Three years ago, faced with a veritable flood of fakes coming from China, the world's top golf club manufacturers decided to join forces. Their main competition, they decided, was not each other. It was pirates.
Prior to that, IPR enforcement was carried out individually, on an ad hoc basis. Whenever PING, Acushnet, Cleveland, Nike, Callaway or TaylorMade-Adidas raided a shop or factory, they would seize fakes of their own products, leaving other brand items behind.
After the manufacturers teamed up, "they could pretty much clear up the shop," explained lawyer Loo Shih Yann, a partner at Baker & McKenzie, the firm that represents a working group of six top golf club manufacturers. "You've got six very fierce business competitors working together. They see the value. If they don't, it's a lose-lose proposition."
Their efforts are backed by a government aware of the importance of intellectual property. Beijing has managed to develop a legislative system of intellectual property protection that meets most of its commitments to international bodies, including the WTO.
"China has come a long way in the last 10 years," said Loo. "The laws are actually very good when it comes to IPR protection. The court system is quite interesting – courts are more transparent but they are not uniformly good.
"China is a large country and you have cases that are pretty bad."
While IPR courts can be found in most major cities, enforcing their decisions in local – and sometimes remote – areas where the legislative and commercial pillars are often entwined is another matter entirely. The logistics of implementing change in a massive country with wildly diverse levels of education, income and interest is a bridge too far.
"Most of China's provinces do not fully protect IP," said Chris Runckel, a former diplomat with long experience in China and now president of consultancy Runckel & Associates. "The problem is not with the laws, it is with enforcement."
China is making progress on intellectual property. Emphasis is being placed on patent protection in non-mainstream fields so, in the short-term at least, the results are less visible, difficult to understand and more subjective – and therefore less headline-grabbing. (See: A brand new game)
But as long as Beijing fails to enforce its laws – particularly in areas with mass consumer appeal like movies and music – it will retain its reputation as an intellectual property black hole where big words from officials are not backed up by decisive action.
"Western companies think China is the wild, wild west," said Professor Phillip Chan of the Hong Kong University of Science and Technology (HKUST).
It's difficult to hide the fact that China is the largest producer of counterfeit everything. Imitation Louis Vuitton bags are pumped out at unbelievable rates. Pirated movies are the mainstay of a unique entertainment industry. Stolen designs for microprocessors are commonplace. Fake malaria drugs produced in unnamed labs are sold around the world to poor people attracted to the price. Even counterfeit toothpaste is available.
Part of the problem is that this kind of activity is so commonplace it has become the lifeblood of local economies. Entire villages and towns subsist on factories that pay all the taxes for the village by manufacturing fake goods, said Loo.
"If the authorities want to shut it down, of course they can, but what is going to happen to all those people?"
The situation is unlikely to change drastically in the near future.
China's miracle economic growth is a largely urban phenomenon. There are still 400 million peasants living in or near poverty in the countryside, the economy is overheating, social unrest is always a consideration and the banking and financial systems need major upgrades. Beyond making regular statements condemning piracy, Beijing's attention is not on stopping movie pirates, music pirates or even manufacturers of fake golf clubs.
It may also not be the first priority for provincial or county governments looking to develop new industries, keep up with the pace of development, develop social safety nets and boost standards of living.
Axe to grind
It is this perceived apathy that is seized upon by the US and Europe as they increase the pressure on China to cut down on counterfeiting. This year, they joined together to form a working group to address intellectual property problems. But the lobbying doesn't stop there as far as the US is concerned.
Last September, China was placed on America's Priority Watch List of countries with IPR problems and in July, US Undersecretary of commerce Frank Lavin told reporters in Shanghai that the country is preparing a WTO complaint against China over violations of intellectual property.
"Our attorneys are increasingly convinced that China is in violation, but we have to have evidentiary basis that ensures we are going to win the case," he said.
"It is a matter of finding the right particular example, the right case, and gathering evidence the right way."
Multinationals have identified improving the intellectual property environment as a key goal.
"China continues to be the single biggest source of counterfeit products worldwide," said the International AntiCounterfeiting Coalition in a paper submitted to the US Trade Representative in February. The IACC represents big businesses, principally in the US, but also in Japan and Europe. Its goal is to cut down on the incidence of counterfeiting around the world.
