
intellectual property-rights enforcement as a zero-sum game in which
foreigners benefit and Chinese lose. Historically, the act of copying
hasn't necessarily had negative connotations: in painting and
calligraphy, Chinese artists sought to mimic acknowledged masters. Too,
under Communism people grew up believing assets should be shared
resources. "The arguments we hear from the Chinese side are, 'Please
lower the prices and then we won't pirate,' " says Thomas Pattloch,
chairman of the European Union Chamber of Commerce Intellectual
Property Rights working group and an attorney in the Shanghai office of
Schulz, Noack and Barwinkel.
| An IP wish list for China |
| For
a nation that didn't even enshrine private property rights in its
constitution until 2004, China can claim some real progress on
modernizing its protection of intellectual property rights. But with
counterfeiting and piracy still rampant, foreign executives would like
to see much more. Specifically: |
| • Sponsor a nationwide public education campaign to discourage piracy |
| • Improve market access for legitimate goods to reduce the large black market for illegal copies of films, books and music |
| • Criminalize corporate end-user piracy for goods such as software |
| • Ensure local copyright offices are well-staffed and motivated to pursue infringement cases |
| • Shorten the time necessary to process patent applications, currently as much as five years |
| • Improve coordination among the many government departments assigned to deal with IPR |
| • Improve transparency by publishing decisions of IPR agencies and courts |
| • Publicize criminal and administrative penalties imposed on copyright violators to discourage other counterfeiters |
|
|
With no relief in sight, foreign companies in China are
developing counter-strategies that aim at the very least to make life
more difficult for wrongdoers. A recent study by McKinsey & Co.
(described in the McKinsey Quarterly) found a pharma company
withholding its most innovative drugs from China altogether, and an
equipment manufacturer that designs and develops hardware in China but
produces the related software abroad, to protect the valuable source
code. Other measures run the gamut, from the political (lobbying and
diplomatic pressure) to the technological (tagging goods to make them
harder to copy) to the instructional (training local police to spot
fakes) to, at last resort, the judicial (filing lawsuits against
offenders).
The diplomatic pressure has been steady. In a strongly worded
January speech in Beijing, then-U.S. Commerce Secretary Donald Evans
complained that in China, token fines for counterfeiters amount to
"simple business expenses." He demanded stronger policing against
intellectual property theft.
Evans' comments underscore one of the leading complaints about
piracy in China: that the government has responded with only token
(albeit widely publicized) confiscations of fake goods that fail to
stop the wrongdoers.
Between 2000 and 2004, law enforcement officials seized nearly 500
million DVDs. But the MPAA, whose members lost an estimated $280
million in China revenue last year due to piracy, says that more than
99% of raids only result in administrative fines.
Indeed, foreign executives complain that part of the reason the
piracy problem is so severe is that China rarely takes criminal action
in the case of IP theft. Here, too, there's a cultural divide. "In
China," says Pattloch of the EU Chamber of Commerce, "criminal measures
against private citizens involve a complete loss of face; you lose your
status."
Yet in the absence of criminal penalties, civil penalties are often
inadequate. Fines against counterfeiters are usually too low to act as
deterrents, and U.S. companies report that such fines have actually
been declining. China's Administration for Industry and Commerce levies
fines based on the counterfeit value of seized goods, which is usually
supplied by counterfeiters themselves. Fines typically end up being
between one-fourth and one-eighth of the value that injured companies
would have considered fair, according to James Haynes, co-chair of the
AmCham-China's IP forum and a partner in the Beijing office of the law
firm Tee & Howe. For 52 cases of copyright infringement involving
the movie "Shrek 2," for example, government officials imposed total
fines of $7,000, or around $134 per incident.
The upshot: Last year in China, roughly 95% of films were pirated -
a rate unchanged from 2003, according to Mike Ellis, the MPAA's
regional director in Asia. The fact that official Chinese policy is to
allow in only 20 foreign films per year makes it even harder to do a
legitimate business.
Over the years, counterfeiting in China has become more
sophisticated. Geographic regions and even cities may specialize in
particular types of fake goods, such as DVDs or shoes, with much of the
production concentrated in the southern coastal provinces of Zhejiang,
Fujian and Guangdong. A given factory may do legal production in the
daytime, only to switch to fakes at night. Some of the most advanced
schemes span borders. Bankrolled with Taiwanese money, they produce
goods in China that are later exported abroad from Hong Kong.
