Safeguarding Your Intellectual Property in China

Of all the challenges multinational corporations face in China, perhaps the single biggest pertains to safeguarding the company's intellectual property (IP). The country is notorious for its counterfeiters, pirates, and IP scofflaws, yet withdrawing from the world's second-largest economy is not an option for most multinationals. On the contrary, given the never-ending travails of developed economies, corporate leaders need to redouble their efforts at going after the rapidly growing opportunities in big emerging markets such as China and India.

Having conducted in-depth discussions with senior executives at several American and European companies regarding how they manage the risk of involuntary IP leakage while remaining deeply engaged with China, we believe corporate leaders must accept the reality that they can never make their company 100 percent leak-proof on the IP front. Movement of people and exchange of knowledge across organizations is a defining feature of every vibrant ecosystem—be it Boston, Bangalore, or Beijing. If you want to play in these ecosystems, you must accept the inevitability of some IP leakage. The key, therefore, is to figure out how to slow down involuntary leakage so you are able to accumulate new IP at a faster pace than the loss. Companies accomplish this objective by focusing on three goals: curbing the motivation for IP theft, reducing others' ability to steal IP, and minimizing the residual damage from the IP leakage that does occur.

Curbing the Motivation for IP Theft

Companies can deploy at least four strategies to dampen the motivation for IP theft. First, unless there are compelling reasons to the contrary, compete in not just the premium segments but also the value segments. Take Microsoft's (MSFT) Windows and Office software products for PCs. Annual per capita income in China is about $4,000, less than one-tenth of that in the U.S. In such a context, unless Microsoft offers low-cost versions of these products to potential customers, any talk of intellectual-property rights will be no better than flailing one's arms in the wind. As the company finally digested this reality, it started to offer extremely low-priced software bundles for students.

Obviously, such a multi-segment approach by itself cannot eliminate software piracy in China. In combination with other strategies, however, it can be a useful plank in reducing the level of piracy.

Second, cultivate strong bonds of affinity and commitment between local employees and the company. As Steven Leonard, Asia-Pacific president for EMC (EMC), noted to us, disgruntled or uncommitted employees can be the source of the biggest IP risks for any company. Companies such as EMC, IBM (IBM), and others pay deliberate attention to ensuring that employees find the work exciting and see the company as a potential lifelong destination rather than just a transitory ramp to better opportunities elsewhere. Offering high potential employees regional or global responsibilities beyond China is one of several mechanisms to cultivate deeper bonds with the local staff.

Third, draw a clear line between inside versus outside. As the China president of a U.S. manufacturing company noted, "We make it very clear. Here is a list of our inviolable rules—relating to intellectual property, corruption, and so forth. If you play by the rules, we'll reward you. However, if you cross the line, we'll be very tough and we'll go after you."

Fourth, as much as appropriate, apply for patent protection within China. In 2007, Schneider Electric (SU:FP), the French engineering company, learned this lesson well when a Chinese court ordered it to pay 335 million renminbi ($51.5 million) in patent infringement damages to Chint, a local competitor. Jean-Pascal Tricoire, Schneider Electric's chief executive officer, has called the charges "baseless" and "absurd." The problem, however, was Chint had filed for patents within China for technology that Schneider Electric argued it had been using for years.

Reducing Others' Ability to Steal Your IP

Companies can deploy at least four strategies to reduce the ability of insiders or outsiders to engage in IP theft. First, know your landlord. In one of the companies in our study, it took senior managers a few years to realize their offices had been wired for bugging before they moved in. Further investigation revealed that the building was owned by an arm of the local government with a reputation for actively appropriating foreign companies' technologies and sharing it with local state-owned enterprises. Once the company realized what was going on, it relocated the offices—discretely but speedily.

Second, manage physical access to the facilities. One of the world's leading packaging solutions companies with a major production hub in China has carefully partitioned its factory premises. While most parts of the factory are accessible to all employees, certain parts of the production process are kept hidden behind high walls and accessible only to highly trusted staff members.

Third, manage access to the codes and the data. While theft of proprietary code and data would be an issue for any company, it can be a particularly serious problem for companies in the information technology and services sectors. Experienced companies reduce such risks by prohibiting employees from bringing in or taking out any type of computing or memory device from well-demarcated zones and by disabling the computers from transferring any files or data outside of the internal network.

Fourth, cultivate relationships with the government and the media, especially at the local levels. Local governments in China face a mixed motive situation. They are eager to attract high technology players and R&D operations. At the same time, they may also like to help local companies get a leg up. In China, perhaps more than anywhere else, it will almost always pay to cultivate solid relationships with government officials and to keep making the case that protecting everybody's intellectual property is the fastest route to creating an innovation-driven economy. Similarly, good relations with the media can come in handy when the company takes on IP violators in not just official courts but also the court of public opinion.

Minimizing the Residual Damage

As we noted earlier, when companies operate in dynamic environments populated by ambitious competitors, some degree of IP leakage is inevitable. Companies can deploy two strategies to contain the actual economic damage resulting from such leakage.

First, disaggregate the total R&D program into modular projects and distribute the responsibilities for different projects across multiple locations not just within China but, if possible, also outside China. As one executive noted to us, "Don't put the whole equation in one location. This way, even if an entire team were to get recruited by your Chinese competitor, they'd still face the challenge of figuring out the other pieces in the puzzle. That'll slow them down."

Last but not least, keep innovating like crazy. A primary reason Silicon Valley has remained the world's epicenter for innovation is because people there move rapidly from one company to another (or to their own venture) and technology secrets are almost impossible to keep. Legal protections and company strategies help, but only partially. The best protection, however, lies in taking to heart the Red Queen's remarks to Alice in Lewis Carroll's Through the Looking Glass: "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

Before it's here, it's on the Bloomberg Terminal.