The copyright challenge in China
The world's most alluring market is also the global center of intellectual-property theft.
But one thing never seems to change, and it's as obvious on street corners today as it was six years ago. In 1999, when "Star Wars Episode 1--The Phantom Menace" debuted, it was quickly pirated on DVDs that sold throughout China for next to nothing.
Fast forward to May 2005--four years after China joined the World Trade Organization and embraced its stringent rules on intellectual property rights. When "Star Wars: Episode III--Revenge of the Sith" opened in U.S. theaters, copies again hit the streets of Beijing within days. Sold out of bicycle baskets by roving vendors, available in mom-and-pop retail stores everywhere, the counterfeit DVDs retailed for about 75 cents each.
For movie executives, those DVDs drove home the fact that their ongoing fight against counterfeiters has basically made no headway. Frustrated, Motion Picture Association of America president Dan Glickman recently raised the prospect of a push for action at the World Trade Organization.
Indeed, the MPAA is part of a Washington, D.C.-based coalition of copyright companies now working with the U.S. Trade Representative to study the possibility of taking China before the WTO to compel a genuine crackdown. Given the tough sanctions provided by the WTO's Trade-Related Intellectual Property Rights agreement, such a move would have major diplomatic implications--at a time when the U.S. urgently needs Chinese help on North Korea and other issues.
The new, harder line says much about the level of exasperation among foreign companies in China. They can't afford to stay out of such a large and potentially lucrative market. They're well aware they face IP theft there. But the extent of piracy--which continues to escalate, according to a 2004 white paper by the American Chamber of Commerce in China--still catches many off guard.
The problem affects virtually every industry, from films to software to drugs to auto parts. What's more, as China's exports have surged in recent years, so have counterfeit exports. About two-thirds of pirated goods seized by U.S. Customs come from China. Though it's difficult to place a value on financial losses, the U.S. Trade Representative estimates that counterfeiting worldwide costs American companies around $200 billion to $250 billion per year, with China likely responsible for the majority of those losses.
What's standing in the way of better intellectual property rights enforcement? "It's not a plot," says Bruce Lehman, former commissioner of the U.S. Patent and Trademark Office and the chairman of the International Intellectual Property Institute. "It's the result of a system in transition."
Lehman, who's also senior counsel at Akin Gump Strauss Hauer and Feld, points out the contradictions: On the one hand, senior officials are earnestly discussing business-method patents. On the other, there are events such as the decision last year by the State Intellectual Property Office to invalidate Pfizer's 2001 patent on Viagra after Chinese drugmakers had challenged it. "That was kind of mysterious," says Lehman.
There isn't a shortage of laws, or of high-level promises. The latest: In a visit to China in July, U.S. Commerce Secretary Carlos Gutierrez won a pledge from government officials to increase criminal prosecutions in cases of IP theft. But while the laws on the books in Beijing exceed WTO obligations, local authorities in this sprawling country usually lack the resources and motivation to enforce them.
"China is very fragmented, so even if there was a lot of political will behind this, you would see local protectionism get in the way," says Clement Ngai, legal counsel in Asia-Pacific for software maker Autodesk.
The enforcement organizations are a bewildering hodgepodge of agencies and their divisions, some with overlapping authority. Among those involved are the Administrations for Industry and Commerce, with its Trademark Division and Economic Supervision Division; the Technical Supervision Bureau; Copyright Administration offices; the customs authorities; and the Public
Security Bureau, with its Social Order Divisions and Economic Crimes Investigation Divisions.There are cultural issues as well. Many Chinese see strict intellectual property-rights enforcement as a zero-sum game in which foreigners benefit and Chinese lose. Historically, the act of copying hasn't necessarily had negative connotations: In painting and calligraphy, Chinese artists sought to mimic acknowledged masters. Too, under Communism people grew up believing assets should be shared resources. "The arguments we hear from the Chinese side are, 'Please lower the prices and then we won't pirate,'" says Thomas Pattloch, chairman of the European Union Chamber of Commerce Intellectual Property Rights working group and an attorney in the Shanghai office of Schulz, Noack and Barwinkel.
Fines for counterfeiters: "Simple business expenses"
With no relief in sight, foreign companies in China are developing counterstrategies that aim at the very least to make life more difficult for wrongdoers. A recent study by McKinsey found a pharmaceuticals company withholding its most innovative drugs from China altogether, and an equipment manufacturer that designs and develops hardware in China but produces the related software abroad, to protect the valuable source code.
Other measures run the gamut, from the political (lobbying and diplomatic pressure) to the technological (tagging goods to make them harder to copy) to the instructional (training local police to spot fakes) to, at last resort, the judicial (filing lawsuits against offenders).
The diplomatic pressure has been steady. In a strongly worded January speech in Beijing, then-U.S. Commerce Secretary Donald Evans complained that in China, token fines for counterfeiters amount to "simple business expenses." He demanded stronger policing against intellectual property theft.
Evans' comments underscore one of the leading complaints about piracy in China: that the government has responded with only token (albeit widely publicized) confiscations of fake goods that fail to stop the wrongdoers.
