Twilight of China's DVD Pirates

Amid a crackdown, Chinese knockoffs are threatened

Even as China has become the workshop of the globe, with just about everything seeming to carry a "made in China" label, it has earned another, more dubious honor: the world center of counterfeiting. With factories producing everything from pirated software to knockoff designer clothes, Beijing is notoriously lax in enforcing intellectual-property rights.

And when it comes to prospering from other people's copyrights and patents, few industries can top Chinese manufacturers of DVD players. In the past few years, their factories have been turning out these machines at a furious pace, exporting more than 10 million in 2001 alone--without paying royalties to the multinationals that own the patents. That has left the likes of Sony, Philips, and AOL Time Warner fuming.

Now, there are signs that the Chinese are starting to heed calls to clean up their act. Last month, a group of six companies--Mitsubishi Electric, JVC, Toshiba (TOSBF ), Hitachi (HIT ), Matsushita (MC ), and AOL Time Warner (AOL )--reached an agreement that could lead to Chinese manufacturers paying royalties on the machines they export. Also in April, an exasperated Sony Corp. (SNE ) filed suit in New York to get the biggest seller of Chinese-made DVD players in the U.S., Apex Digital Inc., to start paying up. The Japanese giant dropped the suit within a few days, after another industry consortium, consisting of Sony, Philips, and Pioneer, cut a deal with Apex. Says Toru Ito, senior manager of Sony's licensing department: "If Chinese companies want to produce DVD players, they must pay royalties."

Whether the Chinese will fork over the money remains to be seen. And while some multinationals want royalties of 4% of the retail price or $4, whichever is higher, most Chinese manufacturers are likely to try for a much lower sum. But there's no denying that there is progress. And that's largely because of Beijing's entry last December into the World Trade Organization. "The WTO is a catalyst," says Erh-fei Liu, Hong Kong-based chairman of Merrill Lynch China. "The government intends to abide by the rules."

For foreign patent holders, that new commitment comes not a moment too soon. For years, multinationals have watched with growing frustration as Chinese manufacturers flooded the globe with cheap DVD players (chart). That has been a boon for consumers in the U.S., where Chinese-made DVD players selling under such names as Shinsonic, Oritron, and Mintek have helped drive down prices. Apex, a Chinese manufacturer that has its corporate headquarters in Ontario, Calif., now sells a bare-bones player for $70, compared with $140 a year ago. And it's not just American consumers who are benefiting: In Hong Kong, DVD players have become so cheap that HSBC Holdings recently gave them to anybody who opened a credit-card account. Inside China, sales in the first quarter jumped over 100%, to an estimated 2 million players.

Despite the prospect of a deal, Chinese manufacturers insist they have been doing nothing wrong. Their argument: By buying components from licensed suppliers that had already paid royalties, the Chinese had adequately addressed the issue. After all, they were just buying parts. "We already have paid. Why should we pay again?" asks Zhao Lingjie, a manager at contract manufacturer Shenzhen Kaixinda Electronics Co.

But that argument didn't hold water, and the multinationals played hardball. As a result, European governments cracked down on imports of Chinese-made DVD players. In the U.S., retailers are falling into line, too. "Buyers at major retail chains are asking for the first time if you are licensed," says Colton Manley, a spokesman for Apex, which racked up $1 billion in sales last year at the likes of Wal-Mart Stores, Circuit City, and Best Buy.

With Chinese electronics makers already battling for survival, paying royalties could wipe out profits and put some DVD makers out of business. Others will try to pass along higher costs to consumers. "You can look for price increases across the board of 10% to 15% by Christmastime," predicts Apex' Manley. It has been a fun party. But the days of dirt-cheap DVD players may soon be over.

By Bruce Einhorn in Hong Kong, with Irene M. Kunii in Tokyo

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