Back on the mainland, the economic boom has carried piracy far
beyond the big cities, and local authorities usually see little reason
to crack down on their own constituents in order to help outsiders.
Case in point: earlier in 2005, the Business Software Alliance, an
anti-piracy group whose members include Microsoft Corp., Cisco Systems
Inc. and Intel Corp., suspected that a company in the central coastal
province of Jiangsu was using unlicensed copies of software. It
appealed to the copyright office to conduct a raid. But local
authorities in Kunshun City foiled the plan when they insisted on
notifying the companies beforehand.
Pfizer's experience highlights the difficulties that the big pharma
companies face in China, which has some 6,000 drugmakers of its own,
most of them manufacturing generic medicines. Pfizer needs to press
ahead in China, which already ranks among the 10 biggest global drug
markets. But since the Viagra patent was invalidated in July 2004, the
going has gotten tougher. Responding to Chinese drugmakers who had
challenged the patent, the state agency invoked guidelines laid down
after the patent had been issued and claimed the pharmaceutical firm
didn't disclose enough information in its filing. Pfizer, which says
the patent approval process involved seven years of evaluation and two
years of review, has appealed the ruling. In the wake of the Pfizer
case, GlaxoSmithKline, facing a similar challenge from Chinese rivals,
gave up efforts to protect its patent on Avandia, a diabetes drug.
Besides worrying about patent protections, drugmakers in
China must contend with a sizable counterfeit problem. The threat of
copycat products has particular urgency: Already, thousands of Chinese
are reported to have died from the ill effects of fake medicine. One
source suggests that 10% to 15% of medicine in China is counterfeit,
primarily in rural areas beyond the reach of central government
authorities. AmCham-China argues that local enforcement authorities pay
more attention to rooting out fake drugs of substandard quality than to
shutting down counterfeit drugs altogether.
Now counterfeit medicine made in China has begun showing up in the
U.S., too. Pfizer, which taps China as the world's leading supplier of
counterfeit drugs, says one major China-based distribution network sent
counterfeit Viagra to as many as 30 brokers worldwide, including some
in the U.S. A formula for counterfeit Viagra that was found in Shanghai
was also discovered in tablets seized in the U.S. and 17 other
countries.
In response, Pfizer is starting to use radio frequency
identification tags to help pharmacies authenticate Viagra sold within
the U.S. and introducing security packaging with a special logo that
changes colors from purple to blue. Separately, in a bid to help shut
down pirate drug factories, Pfizer has begun training intellectual
property rights enforcement officers in Shanghai to identify fakes and
authenticate genuine drugs.
Pfizer's experience also shows the political challenges involved in
asserting IP rights in China. The issue is a sensitive one with the
government - and overt public criticism can backfire. Following a May
2005 talk at a Beijing business conference in which he asserted that
two-thirds of global counterfeit drugs come from China, a prominent
Pfizer executive made a public apology.
The software industry, which has also been hard-hit by piracy, has
employed a combination of punishment and cajolery to deal with
counterfeits. China ranks among the world's worst offenders: about 90%
of the software installed on PCs in the country is pirated, compared
with an average of 35% worldwide and only 21% in the U.S.
The Business Software Alliance estimates that in 2004, software
piracy in China cost its members $3.5 billion in lost revenues - the
second-highest rate of dollar losses in the world, after the United
States' $6.6 billion in piracy-related losses.
To deter offenders, the BSA runs radio and Internet ads in China
with a hotline number offering rewards of up to $3,600 for tips about
companies using unlicensed software on the sly (the industry considers
unlicensed corporate use of software a far greater business threat than
individual acts of software piracy). Armed with a promising lead, the
BSA can press the local copyright administration office to conduct a
raid.
Last year the BSA held a handful of software asset management
seminars in major cities explaining how companies and government
agencies could derive the greatest financial benefit from legally
purchased software. Three hundred fifteen companies showed up, and the
BSA expects to expand the number of seminars to be held in 2005.
There is one bright spot within the software industry: computer game
makers. Only a few years ago, when they were still struggling to get
established in China, they mostly sold retail games for home use. But
business was plagued by piracy rates as high as 98%. Then the game
makers shifted from retail distribution to secure servers in Internet
cafés.