Between 2000 and 2004, law enforcement officials seized nearly 500 million DVDs. But the MPAA, whose members lost an estimated $280 million in China revenue last year due to piracy, says that more than 99 percent of raids only result in administrative fines.
Indeed, foreign executives complain that part of the reason the piracy problem is so severe is that China rarely takes criminal action in the case of IP theft. Here, too, there's a cultural divide. "In China," says Pattloch of the EU Chamber of Commerce, "criminal measures against private citizens involve a complete loss of face; you lose your status."
Yet in the absence of criminal penalties, civil penalties are often inadequate. Fines against counterfeiters are usually too low to act as deterrents, and U.S. companies report that such fines have actually been declining. China's Administration for Industry and Commerce levies fines based on the counterfeit value of seized goods, which is usually supplied by counterfeiters themselves.
Fines typically end up being between one-fourth and one-eighth of the value that injured companies would have considered fair, according to James Haynes, co-chair of the AmCham-China's IP forum and a partner in the Beijing office of the law firm Tee & Howe. For 52 cases of copyright infringement involving the movie "Shrek 2," for example, government officials imposed total fines of $7,000, or around $134 per incident.
The upshot: Last year in China, roughly 95 percent of films were pirated--a rate unchanged from 2003, according to Mike Ellis, the MPAA's regional director in Asia. The fact that official Chinese policy is to allow in only 20 foreign films per year makes it even harder to do a legitimate business.
Over the years, counterfeiting in China has become more sophisticated. Geographic regions and even cities may specialize in particular types of fake goods, such as DVDs or shoes, with much of the production concentrated in the southern coastal provinces of Zhejiang, Fujian and Guangdong. A given factory may do legal production in the daytime, only to switch to fakes at night. Some of the most advanced schemes span borders. Bankrolled with Taiwanese money, they produce goods in China that are later exported abroad from Hong Kong.
Back on the mainland, the economic boom has carried piracy far beyond the big cities, and local authorities usually see little reason to crack down on their own constituents in order to help outsiders. Case in point: Earlier in 2005, the Business Software Alliance, an antipiracy group whose members include Microsoft, Cisco Systems and Intel, suspected that a company in the central coastal province of Jiangsu was using unlicensed copies of
software. It appealed to the copyright office to conduct a raid. But local authorities in Kunshun City foiled the plan when they insisted on notifying the companies beforehand.Fake Viagra, and other drug deals
Pfizer's experience highlights the difficulties that the big pharma companies face in China, which has some 6,000 drugmakers of its own, most of them manufacturing generic medicines. Pfizer needs to press ahead in China, which already ranks among the 10 biggest global drug markets. But since the Viagra patent was invalidated in July 2004, the going has gotten tougher.
Responding to Chinese drugmakers who had challenged the patent, the state agency invoked guidelines laid down after the patent had been issued and claimed the pharmaceutical firm didn't disclose enough information in its filing. Pfizer, which says the patent approval process involved seven years of evaluation and two years of review, has appealed the ruling. In the wake of the Pfizer case, GlaxoSmithKline, facing a similar challenge from Chinese rivals, gave up efforts to protect its patent on Avandia, a diabetes drug.
Besides worrying about patent protections, drugmakers in China must contend with a sizable counterfeit problem. The threat of copycat products has particular urgency: Already, thousands of Chinese are reported to have died from the ill effects of fake medicine. One source suggests that 10 percent to 15 percent of medicine in China is counterfeit, primarily in rural areas beyond the reach of central government authorities. AmCham-China argues that local enforcement authorities pay more attention to rooting out fake drugs of substandard quality than to shutting down counterfeit drugs altogether.
Now counterfeit medicine made in China has begun showing up in the U.S., too. Pfizer, which taps China as the world's leading supplier of counterfeit drugs, says one major China-based distribution network sent counterfeit Viagra to as many as 30 brokers worldwide, including some in the U.S. A formula for counterfeit Viagra that was found in Shanghai was also discovered in tablets seized in the U.S. and 17 other countries.
In response, Pfizer is starting to use radio frequency identification tags to help pharmacies authenticate Viagra sold within the U.S. and introducing security packaging with a special logo that changes colors from purple to blue. Separately, in a bid to help shut down pirate drug factories, Pfizer has begun training intellectual property rights enforcement officers in Shanghai to identify fakes and authenticate genuine drugs.
Pfizer's experience also shows the political challenges involved in asserting IP rights in China. The issue is a sensitive one with the government--and overt public criticism can backfire. Following a May 2005 talk at a Beijing business conference in which he asserted that two-thirds of global counterfeit drugs come from China, a prominent Pfizer executive made a public apology.
Avast, software pirates!
The software industry, which has also been hard-hit by piracy, has employed a combination of punishment and cajolery to deal with counterfeits. China ranks among the world's worst offenders: About 90 percent of the software installed on PCs in the country is pirated, compared with an average of 35 percent worldwide and only 21 percent in the U.S.
