Confronting China’s IP Counteroffensive

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As foreign companies flocked to China over the past three decades, they faced significant intellectual property (IP) risks such as counterfeiting and the difficulty of enforcing IP rights. Now, they have a new problem — foreign firms face an escalating risk of committing an infringement of Chinese intellectual property rights.

While China remains a major factory of the world, government officials in Beijing have been pushing to transform the country into a technological and innovative powerhouse by 2020. In recent years, several decisive and significant moves have been made to help transform the economy, including policies specifically designed to support and subsidize the development of intellectual property (IP). Consequently, we have seen a significant influx of Chinese patents being filed in both the manufacturing and technology sectors, and the impact of these patents is being felt domestically and internationally.

Simply put, Chinese companies are attempting to bolster their competitive advantage by rigorously asserting intellectual property rights (IPR) domestically and overseas.

Using patent-filing data compiled by the author (see Appendix 1), this paper highlights patterns in patent-type growth rates that should alarm foreign companies. It then examines preemptive strategies that can be deployed by foreign market players, especially SMEs in the manufacturing and technology sectors.

CHINA’S IP COUNTEROFFENSIVE

Most intellectual property protection (IPP) litigation involves manufacturing and technology companies. In China, these firms typically exist in one of two forms. There are start-up companies founded by inventors of original product ideas that typically differentiate their firms from the crowd. This type of entrepreneurial business has been growing in numbers for years, especially in the biotechnology, nanotechnology and information technology sectors. However, the majority of Chinese technology companies in operation today are spinoffs from manufacturing operations. Tech firms in this second group evolve from factories into original equipment manufacturers (OEMs) or original design manufacturers (ODMs) that provide contract manufacturing and design for other companies.

As Chinese manufacturing outfits transform into OEMs and ODMs, many attempt to increase profitability by establishing their own brands and product positions and expanding both domestically and internationally. In the past, this was often done without properly understanding the IPP landscape. As a result, many Chinese companies have had legal action taken against them as they have expanded internationally, ranging from intellectual property infringement suits to product-dumping complaints. Huawei Technologies, for example, had many of its routers excluded from the U.S. market thanks to a Cisco lawsuit in 2003. Unlike the smartphone market battles over broad patents, where no direct copying is required for infringement, this action by Cisco alleged Huawei of direct and verbatim copying of the American company’s source code, command line interface, help screens and copyrighted manuals.

At the time of the Cisco action, the U.S. International Trade Commission was experiencing a dramatic increase in IP suits alleging Chinese patent infringements. This prompted Steven Hollman, a Washington lawyer representing nine Chinese alkaline battery makers being sued by Energizer Holdings at the time, to issue some blanket advice for Chinese firms: “We tell our clients that if you do business in the U.S.,” Hollman told Forbes magazine, “you’re very likely going to get sued at some point.”

The long list of IP actions taken against Chinese firms in the past, of course, also includes domestic battles, since foreign companies have aggressively protected intellectual property rights in the Chinese market as well. But the tables have turned. And it is now time for foreign companies to expect to be sued because Chinese companies have learned from their IP battles and started building IP arsenals of their own.

THE CHINESE PATENT SYSTEM

Essentially modeled after the European patent system, Chinese patent law is relatively young, with the passage of its first law taking place in 1984. The system was overhauled in 2000 as China joined the World Trade Organization, and then was further amended in 2008.

Today, the scope of Chinese patent protection has brought the market in adherence with common international IPP practices. But it is important to note that patents granted outside of China have no long-term effect under Chinese law. Under the Patent Cooperation Treaty (PCT), companies can file an international patent application to seek IP protection in the pact’s 148 member countries, including China. But a PCT patent only buys 30 months of protection. To gain long-term IP rights in China requires a local patent, which are granted in the following three categories:

