Challenges of Technology Licensing in China

The benefits of investing in China are well documented as many companies flock there to develop a footprint in the Chinese market. Chinese economic growth is fast, and cheap labor and capital abundantly available. Despite these benefits, there are risks that a company should consider before deciding to join the flock. Over the past decade, a wealth of challenges and best practices were recognized as more companies share their successes and failures doing business in China. One such challenge is technology and IP licensing in China, and some of the best practices to mitigate these challenges. This paper discusses some technology and IP licensing challenges a large chemical manufacturer faced and how the company fared.

BigChem’s Proprietary Technology

BigChem, a large chemical manufacturer, developed and, for decades, successfully protected a proprietary technology for the large-scale manufacture of a commodity chemical. BigChem’s technology is the only process in the world that can convert a cheap, abundant raw material into a profitable commodity chemical. Furthermore, this process is simple, clean, and cheap to operate making it the lowest cost and least environmentally impactful method to produce a particular commodity chemical in the world. ChinaChem, a Chinese chemical manufacturer, expressed interest in using BigChem’s proprietary technology to take advantage of vast Chinese raw material reserves and growing demand for the commodity chemical. BigChem sees this as a lucrative opportunity and decides to license its technology to ChinaChem to build a large manufacturing facility in the Chinese desert. (Manager)

Expert Panel Review

Due to the large size and scope of the project, expert panel reviews were required during several steps of the licensing process. This included reviews of energy conservation, and environmental health and safety assessment reports developed by BigChem. The panel typically includes five or more “experts” that meet the academic and professional requirements set by the Chinese government. This posed a challenge to BigChem as the Chinese government has authority in selecting panel members, including employees of Chinese competitors (such as ChinaChem). This is problematic as the reports the expert panel review contain sensitive technical material that puts BigChem’s proprietary information at risk. (USCBC, 2014)

BigChem, through its wholly owned subsidiary AsiaCo, had already established operations in China. Over the years, AsiaCo established strong relationships with many local and central government officials in China. These relationships were vital in allowing BigChem to provide input in selecting expert panel members. In fact, two of the five expert panel members were AsiaCo employees. The established relationships helped BigChem mitigate the risk of exposing crucial project details to Chinese competitors. (Manager)

Proprietary Information Protection

BigChem was also required to provide detailed process information to local government agencies putting BigChem’s delicate intellectual property at risk during the approval process. Furthermore, China does not have requirements to destroy and the information submitted by BigChem during the approval process keeping BigChem at risk even after the license is approved. (USCBC, 2014)

AsiaCo’s robust knowledge of the regional requirements helped BigChem limit the amount of information disclosed during the approval process. During negotiations with local officials, BigChem signed a non-disclosure agreement as a condition for licensing technology to ChinaChem. This gave BigChem leverage in deciding what information becomes publicly available and what stays secret. Local officials were pleased to comply due to the potential economic benefits a new manufacturing facility brings to the region. The license was eventually approved and the project to build a new facility would move forward. (Manager)(USCBC, 2014)

Following the license approval process, BigChem quickly realized its intellectual property was still at risk. In order to preserve its market share, BigChem only agreed to license a portion of its technology. ChinaChem could reap the benefits of the upstream portion of the process, however, they would have to develop their own downstream design. BigChem had to strategically organize critical steps in process to limit any single employee from access to all IP sensitive information. BigChem kept all vital designs outside of China and ChinaChem was only allowed access to BigChem’s technology through consultation with BigChem’s subject matter experts. (Manager)(USCBC, 2015)

Despite these measures, it was still evident that ChinaChem was probing BigChem for more information. During a tour of BigChem’s flagship facility, ChinaChem brought a large contingent of 15 employees such that it was difficult for BigChem to monitor all ChinaChem employees. ChinaChem employees were often wandering off, taking notes and pictures, and flipping through any and all documents in sight. BigChem employees had to stop the tour and require that a BigChem employee escort each ChinaChem employee, ChinaChem employees were prohibited from carrying notebooks and cameras, and all design data was relocated to secure areas. (Manager)(USCBC, 2015)

After all was said and done, ChinaChem completed construction of one facility, and scrapped construction of a second. BigChem licensing employees oversaw the design, construction, and startup operation of the first facility. Prior to construction of the second facility, the Chinese government raised the price of the critical raw material making the project economically unfavorable. BigChem is still in litigation with ChinaChem to return the equipment built for the second facility’s construction. The equipment, lying abandoned in the Chinese desert, is not only worth millions of dollars, it is all BigChem’s proprietary design. BigChem fears this equipment could be sold to competitors and reverse engineered, putting BigChem’s IP at risk. BigChem has the same fear for equipment used in the first facility that is now idled due to high raw material pricing. (Manager)

Once again, AsiaCo’s strong relationships with government officials are proving invaluable to BigChem. The litigation process is working in favor of BigChem thanks to these relationships; however, ChinaChem’s own relationships are prolonging the litigation process. Both BigChem and ChinaChem stand to lose millions in lawsuit costs, and sunk costs of this massive project. Following this experience, BigChem decided to end the licensing of this specific technology. (Manager)

Conclusion

Foreign companies doing business in China must be vigilant when disclosing sensitive information and dealing with an obscure licensing process. Companies can take steps to minimize the risk of unveiling trade secrets to potential competitors by building strong relationships with local government officials for higher transparency and lower disclosure of vital information. Once licenses are approved, foreign companies must remain vigilant to limit the exposure of proprietary information to the Chinese licensee. This requires careful assessment of what information to disclose and what to keep secret. Measures should be taken to prevent access to all information to any single employee. In the event the license agreement fails, foreign companies must remain prepared to protect their IP. Strong relationships, or guanxi, can go a long way in helping a foreign company combat the challenges of licensing technology in China

 

Sherif Ibrahim

 

References:

Best Practices: Intellectual Property Protection in China (Rep.). (2015). Retrieved April 7, 2016, from USCBC website: https://www.uschina.org/sites/default/files/USCBC Best Practices for Intellectual Property Protection.pdf

Du, Y. (n.d.). Intellectual Property Licensing in China. Retrieved April 08, 2016, from https://www.hg.org/article.asp?id=35379

Manager, B. (2016, April 05). Technology Licensing to ChinaChem [Personal interview].

Licensing Challenges and Best Practices in China (Rep.). (2014). Retrieved April 7, 2016, from USCBC website: https://www.uschina.org/sites/default/files/Licensing-Jan2014.pdf