Applications for new patents in China have increased exponentially and will surpass Japan, the current leader in new patents, by 2012, according to a report released on December 10 by Thomson Reuters Scientific. “China, from humble beginnings, is experiencing the most rapid growth,” said Bom Stembridge, a Thomson Reuters spokesman.


Indeed, intellectual property (IP) has become hot property in China. The total number of patent applications in China now exceeds that of the United States: In 2007, there were 694,153 patent applications in China, compared to 468,330 in the U.S., representing a yearly growth rate of 21% in the former, compared to a 5% rise in the latter.


“China is on the verge of becoming a major technology and IP generator, creating a tidal wave of patents likely to wash over the U.S. and Europe’s shores in the next two decades, enabling China to dominate significant technology areas,” Ian Harvey, chairman of the Intellectual Property Institute in London, wrote in a report published this year. “Chinese companies and universities have begun to realize that if they can invent the next generation of high definition television, or mobile phones, they could be significant players in setting global standards,” he notes.


This is likely to come as a surprise to many. China is known as the world’s low-value-added manufacturing base, with companies lacking their own technology and brands, and has gained a reputation for being a hotbed of intellectual property abuse. Nevertheless, experts confirm that Chinese companies’ newfound enthusiasm for patenting has taken place against a much improved intellectual property environment in the country’s economically developed cities. This trend has been driven by greater central government will power, and intensive capacity building efforts.


Experts interviewed by China Knowledge at Wharton attribute the rapid development in IP awareness and protection to a recognition on the part of the Chinese government, business and research institutions that IP is central to ascending the value stream. Nevertheless, many problems remain. Despite training programs of impressive proportions, for instance, the patent registration process suffers from severe staff and expertise shortages that will take time to tackle. Meanwhile, activity in counterfeiting hotspots has intensified, and may be aggravated by the economic downturn.


Despite the lingering problems, however, there are clear implications for foreign companies: Experts say firms should work to understand and utilize China’s more effective IP regime. Indeed, as they turn in ever greater numbers to China as a research and development base, multinationals are increasingly doing so.


IP Rights and Wrongs


As in Japan and Korea before it, IP abuse in China has followed on the back of a manufacturing boom. Counterfeiting affects a range of industries, extending from advanced pharmaceutical products to low-end DVDs. This has won China a poor reputation for intellectual property protection, and drawn international ire, most vocally from the United States.


The counterfeiting landscape within China may be more nuanced than is commonly realized, experts suggest. Luke Minford, country manager for Rouse & Co International, an IP consultancy, says that although counterfeiting is increasingly pronounced in China, it is a geographically specific phenomenon. “There are counterfeiting hotspots, with quite rampant local protectionism and corruption,” he explains. These pockets have sprung up in manufacturing centers across China. “There are some areas where you have very concentrated industries around particular technologies,” Minford says. In some cases, these areas have concentrations of state-owned enterprises or workers with particular skill sets to support, but are not competitive enough to attract foreign investment. Protectionism and counterfeiting have become increasingly entrenched. “You’ll tend to see a very different approach taken by the authorities, and local industry, because there’s a vested interest in that particular IP,” he says.


However, although it has a high profile, Minford believes counterfeiting does not top companies’ IP concerns: Firms tend to treat it as a fact of life that can be mitigated. Rather, joint venture issues take precedence. “Danone is a great example,” he says. The French food and beverage maker has accused joint venture partner Wahaha of selling products that competed with those of the joint venture under its own trademark, but has seen little vindication in the courts. Minford notes this case is far from unique: Controlling IP and making sure it is not leaked are issues on which his advice is often solicited. “Protecting knowhow and trade secrets is currently a very hot topic,” says Minford.


Gigantic Strides Forward


Despite these persistent problems, however, observers praise China’s efforts to improve its intellectual property regime. “China has made gigantic strides over the last 15 years,” says Minford. Its IP environment is a world apart from when he began dealing with IP issues in 1997. “There are large parts of China where the counterfeit levels and the attitudes to counterfeiting have changed fundamentally,” he says. “You can do whatever you need to stop it and deal with it.” Indeed, all first-tier, and many second-tier Chinese cities now offer a good environment for IP protection, Minford reports.