  1. Regular Invention Patent: Comparable to the U.S. utility patent, a regular invention patent in China is meant for new technical innovations or improvements to a product or process. The patent application is subject to substantive examination; for example, a prior search must be conducted when examining an invention patent. Because of the extensive search and examination involved, it normally takes 3 to 5 years to grant an invention patent. An invention patent will have 20 years of protection, and is the most expensive among the three categories.
  2. Utility Model Patent (UM): The utility model patent is similar to the nation’s invention patent. But most Chinese UM patents cover small incremental technological improvements on existing products or processes and there is no substantive examination process. Utility model patents are not unique to China, but the U.S. and U.K. do not have utility model patents. And because China does not have a patent category similar to the U.S. provisional patent, the UM patent is the only category in which an inventor can receive early IP protection with limited inspection and expense. UM patents are typically granted within one year and are valid for 10 years.
  3. Design Patent: Similar to a U.S. patent that covers visual characteristics or aspects of an object, a Chinese design patent is typically granted within one year and is valid for 10 years. Design patent applications do not garner substantive examinations. Applications only need to satisfy procedural requirements, such as the format and drawings.

ALARMING PATTERNS IN PATENT GROWTH

As foreign direct investment has increased competition in the Chinese market, the number of patent filings from both domestic and foreign companies has dramatically increased. But as seen in Figure 1, domestic filings have outgrown foreign ones by a couple orders of magnitude. Indeed, between 2006 and 2013, foreign patent applications in China increased from 44,142 to 142,501. In the same timeframe, domestic patent applications jumped from 223,860 to 2,234,560, almost a 900 per cent increase.

Figure 1: Total Domestic vs. Foreign Patent Filings, 2000–2013

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The dramatic difference in domestic and foreign patent growth rates isn’t just a result of the natural evolution of China’s high-tech industry. The explosion of Chinese patent applications has been driven by a revised patent system and public policy.

In 2006, for example, a Chinese central government initiative entitled “China’s Medium and Long-term National Plan for Science and Technology Development 2006–2020” pushed innovation, with programs offering R&D tax benefits and preferential government procurement for Chinese innovation products. To support patent filing, the policy also created a US$86.4 million fund to provide domestic companies with legal IPP assistance. In 2008, the government substantially increased financial support available to technology companies showing innovation with the High and New-Technology Enterprise Program.

To continue enjoying the tax advantages, subsidies, and other privileges provided by these government initiatives, Chinese companies are mandated to continue innovating and filing patents. However, in addition to driving a dramatic increase in patent filing, Chinese public policy has had a disturbing side effect — an explosion of domestic UM filings.

As seen in Figure 2, the gap between domestic and foreign filings of utility model patents is simply astounding. Note that the y-axis is plotted on a logarithmic scale so that the number of foreign filings can be visible. At the end of 2013, domestic utility model filings were almost 124 times higher than foreign utility model filings.

Figure 2: Domestic vs. Foreign UM Patent Filings, 2000–2013 (y-axis is logarithmic)

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From the foreign patent-filing patterns depicted in Figure 3 and the domestic filings depicted in Figure 4, it is clear that foreign companies and Chinese companies have very different patent-application patterns, in addition to different patent-filing growth rates.

Figure 3: Foreign Patent-filing Patterns, 2000–2013

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Figure 4: Domestic Patent-filing Patterns, 2000–2013

chart-4

While foreign players have focused their IPP strategies in China almost exclusively on invention patents, domestic firms have not. In 2013 alone, China’s patent office received 892,362 applications for UM patents and 659,563 applications for design patents. Domestic companies accounted for more than 98 per cent of these filings.

These different patterns in the patent of choice have significant implications. Indeed, while the growth rate of domestic filings across all three patent categories has grown exponentially, foreign companies should be alarmed by the large number of domestic UM filings, as well as design patent filings, because these categories of patents are easy to acquire and can’t always be easily invalidated despite being of relatively poor quality.

DEVELOPING PRE-EMPTIVE FOREIGN STRATEGIES

Many foreign companies, especially SMEs, still question the need to have a Chinese IP strategy, arguing that past judgments hardly justify the time and effort.