"Steps taken by the Chinese government and judiciary to reduce counterfeiting and piracy have not yet achieved significant and necessary reductions," the paper said. IACC president Neils Montain believes the country is responsible for up to three-quarters of the global output in fake products.
The fact that there are virtually no criminal penalties for counterfeiting goods, with the exception of fake pharmaceuticals, doesn't help the situation.
Fines average US$650 and make little or no impact. olice rarely get involved in tracking down offenders and the threshold for triggering criminal prosecutions is relatively high.
"Fines are not even the cost of doing business. They are just a nuisance," complained Montain. "The whole thing needs more backbone."
In fairness, Beijing is aware that this problem needs addressing. As part of its commitment to the WTO's Trade Related Intellectual Property Treaties (TRIPS), China is expected to develop or revise laws to protect intellectual property.
A number of new laws have come into play since 1983 that cover patents, trademarks, copyright and unfair competition. Much emphasis has been placed on IP since the country's WTO accession in 2001. Regulations have also been developed to protect computer software, plant biodiversity, integrated circuits and customs.
At the same time, the government regularly launches initiatives at both national and provincial level aimed at cutting down on piracy.
Among the most recent are legislation making market owners responsible for fake goods sold in their properties and a project to hold 100 days of enforcement, which was launched in mid-July and accompanied by a string of highly-publicized seizures of pirated goods.
With a lack of criminal alternatives to prosecute pirates, these efforts may be a useful second best.
Lawyer Loo said working with landlords actually paid off for golf club manufacturers at the Shanghai Mart. The huge retail market used to house up to 17 separate stores in a single floor that did a roaring trade in all kinds of fake clubs.
The golf equipment makers met with the landlord and the mart's management and, while the owners did not take direct action, they did send down new leases to the individual stores. Under these new leases, the stores would forfeit their deposits if they were caught selling fake products. The retailers refused to sign the new documents so the landlord accused them of being uncooperative and shut down power to the floor. "They left within a month," said Loo.
He has found Shanghai to be unusually progressive on IPR. The golf group has already managed to get three criminal prosecutions and, for cases of piracy in a county that usually handles these issues through civil law, "that sends an extremely strong message".
DVDs before drugs
However, the question remains as to whether prosecutions really are strong enough to deter piracy when there is so much easy money to be made from it. Organized sales of pirated running shoes or DVDs provide a juicy alternative to more risky illegal ventures like trafficking cocaine or heroin.
"Counterfeiting can be a very profitable industry and the penalties, if you get caught, are not that harsh in some countries. It's like selling cocaine without the penalties," said Bryant Atkins, from drug-maker Pfizer.
It is also significantly cheaper than illegal, class-A drugs. It costs less than US$0.13 to make a DVD and the markups are more than 1,000%.
According to a study carried out by the Motion Picture Association of America (MPA), the average markup on pirated goods is 1150%, far beyond those for heroin (360%) or even cocaine (1000%).
"It is far safer to deal in DVDs than it is to deal in drugs," said MPA senior vice-president Mike Ellis, a former police officer in charge of the MPA's efforts to fight piracy in Asia, directly echoing the sentiments of Pfizer's Atkins.
"The pirates have an incredible market of opportunity".
The more sophisticated the operation, the higher the profit margins, and operators are willing to go to great lengths to protect their investments. The MPA, which regularly coordinates raids across Asia, has come across gangs armed with grenades and automatic weapons.
"We constantly come up against physical violence across Asia," said Ellis.
During a pan-Asian operation from May to July this year the MPA and law enforcement agencies conducted 405 raids in China and seized 1,961,255 pirated discs. The number was only higher in Indonesia where 2,156,341 discs were seized while in Hong Kong – which has much more stringent IP laws – 56 people were arrested. During one raid in Manila, Philippines, authorities seized hand grenades, hundreds of rounds of 5.56mm ammunition and packets of "ice", an illegal amphetamine, alongside the standard DVDs.
In September, 2005, 39 people were convicted in New York in connection to a range of offences including racketeering, assault, extortion, conspiracy, money laundering, drug trafficking and trafficking in fake DVDs and CDs. The group was linked to a multi-million dollar piracy network that sold illegal DVDs made in China. Authorities tracked profits back to beneficiaries in China, according to the MPA report.