China’s National Intellectual Property Strategy, launched in June this year, is starting to take root, he says. “I think people are starting to take it very seriously,” Minford says. “The courts are starting to get it – certainly in Beijing, Shanghai, Shenzhen and Guangzhou.” The strategy, and European Union-supported training designed to raise courts’ understanding of IP law, are having concrete effects. “You are seeing much greater levels of damages [awarded],” he says.


Ian Harvey of the Intellectual Property Institute gives little credence to many popular criticisms of China’s IP regime. These include complaints that China’s IP laws are unsophisticated, enforcement is poor and that the system is biased in favor of domestic entities. “I’m afraid that a lot of the criticism comes from either policymakers or businesspeople who don’t understand IP,” he comments.


Frustration sometimes comes from the fact that China is a civil law system. Many companies, especially those from common law jurisdictions such as the UK, assume that if you are the first to use a technology in a marketplace, you thereby own the rights — which is not the case in China, Minford explains. “China is a civil system, which means in most cases you need to register your IP with the relevant authorities,” he says. Trademarks and patents need to be registered. “The number-one rule is: get your rights in place,” Minford advises.


Generally, however, faith in the system is rising. “There’s more patent litigation in China than in any other country,” notes Harvey, a past chairman of the UK Government’s Intellectual Property Advisory Committee and a former CEO. “98% of it is [one] Chinese company suing [another] Chinese company,” he notes, “which suggests to me that Chinese companies think that intellectual property is useful for their companies, and secondly that they think their judicial system is worth using.” Moreover, when foreign companies sue over patent infringements, they enjoy a success rate above 90%, Harvey says, compared to a mere 35% success rate for overseas companies suing U.S. companies in U.S. courts. Likewise, litigating a patent in China is relatively cheap (US$60,000 to US$120,000, versus US$5 million in the U.S.) and enforcement is fast (12 to 14 months to enforcement, as opposed to five to seven years in the U.S.).


In many cases, foreign companies’ IP “wounds” are self-inflicted, Harvey argues. For instance, many companies don’t have IP staff in place, and some are reluctant to use the legal system for fear of upsetting government officials. Given the improvements in China’s IP environment, Harvey recommends companies establish IP bases in China, search for their new technologies there, and forge relationships with Chinese technology partners.


Problems and Solutions


None of this is to deny, however, that China still has significant challenges to deal with if it wants to live up to its ambitions. Despite the upswing in domestic patent registrations, experts suggest that the quality of the IP being created, and of some patents, is questionable.


“There are some poor Chinese patents,” says Harvey. Staff shortages and expertise deficits in the patent registration process, for instance, are widely recognized problems. Despite generating roughly the same number of patent applications as the U.S., China has just one-third the number of patent examiners, notes Harvey, while around 70% of these have less than two years’ experience — “a gigantic training issue,” Harvey notes. (It takes at least five years to become a “reasonably experienced” patent examiner, Harvey says.) Moreover, he adds, in order to improve the image of China’s IP system, the most capable examiners are put to work on foreign applications. While this benefits foreign companies, Chinese firms may suffer.


China is responding by recruiting between 300 and 500 patent examiners per year – more than the total number of examiners in the United Kingdom, says Harvey. He urges China’s critics abroad to show patience and support: The U.S., for instance, has suffered from similar problems during patent booms in the past, he notes.


Like Harvey and Minford, Shang Jiangang, a senior partner at Shanghai Diligence Law Firm, which specializes in IP issues, also rejects many sweeping criticisms of China’s IP environment. Nonetheless, he points to remaining deficiencies, including an inconsistency in legal judgments. China’s judicial system tends to be strongly influenced by the lobbying of big commercial consortiums, he adds. As a result, it tends to protect their interests excessively, rather than promoting social fairness and encouraging creativity.


Furthermore, in Shang’s experience, Chinese courts tend to extend disproportionate protection to foreign brand names: Shang has acted as a defense attorney in nearly 50 cases in which foreign companies have attempted to recover internet domain names already in use in China, but he has lost 90% of his cases. Recently, in a comparable case in the United States, the defense was upheld, he notes.