As things stand, most IP infringement cases in China are mediated by law firms. According to the data compiled by SIPO, 87 per cent of infringement cases in 2006 were resolved without a court order. Notable court battles, of course, have taken place. The landmark case that probably caught the most attention from foreign technology companies is Chint vs. Schneider. In 2007, China’s Chint Group sued the European company Schneider Electric for infringing on its circuit-breaker UM patent. The judgment in this case cost the European firm approximately US$45 million. But most IPP lawsuits have not involved big monetary payoffs. A 2009 study of IPP litigation in China by Cox and Sepetys found that more than 90 per cent of damage awards were under US$100,000, with less than 5 per cent of lawsuits initiated by Chinese entities against foreign companies.

However, looking at the alarming patent-growth patterns highlighted in this paper, it is clear that previous scrimmages over IP rights in China were merely the beginning. And because patents granted outside China have no lasting legal effect inside the market, it is crucial for foreign companies, especially SMEs engaged in the manufacturing and technical fields, to have a strong Chinese IP strategy.

Amongst other things, developing a strong IP strategy in China requires understanding that there is significant variation in the enforcement of IPP laws across the country, with many provinces (such as Zhejiang, Liaoning, Hubei, Guangxi, and Guangdong) having their own regulations. But the critical thing that foreign players must do is scan the competitive intelligence landscape to limit the risk of being sued by Chinese patent owners. This is especially true for UM patents, which now exist in large numbers and are skewed towards manufacturing and technology.

In 2013, a report by the Office of the U.S. Trade Representative charged China with promoting “indigenous innovation” policies that could place U.S. companies in China at a disadvantage. One of the policies in question was the UM patent. Simply put, while UM patents are generally considered to be inferior to invention patents, they are relatively easy to get, rapidly granted, and difficult to invalidate. More importantly, a UM patent owned by a Chinese patent holder may potentially stop a foreign company from manufacturing or selling its products in China. As such, they represent a powerful weapon for patent trolls. Any Chinese entity can conceivably apply for a cheap, fast-track, under-examined UM patent on an existing product or process patented outside of China, and then sue foreign manufacturers in China for infringement.

To understand just how critical it is for foreign companies to scan China’s IP landscape, consider this data: By 2013, Huawei had approximately 1,600 UM patents, ZTE had 1,900 UM patents, Midea had 5,200 patents and Haier had 3,500 patents (Meng and Hao, 2013).

Keuppa et al. (2012) define four archetypes of foreign firms filing patents in emerging economies (see Table 1 below) based on three criteria: degree of patent use as a signaling mechanism, the expectations about the local government’s commitment to IPP and the degree of geographic differentiation of the company’s IP policy (global vs local).

Table 1: Four Archetypes of Foreign Companies Regarding Patenting in China

Archetype
Definition
Conditions
Signaler Company uses patents mainly to signal superior technological capabilities to Chinese firms.
  • Strong intention to use patent as a signaling mechanism.
  • Pessimistic about local government’s commitment to IPP.
  • Company’s IP policy is mostly local.
Speculator Company speculates that China’s IP system is improving adherence to international common practices.
  • Strong intention to use patent as a signaling mechanism.
  • Optimistic about local government’s commitment to IPP.
  • Company’s IP policy is mostly local.
Strategist Company with mature global IP policy that believes Chinese IP system will steadily improve adherence to international common practices.
  • Weak intention to use patent as a signaling mechanism.
  • Optimistic about local government’s commitment to IPP.
  • Company’s IP policy is mostly global.
Struggler Company with global IP policy but very pessimistic about Chinese government’s commitment to IPP. Fails to develop a China IP policy.
  • Weak intention to use patent as a signaling mechanism.
  • Pessimistic about local government’s commitment to IPP.
  • Company’s IP policy is mostly global.

Huang (2012), meanwhile, defines four patenting strategies based on two major factors, complex vs. discrete (complex technologies are ICT, computing and hardware, while discrete technologies are chemical, pharmaceutical, biotechnology and life sciences), and the degree of intellectual property rights protection and enforcement, which is essentially the local government’s commitment to IPP.