"You can now make an investment and expect a return; that's key to
investing in new IP," says Erick Hachenburg, general manager of China
operations for Electronic Arts. "Until the online gaming model emerged,
there was no way for us to justify a major investment in China."
Electronic Arts, which has begun staffing an office in Shanghai, plans
to make its first online games available in China by next March.
But examples like the gaming industry are exceedingly rare. With few
alternatives to deal with counterfeiters, other multinationals have
resorted to warning consumers of the dangers of fake goods - including
GM, which estimates that upwards of 30% of auto parts sold in China are
fakes. "Counterfeits made of low quality materials may imperil the
lives of you and your loved ones," counsels a message on GM's Chinese
Web site. "Imagine the results if a brake pad made of sawdust was
installed in your car. This actually happened."
Pirated auto parts may be the least of GM's IP problems in China,
though. In May its GM Daewoo unit filed suit against a local rival that
allegedly filched an entire car design. According to GM Daewoo, Chinese
automaker Chery Automobile's QQ model has a body structure, exterior
and interior design, and components all identical to its own Spark
model. In his January speech in Beijing, then-U.S. Secretary of
Commerce Donald Evans said the incident "defies an innocent
explanation," and was "especially troubling" because Chery Automobile
is partially owned by the local government.
When prevention fails - as it usually does in China -
companies are increasingly resorting to the courts. "This is becoming a
trend in China, that companies would rather go straight to court to
create more publicity and make the point that they're serious," says
Autodesk's Ngai. He adds that Autodesk, which has been in China since
1994, was the first foreign software company to sue a domestic user for
copyright infringement and win. In 2002, it won a landmark case after
proving that a Chinese TV production company was using an unlicensed
version of a highly specialized, $200,000 software product. Including
that case, Autodesk has since received favorable settlements in about
half a dozen cases, according to Ngai.
But no one would argue this is a simple process. An initial
investigation can cost tens of thousands of dollars, and that's just
the first step. Next a company must decide whether to pursue a case on
a criminal or civil track. Typically, if an investigation has uncovered
pirated goods worth at least $6,000, the injured party can press the
government agency known as the Public Security Bureau to take a
criminal case to court. But counterfeit goods are difficult to value,
and it's the company that suffered the loss - not the government agency
- that shoulders the burden of proof. Many companies opt instead to
file an administrative complaint, though this can be complicated due to
China's decentralized enforcement system. Standards vary in different
cities and provinces over what constitutes a copyright infringement.
When it comes to litigation, multinationals also must be prepared to
navigate China's "first to file" system. Though the U.S. is considering
moving to such a standard (from its current "first to invent" system),
first-to-file can pose problems for foreigners in China.
Xiang Wang, a Shanghai-based intellectual property lawyer at the
firm of Jones Day, says he's dealt with a number of lawsuits involving
local companies that either copied a Western patent or publication or
slightly modified it, then filed for and obtained a patent in China.
They might even use their Chinese patent to sue the legitimate Western
patent-holder. Some of the more hopeful China watchers point out that
economic development tends to usher in greater respect for intellectual
property rights. With continued growth, they say, China's stratospheric
piracy rates might drop a little. Market research firm IDC found in a
study that, of the 57 countries that buy most of the world's
information technology, nearly two-thirds had managed to reduce
software piracy rates by 10 points since 1996.
Autodesk's Ngai says he's already seen a change in mentality, at
least in the more developed regions. "In the '90s when you talked to
these companies, they'd admit [to piracy]. The idea you have to pay for
the software was at that time alien; they'd laugh at you if you paid
for it." In what counts as progress, he says, "Now, none of them will
admit they're using illegal software. They know it's not the right
thing to do."
Adds Jeff Hardee, the BSA's vice president for Asia: "If the
[Chinese] government wants to grow the IT sector, it pays to invest in
bringing down piracy levels. Software piracy affects all software
publishers, Chinese included."
While that's true, it will probably take years for China to develop
many of the kinds of companies that require IP protection. In the
meantime, multinationals will no doubt keep coping with piracy as best
they can. Given that they probably can't prevent it, some may even
think of it as a backhanded compliment. "If you're successful in China,
you may very well have problems," points out AmCham-China's Haynes. "If
you're not successful, then no one will want to counterfeit you." - K.C. Swanson
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