Learning to Play Fair in China

Multinationals are gaining in their demands for patent royalties from Chinese makers of DVD players, thanks to Beijing's WTO membership

By Bruce Einhorn

During the tortuous negotiations over China's entry into the World Trade Organization, advocates of Beijing's application said that its admission to the global trading club would help foreigners as much as it would China. WTO membership would get the Chinese to play by internationally accepted rules of trade, benefiting foreign companies that had long suffered unfair treatment. Since Beijing joined in December, 2001, have foreign companies actually seen any benefits? It's still early, but if you look at what's happening to companies that own patents on DVD technology, the signs are good.

Start with Apex Digital, a Chinese manufacturer of DVD players that has enjoyed a meteoric rise. Founded in 1998 by two Chinese-American businessmen, Apex is a leading importer and distributor of made-in-China DVD players. While it can't compete with rivals like Sony and Panasonic on name recognition, the company's low prices -- some Apex machines sell for less than $70 -- have made the brand a hit with U.S. consumers. Revenue last year reached $1 billion. Apex, which does its manufacturing in China's Zhejiang province but has its corporate headquarters in Ontario, Calif., sells more DVD players in the U.S. than any other company.


  Rivals claim that Apex has grown so quickly because of widespread flouting of intellectual-property rights. An Apex spokesman denies any wrongdoing, but companies that own patents on DVD technology contend that Apex is indeed one of many Chinese manufacturers and distributors that have refused to pay royalties for the use of essential technology.

Philips, AOL Time Warner, and Matsushita are among the companies alleging that they're suffering because of Chinese violations of their intellectual property rights. In early April, an exasperated Sony filed suit in New York against Apex. Within days, the Japanese electronics giant dropped the suit, and Apex agreed to begin paying royalties to Sony, as well as to Philips and Pioneer.

Apex may be the most high-profile example, but the multinationals accuse roughly 100 other Chinese DVD-player manufacturers of not playing fair. Lately, the foreigners and the Chinese have been making some progress in resolving the dispute, and chances are good that more companies soon will be following Apex' lead and paying royalties (see BW, 5/13/02, "Twilight of China's DVD Pirates").


  A spokeswoman for Toshiba says it and five other companies in its negotiating group (Hitachi and AOL Time Warner among them) want $4 or 4% -- whichever is higher -- of a DVD's selling price. While that doesn't sound like a huge amount, if you consider how thin the margins are for many of these Chinese manufacturers, the royalties can wipe out almost all of their profits.

Why has it taken so long for the Chinese companies to come around? Why haven't they been paying royalties on DVD players? Let's give the Chinese manufacturers the benefit of the doubt and assume they always had every intention of following the rules.

Tian Yujing, a senior engineer at the China Electronical Video & Audio Industry Research Institute, offers a sympathetic point of view. The whole dispute, she says, has been the result of a big misunderstanding: Chinese didn't mean to be stiffing the foreigners but were simply confused. Two years ago, when the multinationals first started pestering them about the royalty issue, the Chinese said there was no need to pay.


  "We just buy their parts, not the technology," says Tian. "All of us believed that you pay 'tuition' when you learn the technology." And since the Chinese weren't learning the technology, it was only logical that they didn't need to make their tuition payments.

The other day, I talked to Apex spokesman Colton Manley, who offered some other explanations. First, he said the foreign companies hadn't registered their patents in China, so paying royalties was a legal gray zone. Then Manley mentioned that he had spoken with his boss, Apex Chief Executive Officer David Ji, who founded the company in 1998 with Ancle Hsu. According to Manley, Ji -- who has been doing business in China for years -- had an easy answer to why the Chinese manufacturers don't pay: "They don't want to."

There's probably some truth in all those explanations. The intricacies of intellectual-property law aren't easy to master, and small Chinese companies don't have a lot of experience in coping with them. And for the longest time, they haven't really felt the need to do so since the government didn't pay much attention to making sure that companies respect foreigners' intellectual property, especially when associated with software. As a result of that neglect, China has quickly become a major exporter of DVD machines, selling more than 10 million players last year alone.


  To be fair, Chinese companies aren't the only ones to avoid paying royalties. But with the patent-holders increasingly serious about cracking down on scofflaws, some companies are thinking of paying up -- or simply getting out of the business.

Take Sampo Group in Taiwan. A maker of consumer electronics and home appliances, it has been producing DVD players for years without paying royalties. Now that the pressure from multinationals is growing, the Taiwanese company may just give up on the business. Instead, says President and Chief Executive Officer H.C. Ho, Sampo may concentrate on producing components -- which don't require royalty payments. "Once we do that," says Ho, "we can skip the legal issue."

Like China, Taiwan is a new member of the WTO. It's probably no coincidence that multinationals are making progress now that both China and Taiwan are members. Since Beijing's leaders are keen to show foreign investors that China intends to honor its commitments under WTO, the country's manufacturers can't keep saying that they don't have to pay royalties on internationally accepted patents. "They really have no choice," says Viktor Ma, an analyst with Morgan Stanley in Hong Kong. "With WTO, foreign companies can easily make Chinese companies pay."

That may be an exaggeration, since nothing is easy about getting Chinese companies to follow the rules about intellectual-property rights. The multinationals still have a lot of work ahead of them. But it's fair to say that without the WTO, their job would be even harder.

Einhorn covers technology from Hong Kong for BusinessWeek. Follow his weekly Online Asia column, only on BusinessWeek Online

Edited by Beth Belton

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