The problem has already led India, Japan, Hong Kong, Malaysia, South Korea and the Philippines to include copyright provisions in organized crime or money laundering laws.
The IP maze
But if understanding why piracy happens is easy, mastering the convoluted workings of intellectual property frameworks is a different story. For retailers, being on the up and up is not always as easy as it sounds.
Often, to make a single product like a DVD player or a mobile phone requires patents from multiple owners. To sell a music track legally two licenses are needed, one for the music and one for the lyrics, and it is not unusual for different companies to hold each one.
Then there is another barrier: the need for the owners of any intellectual property to actually license a design without disclosing how it is made and the simple reality that virtually anyhing can be copied.
"You can give me any chip and I can take it into my lab and recreate it," said HKUST's Professor Chan. "You can reverse engineer everything."
The scandal involving the dean of the micro-electronics school at Shanghai Jiaotong University earlier this year is a case in point. Chen Jin became a towering figure in China thanks to Hanxin microchips, which the government claimed were independently-developed and lauded as China's coming-of-age in microelectronics.
As it turned out, Chen had copied the designs. Industry press reported the chips were copies of Motorola designs.
Chen's duplicity left Beijing with egg on its face. But the length of time it took for the scandal to unravel shows that, not only is fraud a simple crime to commit, it can also be incredibly difficult to track down imitators.
Microchips are often designed as software, using computer code that can then be translated into an actual chip. Most companies are unwilling to share this software with Chinese firms even if they are willing to share the finished product.
At the same time, disputes are difficult to solve.
"People in China say 'we are not copying them, we are improving them,'" said Christopher To, Secretary General of the Hong Kong International Arbitration Centre. "Why reinvent the wheel?"
Faced with pirates who can more-or-less copy products at will and then evade punishment even if they are successfully prosecuted, some multinationals have set out to fight marketing with marketing.
The counterfeiters have rock-solid distribution networks and amazing market penetration, so businesses have started to treat them as competition, knowing that they can't rely on the authorities to eliminate the problem. The most visible efforts are coming from the home entertainment industry, in particular China's first foreign-invested movie distributor.
CAV Warner Home Entertainment was launched in February 2005. Its focus in the last 17 months has been cutting down the incidence of piracy in China.
"That is our number one priority," said Edward Cheng, marketing director at CAV Warner. "We do not regard the other studios as competition like in other markets. We regard them as partners."
On August 15, DVD buyers in China became the first in the world with access to legitimate copies of Poseidon. The lackluster big-budget release showed up at stores in 40 Chinese cities about two weeks before it became available in North America or Europe. Poseidon was not the first movie released in China first. Harry Potter and the Goblet of Fire was made available to Chinese audiences ahead of the worldwide DVD release.
Both movies were dubbed in Mandarin and priced at about one-tenth of the cost of DVDs in North America or Europe.
The move is only one part of a Trojan-horse strategy to take market share away from pirates. A study by LEK Consulting for the MPA found worldwide losses to piracy among producers, distributors, theatres, video stores and pay-per-view operators hit US$18.2 billion. The company also observed that typical pirates are between 16 and 24 years old and that, at 90%, China has the highest piracy rate in the world.
In the last year and a half, CAV Warner has worked to overcome the first hurdle against fighting piracy: availability.
"China limits the number of foreign films allowed in theatres each year to 20, and imposes a number of restrictions on the distribution of home video products," the LEK study said. "By contrast, pirates operate unfettered and outside the law."
Lack of access
The problem is not so much that Chinese audiences want to buy pirated movies; rather they don't have any other choice, Cheng said. "Consumers told us that it is very difficult to find legitimate products. If they do not have a quality legitimate alternative they have to go to the pirates." (See: Movie madness: Hollywood's copyright conundrum)
Early releases are only one prong of the distributor's efforts to combat piracy. CAV Warner is also releasing inexpensive DVDs with simple packaging and pricing them at just over US$1 to fight head-to-head against the very cheap fakes that are universally available.
The company is also targeting multiple markets with "silver" and "gold" releases priced at US$3 and US$4 that may or may not include features like a director's commentary and additional tracks. At the high end of the market, there are big packages like a new 10-disc edition of the landmark series The Matrix priced at around US$40.
