#231      22 min 33 sec
Prizes and pitfalls: What foreign firms encounter when partnering with China

Innovation management expert Prof Elisabeth Mueller discusses the roles that research and the creation of intellectual property (IP) play in increasing productivity of China's corporations. She also examines the benefits and risks facing foreign businesses who venture into China's enormous market. Presented by Jennifer Martin.

"Judges that have to deal with intellectual property lawsuits, they get a better understanding of the system and therefore the rulings get more predictable. Then we can also see the damage awards that they are increasing and just overall shows that in China there is an increasing appreciation of legal protection of intellectual property." -- Prof Elisabeth Mueller




Prof Elisabeth Mueller
Prof Elisabeth Mueller

Elisabeth Mueller is Professor for Innovation Management at the Frankfurt School of Finance & Management in Germany. She obtained her PhD in Economics from the London School of Economics in the UK and then worked as post-doc at the Centre for European Economic Research (ZEW) in Mannheim, Germany. Her research focuses on innovation in China, the management of intellectual property, and the financing of innovative firms. She was vice-president of the European-wide research network “Science and Technology Research in a Knowledge-based Economy (STRIKE)”. Her research has been published in international journals, such as Research Policy, Review of Finance, and Industrial and Corporate Change. Recently, she visited Boston University, USA and the University of Melbourne, Australia as guest researcher.

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Credits

Presenter: Jennifer Martin
Producers: Kelvin Param, Eric van Bemmel
Audio Engineer: Gavin Nebauer
Voiceover: Nerissa Hannink
Series Creators: Eric van Bemmel and Kelvin Param

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VOICEOVER
Welcome to Up Close, the research talk show from the University of Melbourne, Australia. 

JENNIFER MARTIN 
I'm Jennifer Martin.  Thanks for joining us.  What does it take to successfully conduct business in China in the 21st century?  What do international companies need to know if they are going to have any hope of tapping into the market of the world's most populous nation?  A country that despite huge gains is still playing technological catch up with the west.  China's 1.3 billion population is a huge lure to international businesses but as with any new frontier there are very real risks, such as the theft of intellectual property or IP and a rather flexible attitude towards payments and contracts.  More than half of German companies in China said, they had experienced intellectual property theft.  Joining us by Skype from Germany to help us understand the pitfalls and the prizes of doing business in China is professor for innovation management at the Frankfurt School of Finance and Management in Germany, Elisabeth Mueller.  Elisabeth's research focuses on innovation in China, the management of IP and the financing of innovative firms.  Elisabeth, thank you for joining us.

ELISABETH MUELLER
Thank you very much for having me here.

JENNIFER MARTIN
I would like to begin by asking you to give us an overview if you could of China's technological development since it opened up to the west.  How far has it come?  Where does that mean it now stands in relation to the rest of the world?

ELISABETH MUELLER
You can say that China is investing a lot at the moment into R&D.  We see a real explosion of patent applications and I would say that China is now at a medium level of development.  We see that they are investing a lot but we also see that they still need to catch up to the west and that at the moment their level of technological development I would say, in most areas is below the west.

JENNIFER MARTIN
So how long do you think it will take for China to catch up and what are the repercussions of that for international businesses?

ELISABETH MUELLER
I would say that we will see a lot of development in the next 10 to 15 years and it's also the aim of the Chinese Government in the next 10 to 15 years or say, until 2020, to catch up and to be more of a technological leader.  I think the repercussions for the western companies will be that they face more competition.At the moment the competition from China is mainly in the industries which benefit from low wage costs but we see that wages are increasing in China and therefore the Chinese firms they need to move up with respect to the technology level and try to be competitive in more technologically advanced sectors.  

JENNIFER MARTIN
So taking that timeline that you have just given to us, international companies will be really wanting to hit the ground now in China won't they?

ELISABETH MUELLER
I would think so, yes.  The Chinese population is very keen to buy goods from western companies.  For example, the brands that we have in western companies, they are very attractive for Chinese customers.  So I think it makes a lot of sense to invest now and try to be there at the moment.

JENNIFER MARTIN
So could you tell us a little bit about the history of foreign investment in China and what we call technology transfer?  Now that’s a term I'm going to ask you to explain, of these international companies in China, who has done it really well?

