BAD and how it works in the high-tech capital equipment market

05/07/2015

BAD is an acronym that describes how the Chinese are able to dominate some high-tech business sectors.

The guys at the Strategic News Service call it SAD, which stands for Steal, Amplify, and Dominate.

But I prefer to call it BAD which stands for Borrow, Amplify and Dominate.

The reason that I have changed the ‘Steal’ to a ‘Borrow’ is that the Chinese really don’t see it as stealing. More on this later …

This is the process that the Chinese often follow:

Firstly, a Chinese company gets their hands on a Western piece of high-tech kit, usually from a Chinese customer of the original Western supplier. The less software in it, the better, because this can be harder to reverse engineer.

Secondly, the Chinese company then makes cheaper copies than the Western original and sells these to Chinese customers (that just happen to do about 40% of the World’s manufacturing).

Apparently there is a Chinese Standing Committee that currently has 402 such economic sectors targeted for such ‘copying’ efforts.

There is an argument that the Chinese artificially amplify the domestic value of their copies by use of protectionist policies, ‘champion’ treatment to local suppliers, and rebranding of stolen IP, and related practices.

But in truth they win the local market by having much lower selling prices, and they usually have to overcome the perception of lower quality than the Western originals.

Finally, if and when they put these goods or services onto the global market at discounts of 50% or more, this can wipe out the Western suppliers that developed the IP in the first place.

This export to the West can in some cases be limited by IP enforcement but I have seen cases where the Chinese companies have taken care to file many improvement patents in readiness for such a battle.

I recently talked to the CEO of a Chinese company which is copying a $1m manufacturing tool that is sold mostly to Chinese manufacturers and originally from a high-tech European company.

Initially they got a hold of the product and they just copied it outright but using sub-standard and cheap Chinese components.

This first generation copy was rubbish and the Chinese customers bought one or two, but pretty much stayed with the proven European supplier.

But now these copies are pretty good and they have achieved this by using exactly the same components as the European supplier, many of which are Western sourced.

I asked the CEO of the Chinese company how he sells them so cheaply and he said it’s not so much the low labour costs or choice of parts (since they are using the same parts) but finance cost that gives him his pricing advantage.

They get working capital finance off a development bank to build, say, 50 tools all in one go (as opposed to 1 or 10) and ahead of customer orders. Therefore they can get all those bulk discounts from the parts suppliers. And they don’t have to pay the loans back until they sell the tools. It’s the sort of working capital we can’t but dream about.

As to ‘stealing’ – their brand logo (in Chinese only) reads ‘the very best copy of [insert European company name]’. When they were confronted by the CEO of the European company at a recent trade show in China the employees rushed over to meet their idol and asked ‘how can we copy you better?’

Lacking an enlightenment and centuries of indoctrination that intellectual property is in their collective best interests, the use of the word ‘stealing’ is somewhat mendacious. This is just a clash of cultures.

We in the West have had IP rights for so long that we can’t imagine a world where a state-granted implied right to a monopoly over inventions simply does not exist. The Chinese, on the other hand, despite having a patent system, can’t imagine why the state would prevent a technology being sold at the very lowest cost that is humanly possible.

I have had discussions with Chinese where I made the argument that the implied monopoly granted by a patent helps companies get higher margins, and thus enables them to invest more into R&D for technology improvements and lower costs. Usually, about half-way through these arguments I sort of stop believing myself. All I am doing is parroting the party line that we have been fed in the West forever, without questioning.

This argument would be a lot easier if the patent systems around the world were restricted to genuine breakthrough inventions rather than zillions of incremental innovations.

My personal view is that the challenge to the patent systems proffered by the BAD behaviour of the Chinese will end up causing a re-assessment of the threshold of what is, and what is not patentable. And not a moment too soon me thinks.

Even so, I can hear you say, won’t the Chinese then ‘steal’ even those ideas that are still patentable? Especially since these may be correlated to the most valuable product niches. All we will do is work harder and harder to get the Chinese to allow efficacious patent enforcement in China. This will happen anyway because they are also fast tracking their original technology development and when they dominate in this endeavour the patent system will be working for them and not against them.

By the way, when a Chinese company has copied another company’s product they haven’t ‘stolen’ anything under law. A patent is an option to enforce a technology monopoly right in court, and until a court deems that the patent remains valid and that the copying party has indeed infringed one or more of the claims in the patent, the use of the word ‘stolen’ is quite unjustified.

And just to add a little colour to this comment, in the UK over half of the patent enforcement cases that go to court result in the court invalidating the patent that is being enforced! In Australia more than 80% of cases where a patent owner is aware of patent infringement are never the subject of any type of enforcement activity because of the high costs, the super slow process, uncertain outcomes, risks of counter-suits related to unwarranted threats, enforced licensing and very low damages.

When we say the Chinese are unfairly ignoring patent rights I simply don’t buy it. In the West we also ignore them in many cases. Small companies, for example, often cannot afford to chase up their patent rights. Only in the US is there a well-developed contingency legal service for patent enforcement and even these guys will only really take on the open-and-shut cases. The whole patent system is weighted towards the interests of large companies.

The true reason that the Chinese can copy technology products is that they have the energy and capital to do so. Many of the companies that they are copying are selling over-priced products which support whole organisations of entitlements. High margin Western tech companies that have a dominant position in a market niche tend towards what I would call an ‘aristocratic’ lifestyle choice that isn’t necessarily in the best interests of their customers.

I have had founded and run many tech companies in my time and it is always frustrating when a larger competitor sees the value of the products and copies them, thus putting downward pressure on margins and market share. And I should add that it’s not just the Chinese that do this. Everyone does. Over time I have decided that angst on the matter is futile and now I work with an awareness that copying will occur so this helps me frame what technologies that I take on. Some technologies are simply harder to copy, mostly because a lot of the ‘secret sauce’ is hidden deeply in the software.

And in making this comment you can see rampant copying without any checks and balances might in fact retard investment into technology development. Even in the single data point that I have to work with, me, it has caused me to pass on opportunities. But then I would counter that there are many more technology opportunities than there are people able and willing to make them a reality.

If I was forced to put the crystal ball to use and predict what the Chinese landscape will look like in 10 or 20 years time then I would suggest that they will doing much of the world’s inventing by then. And under these circumstances they will be very happy to have a strong patent enforcement system with all the reciprocal right in other countries to prevent their technologies being knocked off.

At this stage, at least here in Australia where the rate of technology invention is quite low, we would be well placed to find a source of low cost working capital for tech companies, water down our patent enforcement system even further (if that is possible), and then get busy knocking off the Chinese tech companies.

When something BAD happens to you, don’t get SAD, don’t get MAD, get even!