Harry Potter and the Goblet of Fire sold 30-40% more copies than expected, said Cheng. "We are planning to release other titles, in the silver version, weeks before [the release] in international markets."
The approach has attracted the attention of another Hollywood major leaguer, Universal, which has signed up to release movies in China through the joint venture.
The company is also taking a different approach in its domestic productions. Its first made-in-China movie, Crazy Stone hit theatres on June 30. The movie cost US$400,000 to make and made US$1.5 million at theatres. More significantly, home video products like DVDs and VCDs were on the streets 12 days after the theatrical release.
"If we do not release it, pirate copies would soon be available in the market," Cheng said.
CAV Warner is betting that customers will shell out just a little bit more money for a guarantee of quality pirates cannot offer. At the same time, it is hoping small retailers will see that they can make good money with legitimate copies.
"In the last one and a half years we have expanded the legitimate distribution network," Cheng said.
The approach is long term. Legitimate DVDs are available in at least 40 cities, notably from big retailers like Carrefour and Wal-Mart, but with more than 600 viable cities across the country, the battle is very much in its infancy. In second and third-tier cities, genuine products are often unavailable while the fakes are always just a few steps away.
"We need to find more people that want to invest in legitimate products," Cheng admitted.
Another initiative, this time from the music industry, is countering the supply of illegal copies by offering a flood of legal downloads for as little as US$0.13 each.
One site offering these services is top100.cn, which has a million-song catalogue and provides entire albums online for about US$1.25 as opposed to US$5 to buy a CD. The first such legitimate site was aigomusic.com, launched last year by Huaqi Information Digital Technology. Newcomers A8.com and top100.cn started doing business in March.
The music industry is also stepping up enforcement efforts. The most recent example is a suit by the International Federation of Phonographic Industries (IFPI) on behalf of 1,400 music companies in 73 countries against Yahoo!China for allegedly offering downloads with just two clicks – a practice known as deep linking.
"Yahoo!China has been blatantly infringing our members' rights," said IFPI Chairman and CEO John Kennedy in a well-publicized statement.
Last year, the IFPI won an order from Chinese courts forcing search engine Baidu to stop linking to illegal sites.
The multi-pronged approach seems to be having the desired effect. Legitimate music sales in the mainland hit US$450 million last year, higher than the record US$337 worth of legitimate CDs sold in 2003. Still, as with movies, there is a long way to go since 99% of digital sales are mobile ringtones.
Other companies have employed a wide variety of approaches.
Drugmaker Pfizer is experimenting with small radio-frequency ID chips to track Viagra packages, which can be scanned to check authenticity. Meanwhile, Microsoft has created the Genuine Advantage program, which, among other things, works with the government to promote the benefits of using real software.
We "recognize a responsibility of working with the government and our partners to educate the value of genuine products," explained David Kay, general manager of Microsoft China's Genuine Software Initiative. "We are really targeting business because the government itself is targeting business."
Microsofts's top priority for IP in China is to "generate an appreciation and desire for genuine products?It's a long-term commitment."
Just like CAV Warner and the music industry giants, Microsoft accepts it is in China for the long haul and that developing a better environment for their intellectual property cannot be achieved overnight. At the same time, most experts agree that China has made remarkable progress in the last decade.
On the right path
"Is there a long way to go? Absolutely ? But the progress that has been made in a short amount of time is formidable. It is laudable," said Kay.
"They are doing this because they know that in order for them to maintain the level of economic growth they have to attract companies that are on the very cutting edge of innovation."
Indeed, for long-time observers of China's intellectual property environment, the landscape is unrecognizable from 10 years ago.
"IP is much more important than it was before because it is a knowledge economy," said Pancy Fung, assistant director of intellectual property with the Hong Kong government and the person responsible for international cooperation on IPR issues.
"Technology is changing. Things move very fast. When I first joined this department people did not know about IP but now, everybody knows."
This evolution may shift from the theoretical environment of laws, rules and regulations to the very practical world of business and make it possible for entire areas that live on manufacturing to slowly shift to the production of legitimate goods.
Baker & McKenzie's Loo points to the lighter industry. The vast majority of the world's lighters are manufactured in factories based in Zhejiang province. Not long ago most of these factories were producing fakes at an astonishing rate but now "it has mostly gone legit."