The Business Software Alliance estimates that in 2004, software piracy in China cost its members $3.5 billion in lost revenue--the second-highest rate of dollar losses in the world, after the United States' $6.6 billion in piracy-related losses.
To deter offenders, the BSA runs radio and Internet ads in China with a hotline number offering rewards of up to $3,600 for tips about companies using unlicensed software on the sly (the industry considers unlicensed corporate use of software a far greater business threat than individual acts of software piracy). Armed with a promising lead, the BSA can press the local copyright administration office to conduct a raid.
Last year the BSA held a handful of software asset management seminars in major cities explaining how companies and government agencies could derive the greatest financial benefit from legally purchased software. Three hundred fifteen companies showed up, and the BSA expects to expand the number of seminars to be held in 2005.
There is one bright spot within the software industry: computer game makers. Only a few years ago, when they were still struggling to get established in China, they mostly sold retail games for home use. But business was plagued by piracy rates as high as 98 percent. Then the game makers shifted from retail distribution to secure servers in Internet cafes.
"You can now make an investment and expect a return. That's key to investing in new IP," says Erick Hachenburg, general manager of China operations for Electronic Arts. "Until the online gaming model emerged, there was no way for us to justify a major investment in China." Electronic Arts, which has begun staffing an office in Shanghai, plans to make its first online games available in China by next March.
But examples like the gaming industry are exceedingly rare. With few alternatives for dealing with counterfeiters,
other multinationals have resorted to warning consumers of the dangers of fake goods--including GM, which estimates that upwards of 30 percent of auto parts sold in China are fakes. "Counterfeits made of low quality materials may imperil the lives of you and your loved ones," counsels a message on GM's Chinese Web site. "Imagine the results if a brake pad made of sawdust was installed in your car. This actually happened."Pirated auto parts may be the least of GM's IP problems in China, though. In May its GM Daewoo unit filed suit against a local rival that allegedly filched an entire car design. According to GM Daewoo, Chinese automaker Chery Automobile's QQ model has a body structure, exterior and interior design, and components all identical to its own Spark model. In his January speech in Beijing, then-U.S. Secretary of Commerce Donald Evans said the incident "defies an innocent explanation," and was "especially troubling" because Chery Automobile is partially owned by the local government.
Counterattacking via the courts
When prevention fails--as it usually does in China--companies are increasingly resorting to the courts. "This is becoming a trend in China--that companies would rather go straight to court to create more publicity and make the point that they're serious," says Autodesk's Ngai. He adds that Autodesk, which has been in China since 1994, was the first foreign software company to sue a domestic user for copyright infringement and win. In 2002, it won a landmark case after proving that a Chinese TV production company was using an unlicensed version of a highly specialized, $200,000 software product. Including that case, Autodesk has since received favorable settlements in about half a dozen cases, according to Ngai.
But no one would argue this is a simple process. An initial investigation can cost tens of thousands of dollars, and that's just the first step. Next a company must decide whether to pursue a case on a criminal or civil track. Typically, if an investigation has uncovered pirated goods worth at least $6,000, the injured party can press the government agency known as the Public Security Bureau to take a criminal case to court. But counterfeit goods are difficult to value, and it's the company that suffered the loss--not the government agency--that shoulders the burden of proof.
Many companies opt instead to file an administrative complaint, though this can be complicated due to China's decentralized enforcement system. Standards vary in different cities and provinces over what constitutes a copyright infringement.
When it comes to litigation, multinationals also must be prepared to navigate China's "first to file" system. Though the U.S. is considering moving to such a standard (from its current "first to invent" system), first-to-file can pose problems for foreigners in China.
Xiang Wang, a Shanghai-based intellectual property lawyer at the firm of Jones Day, says he's dealt with a number of lawsuits involving local companies that either copied a Western patent or publication or slightly modified it, then filed for and obtained a patent in China. They might even use their Chinese patent to sue the legitimate Western patent-holder.
Some of the more hopeful China watchers point out that economic development tends to usher in greater respect for intellectual property rights. With continued growth, they say, China's stratospheric piracy rates might drop a little. Market research firm IDC found in a study that, of the 57 countries that buy most of the world's information technology, nearly two-thirds had managed to reduce software piracy rates by 10 points since 1996.
Autodesk's Ngai says he's already seen a change in mentality, at least in the more developed regions. "In the '90s when you talked to these companies, they'd admit (to piracy). The idea you have to pay for the software was at that time alien. They'd laugh at you if you paid for it." In what counts as progress, he says, "Now, none of them will admit they're using illegal software. They know it's not the right thing to do."
Adds Jeff Hardee, the BSA's vice president for Asia: "If the (Chinese) government wants to grow the IT sector, it pays to invest in bringing down piracy levels. Software piracy affects all software publishers, Chinese included."
While that's true, it will probably take years for China to develop many of the kinds of companies that require IP protection. In the meantime, multinationals will no doubt keep coping with piracy as best they can. Given that they probably can't prevent it, some may even think of it as a backhanded compliment. "If you're successful in China, you may very well have problems," points out AmCham-China's Haynes. "If you're not successful, then no one will want to counterfeit you."
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