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(originally published by Booz & Company)


Protecting the Company Jewels in an Unprotected Country

As governments wrestle over safeguarding intellectual property rights in China with no solution in sight, more and more companies are taking the problem into their own hands.

The uninitiated might conclude that Chuck Cheng, a veteran of Silicon Valley startups, was overly paranoid in organizing his company’s product development efforts in China. Cheng’s company, AppoTech, headquartered in the Shatin district of Hong Kong not far from the Chinese mainland border, designs systems on chips, or very sophisticated combinations of analog and digital functions on the same piece of silicon.

Rather than having his chips made in China, Cheng ships his designs to fabricators in Singapore and Taiwan — and only then does he send finished chips to application development centers in China’s nearby Guangdong Province. These centers employ Chinese researchers who develop new ways to use Cheng’s chips in audio and video products for export, mostly to the United States. But the researchers work on computers that cannot be connected to the Internet and their USB ports have been disabled to make sure no one can download any proprietary data or information.

Cheng’s great fear, of course, is that his intellectual property will be stolen — the polite term is “reverse engineered.” It’s not unusual for Chinese copycatters to take pictures of foreign semiconductors, blow up the images so that they can see the precise circuitry, and then copy the design. Other Chinese employees of foreign software companies have obtained source codes and auctioned them off on the Chinese equivalent of eBay. Cheng’s safeguards make any of those steps much less likely. “I am forced to be very careful,” says Cheng. “I set up my headquarters in Hong Kong because it has the infrastructure and culture to protect my intellectual property.”

As Washington and Beijing engage in a shouting match over Chinese violations of Western intellectual property, the reality on the ground is that foreign companies are either finding practical solutions to prevent their IP from being stolen in the first place or are working through the Chinese system to put pressure on imitators to cease and desist. The wrangling between Washington and Beijing, including a U.S. threat to take the Chinese to the World Trade Organization, seems unlikely to have as deep an impact as what companies like AppoTech are already doing.

Their efforts fall into two broad categories: thwarting IP theft before it occurs and recovering losses after the fact.

Putting Safeguards in Place
More companies are realizing that they have not done the best possible job in setting up their Chinese operations to guard against theft. Extra care needs to be taken in understanding the background of Chinese partners or licensees, and the same is true for employees.

The basic mistake many companies have made, incredible as it may seem, is assuming that the Chinese operating environment is similar to the one they experience at home. So they fail to do obvious things. For starters, companies need to register their trademarks in China and Hong Kong. It’s possible to seek redress for trademark infringement in China, but in many cases it’s much more effective to get prospective Chinese partners to agree up front that if arbitration is needed, it will occur in Hong Kong or the United States. Companies should also explicitly decide what is privileged information and set up strict protocols for who has access to it. “Assume nothing,” says Judith Crosbie, a longtime compliance monitor in China for the Gap, McDonald’s, and other large U.S. corporations, and now an attorney for MMLC Group, a legal and consulting services firm in Beijing that specializes in, among other things, intellectual property protections. “The assumptions are the things that cost dearly and take years to sort out.”

Under greater pressure from the Chinese government to bring leading-edge research to China as part of an unspoken arrangement that allows these companies to continue to enjoy lucrative manufacturing engagements, multinationals such as Microsoft, Intel, and Lucent do conduct advanced R&D there. But they focus on small slivers of their core intellectual property — perhaps just one element of a given application — so that no Chinese rival could ever assemble that body of knowledge into a coherent product, says Clifford Ng, a partner at K&L Gates in Hong Kong, the law firm of William L. Gates (father of Microsoft chairman and chief software officer Bill Gates). Microsoft claims that as much as 90 percent of the software used in China is pirated, but that it still makes some money on legitimate sales. Intel’s recent US$2 billion-plus investment in a new plant in northeastern China involved chip technology that is three generations old.

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  1. Business Software Alliance Web site: One of the most active trade groups arguing for better protection of software in China. Click here.
  2. Hong Kong Intellectual Property Department Web site: Details intellectual property protections and activities in Hong Kong. Click here.
  3. Quality Brands Protection Committee of the China Association of Enterprises with Foreign Investment Web site: The leading China-based foreign alliance working to improve IP protection. Click here.
  4. State Intellectual Property Office of the People’s Republic of China Web site: Information about China’s intellectual property initiatives, rules, policies, and regulations. Click here.
  5. U.S. State Department Intellectual Property Web site: A wide-ranging compendium of information about legislative and diplomatic initiatives regarding IP. Click here.
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