"I think that shows you the changes that will happen sooner or later."
A brand new game
There is growing recognition across China of the value of intellectual property. And as nothing can be done, beyond paying royalties, about intellectual property already in existence, China has turned its attention to the future.
Scientists and engineers across the country are developing and stockpiling new standards in preparation for a paradigm shift that would put the country at the forefront of the world economy.
"Because the government drives everything, it is going to happen very fast," said Professor Phillip Chan, dean of engineering at Hong Kong University of Science and Technology (HKUST). "China is going to do this its own way ? In a way, they are respecting IP."
Most of the actual progress is difficult to see and not fast enough to satisfy foreigners intent on instant gratification. And then of course, any headway is undermined by a very bad reputation: China is considered an IP black hole.
Fake retail goods are widely available and it is generally up to copyright owners to protect their own intellectual property.
Ongoing changes are unlikely to produce reams of good publicity. Much of the work is going into education and, more significantly, patent protection for products that are not exactly in the consumer sphere; things like software for mobile phones and computer chips. In broad copyright areas like movies and music, progress seems limited to big words backed by ineffective enforcement and administrative measures.
It is in science-heavy patents for very specific high-tech products where change is virtually in the eye of the beholder.
"If you see things at one particular point [in time] you may think they are not doing enough but if you see it over the last 10 years you can see that they are making progress," said Pancy Fung, assistant director of intellectual property with the Hong Kong government and the person responsible for international cooperation on IPR issues.
Aware that intellectual property is currency in the new knowledge economy, China is doing what it does best: saving a lot.
Homegrown standards have sprung up in a number of technological fields, the hope being that they can generate influence and income in the long term. For example, behind the foreign-versus-domestic tug-of-war over a standard for 3G mobile networks, China is making a separate effort to push forward its own Audio Visual System (AVS) standard for 3G phones.
HKUST's Chan expects AVS technology to compete with the MPEG4 standard when 3G handsets are finally licensed. Phones that do not incorporate the standard will simply not work properly in China.
Another broader example includes work to develop a DVD standard that could allow Chinese manufacturers to avoid licensing fees. Up to 80% of all DVD players in the world are made in China, according to state media, but manufacturers have to pay almost 40% of the cost of each unit to foreign license holders.
If endorsed by manufacturers, the new standard could change the dynamics of DVD manufacturing. This is China's second kick at the can after failed efforts to develop the EVD, or enhanced versatile disk, into a viable commercial product. The new DVD standard could come into play by 2008.
Force for the future
It is not difficult to imagine a not-so-far-away future when foreign companies will have to pay through the nose to use Chinese developed standards that provide the only entryway into the fastest-growing market in the world.
There are plenty of examples. China limits access to foreign movies while ramping up exports of its own productions. Online, the country is moving forward with a keyword system that could work with browsers and 3G phones and do away with search engines for quick look-ups like movie listings or a taxi company.
"The Chinese government is taking a very strong lead in this and, if we don't hurry up, we are going to lose out," said Christopher To, secretary general of the Hong Kong International Arbitration Centre (IAC). The IAC often arbitrates IP-related disputes and has created the first world-class domain name arbitration center in Asia.
Through sheer numbers, China could easily become the world's largest producer of intellectual property.
The country's universities produce more engineers than the US and Japan combined and almost three times as many as India. In 2004, for example, India graduated some 215,000 engineers according to a Purdue University study. Meanwhile, the US trained somewhere in the region of 70,000 new undergraduate engineers, although the number balloons to over 220,000 when it uses an operational definition that compares equivalent degrees.
China, by contrast, produced 644,000 new engineers last year.
In 2005, there were some 4 million new university graduates while researchers across the country are registering patents at breakneck speeds. The growth is almost exponential.
The number of new patents has hit the 3 million mark, Tian Li Po, director of the State Intellectual Property Office told state media in June. The number is not nearly as significant as the progression that has led to it.
It took almost 15 years, from the implementation of the patent law in the 1980s to the year 2000, for China to register one million patents. Four years and two months later, that number had doubled.
"The fast and continuous growth of patents in China embodies the great leap forward in the development of intellectual property rights while China is developing her economy and society," said Tian.
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