I just returned from a month-long trip to China touring with a U.S. law delegation under the Eisenhower Citizen Ambassador Program led by Deborah Enix-Ross of the law firm of Debevoise & Plimpton with 29 participants. We visited Chinese law firms, law schools, seminar forums, and bar associations in Beijing, Xi’an and Shanghai (photo of our law tour delegation which held a joint U.S.-Sino law seminar with the Lixiaohua Law Firm). Including my trip extensions to Hong Kong (SAR) and Shenzhen, China, I visited 10 Chinese law firms in 5 major cities. Meeting Chinese law professionals and seeing the economic development in cities first-hand since my last visit to China 20 years ago, I came away thoroughly impressed with China’s accomplishments to date and with its dynamism and optimism for the future. We Americans need to reset our held-myths about China from 20 years ago and realize that it is a completely different country today. While China’s Government is asserting its increasing strength and elevating stature in economic and foreign policy, it is transforming its domestic institutions to a society based on rule-of-law (under civil code similar to Europe) and free-market principles (tempered by practical controls over social order). China’s economic development in the past 15 years has lifted an estimated 300 million people of its current 1.6 billion population out of poverty, and managed a transition from a predominantly agrarian society to one where 50% of its people now live and work in cities. Whole cities populated in the millions have been built new. China’s goal over the next 15 years is to continue its transformation to a middle-class society, while it works toward a new social order in the world based on sustainable use of resources for needed economic growth. Its biggest challenge will be to continue to adapt its internal political system commensurate with its economic development.
One area providing a useful example of China’s development is in technology and its transformation to a technological society. In preparing for my trip, I came across an article entitled “Five Reasons China Will Rule Tech”, by Ray Kwong, published in Forbes Online, July 13, 2010. He notes that China's leadership places a high priority on educating its upcoming generations in science and engineering. Most of its Politbureau members including President Hu Jintao have engineering degrees. Its science and engineering pool is vast – in 2005 China awarded 351,500 science and engineering degrees, compared to 137,500 in the U.S. It now emphasizes an “indigenous innovation policy” to promote development of Chinese-origin technology while at the same time encouraging transfer of foreign technology and high-level management services to China.
U.S. innovation companies are typically small-to-medium sized enterprises (SMEs) lightly capitalized with venture capital. Such SME companies will find it increasingly difficult to compete head-to-head with Chinese companies. As an example, I came across an article entitled “Chinese Solar Giants Cast Shadow on U.S.”, by Todd Woody, Fremont, CA, published in the International Herald Tribune, Business Asia with Reuters, October 14, 2010. The article notes that in competing with Chinese companies, American technology companies are struggling to find niches where they can survive. Silicon Valley start-ups in Clean Energy like Solyndra, Nanosolar, and MiaSole are finding it difficult to make headway in world markets and even in the U.S. against low-cost Chinese manufacturers supported by government investments and favorable trade policies. The article quotes Conrad Burke, CEO of Innovalight, saying, “Innovation will be the heart of the U.S. [survival] strategy, and although it might not create the same scale, we are exporting well-protected technology to China and creating well-paying jobs here”.
In other words, American companies are finding that they can survive by transferring their innovation technology to Chinese companies to manufacture products at China’s low costs. If a joint venture is formed through Hong Kong or Singapore, which have strong rule-of-law systems, the U.S. company can provide licensing of reserved IP rights in China and technology and innovation expertise to optimize products for marketing in China, and earn license royalties or a revenue share of sales in China. The U.S. company can then import the low-cost Chinese-supplied products back into the U.S. and other markets where it retains IP rights for profitable sales of its own.
As outlined in my November 2009 blog article, U.S. technology companies can advantageously transfer or license IP (patent) rights as primary assets in IP-based tech-transfer transactions with Chinese companies according to the following model:
1. U.S. researcher invents a new technology, and applies for IP rights.
2. U.S. innovation company acquires inventor’s IP rights, develops and proves the feasibility of the new technology, and files for patent rights in the U.S., China, and other countries.
3. The U.S. company transfers or licenses the Chinese patent rights to a joint venture company which engineers the product and manufactures it for marketing and sale in China.
4. The joint venture company in China establishes the product at efficient manufacturing costs through domestic sales, then supplies the product at low cost to the U.S. company for import.
5. The U.S. company makes profitable sales in the U.S. and foreign markets where it owns strong IP protection rights.
The typical small-to-medium sized U.S. technology company has little leverage or sufficient resources to enforce Chinese patent rights against large companies in China anyway, so that a transfer to the Chinese joint venture partner is the best use of the China IP rights and provides an incentive to the Chinese joint venture partner to invest in engineering the product and gearing up for manufacture and sales in China. The U.S. company can control export of the low-cost product from China for sale in the U.S. and other countries such as Japan, Korea, Australia, Canada, and/or Europe by relying on strong IP rights there.
In a typical patent filing strategy, the U.S. company should file a home country (U.S.) patent application as soon as the invention has been completed, then file an international (administrative) filing under the Patent Cooperation Treaty (PCT) within one year in order to claim the U.S. priority date and extend the treaty deadline for foreign filings for a further 18 months while also receiving an early international search and patentability report. The U.S. company must then elect in which countries to file national-stage patent filings from PCT by the 30-month deadline (from the U.S. filing date), which would include China and any other foreign countries of strong commercial interest. The USPTO grants an export license for foreign patent filings automatically within 6 months of the U.S. filing date, unless the application is sequestered within that time for national security purposes. The U.S. company may need to apply for an export license to transfer related technology (such as software and engineering data) if they contain technical subject matter that goes beyond the scope of the patent application disclosure.
The challenge for a small-to-medium sized U.S. technology company in this IP-based tech transfer model will be finding a trusted Chinese joint venture partner and making a compelling business case why the product is likely to be profitable to them in domestic China sales as well as for export for foreign sales. Deal-making in China is still strongly dependent on personal relationships (“guanxi”), so an introduction to persons with decision-making authority in the target Chinese company will depend on going through well-connected intermediaries. In technology deals, such intermediaries may be bilingual business consultants and/or attorneys handling corporate and/or IP matters for the target Chinese company. Chinese companies have access to plenty of capital and no longer prefer to structure cross-border deals based on foreign investment. However, they still need to justify their access to domestic investment capital based on projecting a strong likelihood of profitable domestic sales.