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Why Access To China Can Be Suicide For U.S. Companies


The wall-to-wall news coverage on political events such as “Brexit” and the Republican and Democrat national conventions have crowded out some other important news in recent weeks. One is that a barely existing startup company in China sued Apple for patent infringement in a Chinese court and won an injunction against the sales of Apple’s iPhone 6 and iPhone 6 Plus.

According to a MarketWatch report, Shenzhen Baili Marketing Services Co, the unknown start-up, doesn’t even have a website. No one answered the listed company’s phone number when journalists tried to reach the company. No operation exists at the three different addresses the company listed. You can’t even buy a Baili-branded phone today because it has gone under financially. Yet Baili is still determined to press its patent infringement case against Apple, claiming the design of the latest iPhone infringed their smartphone design.

So Apple, one of the most innovative companies that has ever existed and with a market cap of $523 billion, lost a patent case in China to a tiny, out-of-business Chinese company. The whole case is so ridiculous you have to laugh out loud first, except this is no laughing matter for American companies.

China is not known for strong intellectual property rights protection. Since taking over China in 1949, the Communist Party successfully wiped out private property rights, so there’s very little distinction between what’s “yours” versus “mine.” Wholesale “copy and paste” of foreign companies’ intellectual properties has been rampant in China and is rarely prosecuted. Anyone who walks through a Chinese market or mall will find merchants who have no shame in selling fake goods, and consumers are not embarrassed to buy them. Bloomberg reported “U.S. businesses lost $48 billion in sales, royalties and licensing fees due to intellectual property rights infringement in 2009.”

The Chinese Cheating Playbook

The Chinese government has paid lip service to protecting foreign companies’ intellectual property rights. Its actions show it follows a different playbook.

Step 1. Entice foreign companies to China with the allure of a giant consumer market, while forcing foreign companies to share their intellectual properties with a selected few large Chinese companies (so-called “national team”) through ruinous laws and regulations.

For example, according to a Harvard Business Review analysis, “Since 2006 the Chinese government has been implementing new policies that seek to appropriate technology from foreign multinationals in several technology-based industries, such as air transportation, power generation, high-speed rail, information technology, and now possibly electric automobiles. These rules limit investment by foreign companies as well as their access to China’s markets, stipulate a high degree of local content in equipment produced in the country, and force the transfer of proprietary technologies from foreign companies to their joint ventures with China’s state-owned enterprises.”

In 2015, China passed a new cyber-security law, which requires any telecom and Internet companies operating in China to provide Chinese law enforcement with assistance such as decrypting user data when deemed necessary to fight against terrorism. Despite objections from U.S. and European trade groups, the law became effective January 1.

Step 2. Punish foreign competitors to aid domestic companies. For example, Qualcomm, a U.S. technology company, had to pay the Chinese government $975 million to settle an anti-monopoly charge in 2015. In addition to the fine, Qualcomm had to “agree” to offer licenses to some of its cutting-edge technology at a sharp discount to what it charges companies elsewhere.

Step 3. Replace foreign goods and services in key industries with homegrown products and services after Chinese companies obtain the technical know-how. China just announced it has built a supercomputer that performs five times faster than a comparable U.S. one, with 100 percent made-in-China processor chips. Chinese leader Xi Jinping pronounced a goal to replace foreign technology in key strategic areas with homegrown ones by 2020.

Step 4. Shut foreign competitors out of strategic sectors. For example, Facebook is completely blocked in China despite CEO Mark Zuckerberg’s persistent charm offensive—Zuckerberg learned to speak Chinese and jogged through Tiananmen Square without a mask in the midst of suffocating air pollution.

Wake Up, U.S. Companies

So what the Chinese government intends to achieve is obvious. But the responses and actions from American companies are rather confusing.

Let’s go back to Apple. While Apple fought an honorable battle against the FBI’s request to build backdoor access to an iPhone one of the San Bernardino terrorists used, Apple has been bending over backwards to comply with Chinese regulators’ demands. Apple has agreed to China’s security checks, moved local user data onto China-based servers, and disabled a news app. Like other foreign companies, Apple views its capitulation to Chinese authorities merely as the price of market access. For a while, the return seemed justify the price tag—sales in China accounted for more than half the company’s growth for several quarters.

But that honeymoon is turning sour. The Chinese government shut down the iBooks store and iTunes Movies. It rejected Apple’s right to trademark the name “iPhone” in China. Apple total sales in China plunged 33 percent in the most recent quarter of 2016, due to stiff competition from home-grown brands such as Xiaomi.

For all foreign technology companies, the lesson from Apple’s China problem is that capitulating your beliefs and sharing your intellectual property in exchange for market entry is no different than signing a death certificate for your own company with a short-term sweetener. If your company only plans to exist for a few quarters, go ahead and pay the steep price.

But if your company plans to be successful for years to come, don’t let the size of the Chinese market blindside you into giving up your most valuable asset—your intellectual property. Don’t bow to any demand that will put your company in harm’s way. Don’t bend your mission and ethics.

Do insist on doing the right things no matter where you do business. Learn from Google, which pulled its search engine out of China and still remains one of the most profitable and successful companies in the world. No authoritarian government will change for the better unless there are enough voices to say “No.”