The Hutong view of the intellectual property issue in China

Beyond Intellectual Property: The Counterfeit Dilemna

Covering a major issue, The Washington Post once again only manages to cover a single dimension.
In a story written by special correspondent Wang Ting in Shanghai, the Washington Post noted today that the Chinese public has a growing taste for brand-name luxury items, but that many of China’s consumers – even relatively prosperous ones – were choosing fakes over the real thing.

Counterfeiting is a severe problem in China, and while fake Dior, Cartier, and LV make really good press, an equally and arguably more serious problem lies in the faking of fast-moving consumer goods. A fake Cartier watch making it to New York may deprive maison Cartier of a sale (and it might not, since anyone in New York who could afford the real thing would probably buy it), a fake watch probably never killed anyone. But counterfeit edibles certainly could, as has happened in the case of one international beer manufacturer and reportedly in other cases as well. Worse, some firms are even starting to knock-off complete cars. For the technology industry, the problem is at least a $10 billion a year issue just in the case of electronics, and China is perceived as the key.

A far better piece on the problem – and one that, quite politically incorrectly does not leave the unspoken impression that China is the center for all such evil – was written up in The Economist last year, and you get a broader perspective on the issue in China from Ed Young’s outstanding feature on Brandchannel from a few years back.

The standard approach to these issues has been to hire investigators and attorneys, and in many cases they can be quite effective. Probably one of the best counterfeit investigators in China, Peter Humphrey, did a presentation (pdf here) not to long ago to the Swiss Chamber of Commerce in Beijing that gave a good explanation of the micro-issues surrounding counterfeiting.

But counterfeiting is not a simple problem to solve, and indeed part of the challenge for the wide range of institutions, companies, and individuals seeking to fight it is that counterfeiting is actually several problems.

First, counterfeiting is to some extent a legal problem. China’s laws on protecting intellectual property rights have long lagged the rest of the world. But in recent years, and in particular in the wake of China’s accession to the WTO, legislators and policymakers have stepped up to the plate and an international-standard legal framework is emerging with fairly respectable rapidity.

This leads us to the second problem, which is enforcement. Enforcing intellectual property rights requires well trained investigators, good intelligence, solid security, sharp tactics, and a legal bench prepared to do more than slap the wrists of offenders. This requires a highly professional law enforcement community (China is getting there, but it will be a long haul, especially in the provinces), and one that is divorced from the self-interests of local government. You see, the funny thing about counterfeiters is that through employment, use of services, taxes, and outright payoffs, these enterprises actually do much to support economies in areas that have not yet enjoyed the full benefits of development. Shutting down a counterfeiters factory is a pretty straightforward process. Replacing the jobs, the income, and the local political stability that factory brought is far more tasking. It is this prospect as much as anything else that hobbles enforcement.

In recent years Beijing has turned to its domestic paramilitary police arm, the People’s Armed Police, or the Wujing, (founded in 1990 to ensure that protests are never again handled by an inappropriately trained and armed force) to engage in enforcement. But this carries with it an implicit danger by compelling local groups (counterfeiters, government, police, and, God forbid, the general populace) to band together in defiance of a team from Beijing. Apart from the tactical damage that such defiance brings (lets the bad guys get away), it also foments about a situation when a local government is facing down Beijing. In the context of the center-periphery strains implicit in Chinese politics, that is an extremely dangerous scenario. All of the above combine to make tactical enforcement highly problematic. The issues surrounding judicial performance in this area could be (and might be) the subject of another feature, but suffice to say that the best tactical execution of a counterfeit bust can all be for naught when an adjudicator sees matters in a different way.

The third problem is internal. Many companies (as Peter Humphreys alludes to in his presentation) find that the primary source of counterfeiting is coming from a cabal operating within its own ranks. Peter likes to explain how one fast-moving consumer goods company discovered a group of employees that was over-ordering packaging, sending it on to factories that were making fake product, and fulfilling orders from the counterfeit factory – orders that never showed up on the FMCG company’s books and that ensured that counterfeit product in legitimate packaging went to the legitimate outlet.

Another challenge comes from the factory. A wholly-owned or contract factory for a luxury handbag manufacturer takes an order from Milan (or an ASICs order from Tokyo) for, say, 10,000 pieces. The manufacturer makes 10,500 to prepare for production or quality problems. Inspectors clear 10,000 pieces in the shipment. To recoup the cost of the extra product, the factory manager dumps 500 pieces (including the quality problems) onto the domestic black market. Result? The real thing, but companies loose money. The infusion of “off the back of the truck” merchandise like this continues to grow, but it is not a problem that is being tracked.

Finally is the matter of the consumer. Most consumers don’t understand the difference – indeed the value – of buying the real thing over the fakes. As important as it is to have an external environment and internal systems that discourage counterfeiting, in the long run consumer education will be the critical tipping point. If a company can make a better bag than a counterfeiter, that value needs to be made clear, as does the critical social statement someone makes by buying from a legitimate businessperson rather than a supply-chain owned and managed by organized crime. Certainly the idea of handing a growing amount of power and control to criminals in China would give anyone here pause if the prospect of the nation evolving into a Russian-style kleptocracy were made clear.

Projectile Dysfunction

The coming showdown over the State Intellectual Property Office’s decision to void Pfizer’s Viagra patent will likely be long and ugly. If the past is any guide, the heavy media focus on the IPR protection problems around Viagra will lead many to conclude that the IPR issue is the primary cause of Viagra’s commercial failure in China.

The full blame cannot be laid on China’s failure to protect Pfizer’s intellectual property. Distribution issues caused by the government’s determination that Viagra is a controlled substance certainly were a contributing factor.

But if one were to dig deep enough into the Wall Street Journal story covering the government’s decision, one would find that Pfizer itself suggests the problem was caused by inadequate information filed with the original patent application. While the information was not required by the government at the time, the government is apparently requiring the data retroactively. Pfizer has 3 months to file an appeal along with the data. Given the saber-rattling going on today, smart money in Beijing has SIPO granting the patent again once the information is filed.

One also discovers that Pfizer never tried to patent the compound. There could have been a range of reasons for this.

Finally, the story notes that a coalition of Chinese pharmaceutical companies are the proximate cause for the voiding.

This entire case makes a few important points:

1. Chinese intellectual property law continues to evolve. Even if you have patents, copyrights, and trademarks in China, you are likely to have to keep watching the law, because today’s protection is tomorrow’s loophole.

2. Don’t count on intellectual property protection to create a market position for you in China. Market position needs to be built the old-fashioned way – branding, distribution, positioning.

3. The locals are a powerful force if allied against you. Don’t let those alliances grow by being aloof – find strong local partners (either in manufacturing, the channel, or among key advocates) and make them your shield against this kind of ambush.

Standards that Kill

As the Chinese government works to help its local firms develop and commercialize technology standards, overzealous bureaucrats appear to be using government mandated standards to allow local developers a leg up. But by making China a proprietary island in a sea of standardization, policymakers risk shutting Chinese industries out of the global game.