ELISABETH MUELLER
I would say that Volkswagen, the German car manufacturer did it very well because they are quite successful in selling cars in China and technology transfer in general means that one company is learning from a different company or is also learning from a university.  It always means that knowledge is passed from one person to another person. 

JENNIFER MARTIN
Tell us a little bit more about the history of foreign investment in China?  What problems and obstacles have companies faced?

ELISABETH MUELLER
In the '90s, we saw that there was a lot of forced technology transfer, the Chinese Government tried to condition access to the Chinese market to making technology available to Chinese companies.  But then it was later found that the Chinese companies actually did not benefit too much from this technology transfer because at that stage they were just not developed far enough to be able to benefit from this knowledge.I woud say, it is different now, that the Chinese firms are more developed.  We see that they are in a process of being able to learn from international knowledge.

JENNIFER MARTIN
So what impact does China state owned enterprises have on this business landscape?

ELISABETH MUELLER
They are very influential because the state owned enterprises, they often have a monopoly situation in their home market which means that they are quite profitable.  They also have government support, but on the other hand they are also obliged to fulfil government regulations which also costs them a lot of money, but all we can say is that state owned enterprises are very powerful and they are a force that western companies have to reckon with.

JENNIFER MARTIN
Now, Elisabeth, a recent study of German businesses found 57 per cent had experienced intellectual property or IP theft in China.  Can you explain the mindset in China that this occurs?

ELISABETH MUELLER
Yes.  I would say that appreciation for intellectual property and it has to be protected is only developing at the moment and that so far we see that it can be an honour if a Chinese person is copying from someone else, it's a recognition that the other person has done something very well.  Therefore it's a process of learning that the Chinese as they for example, also file for their own patent applications, they get a better appreciate that we have to protect intellectual property rights.

JENNIFER MARTIN
On the face of this risk, why does a successful innovative German company risk IP theft in China?

ELISABETH MUELLER
The German companies they are export orientated and so they will need to enter this attractive market as well and if they do not enter it themselves, then the Chinese firms they can copy the products off the German companies even if the German companies do not directly enter the market because the Chinese companies they can also buy some sample products and then reverse engineer them.So in fact entering the market is increasing the risk of IP theft but by not entering the market that's also not a complete safeguard that IP is not stolen.

JENNIFER MARTIN
This is Up Close.  I'm Jennifer Martin, and our guest today is innovation management expert, Elisabeth Mueller, and we are talking about doing business in China.  Elisabeth, what indications do you see of this culture changing, of it becoming more aligned with western attitudes on patents and intellectual property?

ELISABETH MUELLER
What we can clearly see is that judges are getting more educated so the judges that have to deal with intellectual property lawsuits, they get a better understanding of the system and therefore the rulings get more predictable.  Then we can also see the damage awards that they are increasing and just overall shows that in China there is an increasing appreciation of legal protection of intellectual property.We should also say that because China is such a huge market sometimes infringement of intellectual property is actually not a problem for the local Chinese firms if the infringing company is selling in a different region, though that's a bit unusual for other countries, that in fact infringement might not harm the actual company.

JENNIFER MARTIN
That's so interesting.  So that raises a question, just how crucial is it for international businesses to partner with local firms in China?  What happens if they don’t?

ELISABETH MUELLER
I think it's quite important to partner with the local firms because the local firms have the local knowledge.  They have the distribution networks.  So I think that's a crucial element and sometimes it's also a condition to get access to the Chinese market.

JENNIFER MARTIN
What's the advantage of partnering, an international company partnering with a state owned business in Chinese as opposed to a private owned business?

ELISABETH MUELLER
There is an advantage of partnering with a state owned enterprise because the state owned enterprises typically are better connected to the Government and in China one has to know that a lot of decisions are influenced either by local governments or by the Federal Government.So it makes business easier if the international companies partner with the state owned enterprises, but some private firms are also well connected.  So I would say that in general when choosing a partner one has to be careful to figure out how well this company is connected to the Government.

JENNIFER MARTIN
Now, Elisabeth, we have looked at the ways in which international companies can make inroads into China's business world, but you have done a research project that looks from China outwards.  You have analysed the influence of research and development or R&D on productivity for more than 1000 Chinese firms.  So what was your premise for doing this research?

