Friday, November 26, 2010

Knowledge Transfer in China: How To Train The Dragon To Consume You

Professor Pierre Sauvé, deputy managing director, director of studies and faculty member at the World Trade Institute (WTI), Switzerland gave a very interesting guest research lecture at CUHK November 24, 2010: "Waiting for Godot? The troubled prospects of (coherent) multilateralism in investment rule making". Inspired by his speech in which he mentioned the requirement of many countries to use a certain percentage domestically produced parts in the product to prevent that tariffs are imposed that make the product uncompetitive (for example there is a domestic content requirement in the U.S. car industry of 75 percent. Therefore Japanese automobile plants opened in the U.S.), IP Dragon has been thinking about knowledge transfer in China.

Also on November 24, Leslie Hook wrote on the front page of the Financial Times an article called 'Westinghouse gives China details of nuclear reactor technology':
"Westinghouse Electric has handed over more than 75,000 documents to its Chinese customers as the initial part of a technology transfer that it hopes will secure the company's place in the world's fastest-growing nuclear market."

Whether this hope can become a reality remains to be seen. There are ample examples of companies that transferred their technology in the hope of selling more products in the future, only to find out that their customer metamorphosed into formidable competitors.

Speed railway system: Alstom (France), Siemens Mobility (Germany), Kawasaki Heavy Industries Ltd. (Japan) shared high-speed rail technology with China's CSR Corporation Ltd, and China CNR Corporation Ltd.

Thomas Hout and Pankaj Ghemawat wrote the article 'China vs the World: Whose Technology Is It?' in the Harvard Business Review of December 2010. In this article they give an overview of China's plans, which they formulated in 2006, to close the technology gap with the west.

"China wants to strengthen innovation, particularly in energy, transportation, the environment, agriculture, information and health." Professors Hout and Ghemawat write that China wants to increase their proprietary IP. In order to prevent that Chinese companies have to pay royalties for foreign IP, China is promoting its own unique national technology standards, that form de facto entry barriers to foreign manufacturers: WAPI (Wireless local area network Authentication and Privacy Infrastructure) and TD-SCDMA (Time Division Synchronous Code Division Multiple Access).

Because China has many state-owned enterprises, it can orchestrate mergers and acquisitions in industries that are considered of key importance to China. Professors Hout and Ghemawat give four mechanisms that China is using to support their industries:

1. Tax incentives for key industries;
2. Spending and soft loans for key industries;
3. Procurement that favours indigenously developed technologies (China is an observer to the WTO General Procurement Agreement and not a member);
4. Forcing multinational companies to transfer their newest technologies to their joint ventures with state-owned companies.

The following companies are among those that will probably thrive under these circumstances:
Wind energy: Sinovel, Goldwind
Enterprise Resource Planning (ERP) software: Kingdee International Software Group
Solar energy: Suntech, Yingli Solar, JA Solar

How to train the dragon ... to become your competitor?

Why would a company transfer their technology, which is their only advantage in comparison to Chinese companies that can produce much cheaper? Are these foreign companies suicidal?
Some are lured by the prospect of great deals in the long run, and expect loyalty from Chinese companies and China. However, this might never materialise. Instead it is very possible that after the technology transfer has been completed the joint venture will be dissolved so that the Chinese part will leapfrog and become a formidable competitor of the foreign company.

Some foreign companies might be more realistic. They might have the conviction that if they don't do it, some other foreign company is cooperating with the Chinese and securing in the short term big orders. Because of the prisoner's dilemma they might be right. China does not have this problem. The foreign company has probably the idea that the revenues from the Chinese orders can be reinvested into new technology, so that the technological edge can be sustained. Nevertheless, it seems a risky strategy.

UPDATE November 29, 2010:

Francois de Beaupuy and Tara Patel wrote: 'China Builds Nuclear Reactor for 40% Less Than Cost in France, Areva Says', November 25, 2010.

Nuclear Townhall reports in the article 'China, Russia Leveraging Nuclear Energy For World Economic Lead', November 26, 2010: "Chinese technicians have already reversed-engineered Areva 900-MW reactors built at Daya Bay into the CPR-1000 and have 16 under construction, the first scheduled to open next September. Zhang [Shanjing, president of China’s Guangdong Nuclear Power Corporation] said that once certain intellectual property issues are cleared up with Areva, Guangdong would begin exporting, probably by 2013."

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