Shang adds that government incentives, provided in the form of patent subsidies, are a relatively blunt instrument. He believes a more long-term approach is called for. Indeed, many observers draw attention to the fact that most new Chinese IP does not represent technological innovation. Of the 288,331 domestic patents granted between January and October of this year, a mere 13% were for classified as “inventions” on the State Intellectual Property Office website. (The remainder were for “utility models” and “designs.”) “There is still a huge lack of sophistication and knowledge about how to create valuable IP,” says Minford. Much greater investment is required in educating Chinese companies in how to produce value from an IP portfolio, he notes.


As for foreign companies’ shortcomings, Minford describes how awareness of the need to register rights and confidence in the system have improved. In the past, firms often held back from registering — partly out of concern that, due to poor enforcement mechanisms, it would be difficult to protect patents once they had been made public following registration. “Ten years ago, most companies would have said, ‘We will not register a patent in China unless there are strategic reasons to do so.’ And now, it is the opposite of that: Most companies will say, ‘We must register our patents in China unless there are strategic reasons not to do so.’” Nonetheless, Minford notes that companies do not necessarily create particularly strong portfolios – by omitting important elements, for instance. “Make sure that you have a robust portfolio of rights that you can actually rely on,” he advises.


On the counterfeiting front, Minford is concerned that the economic crisis may cause an upsurge of activity in hotspots, as a last line of defense against factory closures and rising unemployment. Companies therefore need to be prepared, he says. But just as things seem poised to take a turn for the worse, financial crisis-induced budget cuts may harm firms’ anti-counterfeiting efforts. “There’s a potentially lethal combination there,” he warns. In a year or two, the Chinese market could actually be “much more exposed” to counterfeiting.


IP and Innovation


Another common complaint about China’s IP environment is that the central government is apathetic towards protecting IP. Counterfeiting provides too many jobs and Chinese companies do not yet stand to gain enough to make stringent enforcement worthwhile for China, runs the argument.


While acknowledging that the situation is not clear cut, Minford, among others, is convinced that the central government now places a high priority on IP. “The Chinese recognize that it’s a path that they have to take, and they have to do it in a measured way, but they’ve got to do it as quickly as they possibly can,” he says. “China is going down that path more quickly than Japan did, and more quickly than Korea did.” A third revision of the patent law is expected to be passed early next year, and the government has made dealing with counterfeits a top priority for the first time.


Creating an innovation-based society has become a top government priority, Minford notes. “Innovation is all about IP,” he says. The government wants to encourage China’s shift away from being a low-cost manufacturing base toward industries higher up the value chain. “An inevitable consequence [of this] is that Chinese companies have to start developing their own IP, and [they] have to move away from copying,” he says. “It’s now right up at the very top of the agenda.”


Philips: Shining a Light on IP


An improved IP regime supports a key pillar of the Chinese government’s strategy to hasten the country’s journey up the value chain — a switch towards seeking to attract higher quality foreign investment, including in research and development facilities. China’s ability to do so will partly depend on the quality of domestic IP protection.


Multinationals’ R&D activities in China have been the subject of some skepticism, with some observers dismissing them as window-dressing or unproductive. “At present, financial and other inputs into foreign-owned R&D centers seem high compared to observable, innovative output,” write Rebecca Ordish and Alan Adcock in their book, China Intellectual Property Challenges and Solutions: An Essential Business Guide (John Wiley & Sons, 2008). At the same time, Ordish and Adcock also point out that these are still the early days. Indeed, many R&D centers have opened in a recent wave: Chinese R&D facilities are becoming increasingly important for multinationals. But is it possible to protect IP while doing R&D in China?


Harvey points to Philips as one example of success. The Dutch multinational has 12 R&D centers in China (including the company’s Asian R&D hub in Shanghai) with nearly 1000 full-time staff, and carries out collaborative research with universities and others. In concert, the company employs a range of strategies to protect its IP.


The main instruments we use to protect our innovations are educating our staff on IP-related issues and retention of our people,” says Jimmy Zhong, Vice President of Philips Intellectual Property & Standards. The company employs nearly 50 IP professionals to look after its interests, and utilizes local government relations when problems occur. “Last year alone, we did more than 420 raids in [