ELISABETH MUELLER
We were quite intrigued by the increasing patent applications and by the increase in R&D expenditure of the Chinese firms and what is so far not known is whether these investments are actually productive, whether these investments increase the productivity of the Chinese firms, or if they are mandated by the Government and in fact worthless.

JENNIFER MARTIN
So that takes us to the heart of the question, how do you measure productivity?  What for you is your definition of productivity, Elisabeth?

ELISABETH MUELLER
Yes, we relate the output of the companies to the inputs they use.  So we look at the sales that the companies achieve and control for the input that they use in terms of employees, in terms of capital, in terms of materials and what we cannot explain by these inputs is this total factor productivity or just productivity for us?  Then we can see whether research is making the productivity higher for the companies.

JENNIFER MARTIN
So does this index of TFP, does that only apply to technological or high tech or biotech firms in China or can it apply to other types of business?  Can you apply it to such things like restaurant chains or hotel chains?

ELISABETH MUELLER
Yes, in general this measure of TFP or total sector productivity can be applied to any firm because all firms are producing some output and using inputs but we have to be careful not to compare directly with service-oriented firms, with manufacturing firms, but in our sample we therefore concentrate on manufacturing firms.

JENNIFER MARTIN
So what conditions are needed to boost productivity in Chinese firms?  What has your research revealed?

ELISABETH MUELLER
What we see is that actually the research that the Chinese firms are conducting is quite productive, that it is increasing the TFP of the firms and we also investigate it as specific types of R&D.   For example, using domestic knowledge sources outside of the firm and using international knowledge sources.  Here we find that the use of domestic knowledge sources is increasing the productivity.  So the Chinese firms are able to benefit from this knowledge, but we found for the use of the international knowledge sources that we need to differentiate.  We only see for the long term involvement with one partner, for example, in terms of joint ventures that we see an increase in productivity.

JENNIFER MARTIN
Could you give us an example of each of those types of knowledge transfers?

ELISABETH MUELLER
Yes, one possibility would be for a Chinese firm to buy a foreign company.  This is what happened in the solar industry, the Chinese firms bought German or US based companies and then they would get access to the technology of these firms.  Or Chinese firms, they can also hire inventors and scientists from abroad and then employ them in their companies.  So this would also be a part of technology transfer because the scientists bring with them their education from abroad.

JENNIFER MARTIN
Who has done that?

ELISABETH MUELLER
We see for the large Chinese companies that they do in fact hire foreign inventors and that at least some of them have their research labs outside China, but this is only a mechanism of knowledge acquisition that is used recently and in our research we see that this form of knowledge acquisition is not increasing their productivity.  It could be that it is related to costs that are too high at the moment for the firms, but we expect as the firms develop that they will in fact be able to profit from this type of technology transfer as well.

JENNIFER MARTIN
I'm really interested in you giving us some examples of Chinese companies that are doing this well or perhaps not doing it well.  Who sticks out in your mind?

ELISABETH MUELLER
For example, there is the Chinese car producer, Jili, they bought the Swedish car producer, Volvo and they were hoping with the Volvo brand to be able to increase their market share in China, but in this example it did not work out very well.

JENNIFER MARTIN
You are listening to Up Close.  I'm Jennifer Martin.  We are talking about the challenges of entering the Chinese market and we are joined by innovation and management expert, Professor Elisabeth Mueller, from the Frankfurt School of Finance and Management in Germany.  Elisabeth, when you talk about inventors coming from outside to China and working within those companies, is there a difference between how successful they are, whether they are based in their own country and just sharing their knowledge via computers or is it more successful if they are actually in China?

ELISABETH MUELLER
In fact we see no difference between the two possibilities.  In both cases we see that there is no increase in the productivity of the Chinese firms and here we think that possibly the cultural barriers and the language barriers are too high.  So that Chinese firms can only benefit from the international knowledge if there is deep organisational integration of the knowledge as it happens for example with joint ventures, but just to hire some single inventors does not seem to work.

JENNIFER MARTIN
So, Elisabeth, how do they get that deep ingrained relationship at that organisational level?  How does it drench through?  What do they need to do?

ELISABETH MUELLER
They need to work together on a long term basis and both sides of the joint venture I would say, need to establish a level of trust.  Otherwise it's not possible for the scientists to work closely together and to share the knowledge.  With knowledge sharing you always need face to face interaction and it just requires that scientists also like to work together with each other.