Table 2: Huang’s Patenting Strategies in China

Name of Strategy
Conditions
Strategy
Incremental patenting Low commitment to IPP, complex technology File mostly UM patents with fewer invention patents
Augmented patenting Low commitment to IPP, discrete technology File more invention patents than UM patents
Effectual patenting High commitment to IPP, complex technology File more invention patents than UM patents
Foundational patenting High commitment to IPP, discrete technology File predominantly invention patents

While both of the above frameworks are conceptually interesting and comprehensive, the required decision making is in fact much simpler. Instead of overlooking UM patents, this paper recommends that foreign companies file UM patents on their OEM and ODM products in China as soon as possible — even before sourcing Chinese manufacturers. With the rapid growth of Chinese UM patents and the improvement of China’s commitment to IPP in recent years, this is both a sensible and practical strategy for foreign firms, especially SMEs in the manufacturing and technology sectors.

Filing UM patents serves multiple purposes. First, they raise awareness of a foreign firm’s superior technological capabilities to Chinese companies, similar to Keuppa’s signaler concept. Second, UM patents can attract local Chinese business partners while deterring local competition. And lastly, filing these patents can qualify foreign firms as high-tech companies and lead to local tax benefits.

While China is not yet an IP powerhouse, it is clearly on the road to being a top contender. As a result, foreign companies, especially SMEs in the manufacturing and technology sectors, can no longer ignore China’s IP counteroffensive. It is now critical to design and implement a Chinese market IP strategy that includes filing UM patents and/or design patents before entering the market. In fact, foreign companies should see this as a must-do step, even if they don’t plan to enter the Chinese market in the near future. If they don’t, foreign companies should heed the advice given to Chinese firms by Washington lawyers in 2003 and expect to be sued.

 APPENDIX 1

ALL CHINESE PATENTS, 2000–2013
Total
Invention
Utility Model
Design
2000 105,345 12,683 54,743 37,919
2001 114,251 16,296 54,359 43,596
2002 132,399 21,473 57,484 53,442
2003 182,226 37,154 68,906 76,166
2004 190,238 49,360 70,623 70,255
2005 214,003 53,305 79,349 81,349
2006 268,002 57,786 107,655 102,561
2007 694,153 245,161 181,324 267,668
2008 828,328 289,838 225,586 312,904
2009 976,686 314,573 310,771 351,342
2010 1,222,286 391,177 409,836 421,273
2011 1,633,347 526,412 585,467 521,468
2012 2,050,649 652,777 740,290 657,582
2013 2,377,061 825,136 892,362 659,563

 

DOMESTIC CHINESE PATENTS, 2000–2013
Total
Invention
Utility Model
Design
2000 95,236 6,177 54,407 34,652
2001 99,278 5,395 54,018 39,865
2002 112,103 5,868 57,092 49,143
2003 149,588 11,404 68,291 69,893
2004 151,328 18,241 70,019 63,068
2005 171,619 20,705 78,137 72,777
2006 223,860 25,077 106,312 92,471
2007 586,734 153,060 179,999 253,675
2008 717,144 194,579 223,945 298,620
2009 877,611 229,096 308,861 339,654
2010 1,109,428 293,066 407,238 409,124
2011 1,504,670 415,829 581,303 507,538
2012 1,912,151 535,313 734,437 642,401
2013 2,234,560 704,936 885,226 644,398

 

FOREIGN CHINESE PATENTS, 2000–2003
Total
Invention
Utility Model
Design
2000 10,109 6,506 336 3,267
2001 14,973 10,901 341 3,731
2002 20,296 15,605 392 4,299
2003 32,638 25,750 615 6,273
2004 38,910 31,119 604 7,187
2005 42,384 32,600 1,212 8,572
2006 44,142 32,709 1,343 10,090
2007 107,419 92,101 1,325 13,993
2008 111,184 95,259 1,641 14,284
2009 99,075 85,477 1,910 11,688
2010 112,858 98,111 2,598 12,149
2011 128,677 110,583 4,164 13,930
2012 138,498 117,464 5,853 15,181
2013 142,501 120,200 7,136 15,165

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