JENNIFER MARTIN
Now, Elisabeth, you had to face a number of problems in gathering and analysing your data.  Not least of all was as we have discussed, deciding how you actually define and measure productivity.  There was also this issue of state mandated R&D.  Did this skew your figures at all?  What impact did it have?

ELISABETH MUELLER
We only use basic measures of our Chinese companies.  So we use number of employees, the capital stock, sales and we trust that these measures are reliable.  Furthermore we use only information on listed companies because it is easier to get information on them.  Then the measure we use for R&Ds coming from patent applications and they are taken from the Chinese Patent Office, it is administrative data and we also trust that this data is reliable.  We have to say that the Chinese policies that they go through to our data. For example we see that the patent stock of the state owned enterprises has no direct effect on productivity and here we think this is an implication of the policies, namely that state owned enterprises are under much more pressure to fulfil government rules and to increase the number of the patent applications, so that here we do not see effect on productivity.

JENNIFER MARTIN
So what proportion of these patents are local to China and how many go out say, to the US Patent Office?

ELISABETH MUELLER
The vast majority of the patent applications are actually local to China.  It's about 10 per cent of the invention patent applications that go to other countries and the reason is that the technological development of most Chinese companies is still quite limited and that the hurdles to get a patent granted outside of China are generally higher.  So the Chinese companies first need to learn how to apply for patent protection and how to do good research before more of them can get international patents.

JENNIFER MARTIN
So from your research, what conclusions were you able to draw?  And do Chinese firms benefit from this in-house R&D and working with domestic partners?  Can you talk us through this and give us some examples?

ELISABETH MUELLER
We get the impression that the Chinese companies benefit from this in-house R&D but for the state owned firms it's not so clear.  The state own firms might be under more pressure to spend more on R&D so here we don’t see clear benefits.  Interestingly, we see quite a clear learning effect when it comes to these international knowledge sources.For the first part of our database until the year 2007 we did not find that there is a positive influence on productivity from the international joint ventures but for the second half, 2008 to 2010 we do see that there is a positive effect.  So there is a clear indication that the Chinese firms are catching up and that they are learning.

JENNIFER MARTIN
Look, there are some very real practical problems with doing business in China aren’t there?  Foreign businesses often talk of the difficulty in finding good managers and the need to have someone from their company on the ground to make sure things run smoothly.  Why do you think that is?

ELISABETH MUELLER
I think it's because there are cultural differences, but I think this applies to other countries as well that in order to do business you need to have a local presence.  I think that's generally true for doing business.

JENNIFER MARTIN
So, Elisabeth, if you had to give some advice to an international company coming in to China, what would you tell them?

ELISABETH MUELLER
I would tell them to be patient, to try to get in now, to be careful about what knowledge to share with the Chinese partner.  That's the strategy that we see for many companies that they are very careful to decide which type of technology to share with a Chinese partner and which type of technology to keep outside.  In general I see China as a very attractive market with great future prospects.  So I would advise companies to try to enter this market.

JENNIFER MARTIN
On the side of that, what would advise Chinese companies to do?

ELISABETH MUELLER
For the Chinese companies we see that some of them have a lot of capital at their disposal.  So for some of them it might be useful to buy western companies to get the technology of the western companies and also to make use of the brands that western companies have.

JENNIFER MARTIN
Elisabeth, thank you so much for joining us.

ELISABETH MUELLER
Thank you very much for having me on the show.

JENNIFER MARTIN
We have been speaking with innovation and management expert, Professor Elisabeth Mueller, from the Frankfurt School of Finance and Management.  She joined us via Skype from Germany and she discussed with us how international firms are doing business in China and the problems that they face.  This episode was recorded on Thursday, 17 January 2013 and our producers were Kelvin Param and Eric van Bemmel.  Audio engineering by Gavin Nebauer.  Up Close is created by Eric van Bemmel and Kelvin Param.  I'm Jennifer Martin.  Until next time, goodbye.

VOICEOVER
You have been listening to Up Close.  We are also on Twitter and Facebook.  For more info visit upclose.unimelb.edu.au.  Copyright 2013.  The University of Melbourne.


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