In Present Tense
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In Present Tense

Photo by Daria Shevtsova on Unsplash

Guanxi over IP

The Role of Counterfeiters in Innovation

For our recent report “Sensors, Identifiers, and Digital Twins: Tracking Identity on the Supply Chain,” we delved into the world of counterfeit manufacturing and supply-chain fraud. One recurring theme was the assumption that counterfeits are invariably bad. And indeed, our research turned up a number of examples to support this view, such as profits from counterfeit luxury goods that may have been used to fund terrorism. In another case, a German apparel company discovered that their Asian factory was diluting or adulterating the sustainably sourced Tencel used in their clothing. And in a lawsuit currently moving through the U.S., it’s alleged that a contractor sold the U.S. military some $20 million worth of counterfeit uniforms from China. Governments and companies spend significant resources to protect their IP. In the U.S., for example:

“CBP (The United States Customs and Border Protection) found nearly 34,000 shipments in violation of intellectual property rules worth nearly $1.4 billion dollars in total. Ninety percent of those seizures that violated intellectual property rights occurred in international mail and express shipments.”

— 21st Century Customs Framework Public Meeting Transcript at the US Department of Commerce, Washington DC, March 2019

And, as this article states:

“Today Russia has come to accept China’s technology theft as the inevitable price of doing business with its southern neighbor,’ explained Vasily Kashin, a senior fellow at the Institute of Far Eastern Studies of the Russian Academy of Sciences. “

Yet China remains the factory to the world, IP theft and counterfeiting notwithstanding. When I come across such a one-sided perspective, my foresight training kicks up a red flag. Consider the fact that many if not most customers who buy counterfeit goods know that they’re getting counterfeits, and choose to buy them anyway. Clearly the methods used to “combat” counterfeiting in this market environment will never fully succeed, which made me wonder whether counterfeits are really always 100 percent negative.

Understanding Guanxi

The idea that counterfeits might have a more subtle and complicated impact was largely inspired by reading Bunnie Huang’s comments in this 2011 IFTF conversation. Huang describes six Shanzhai rules; informal but widely understood tenets by which the Shanzhai manufacturing community operates. The last rule centers on guanxi:

“The only intangible property worth anything are personal relationships (‘guanxi’); also, the most valuable thing one may have is good guanxi.

“A corollary of that is ‘If I can’t embody it in a physical vessel, it has no value’. This explains why IP licensing in China is so awkward because they think of everything in terms of a bill of materials; every item must be inventoried and counted. (italics mine) Yet strangely, IP takes up a line item but has no space on the shelf in the factory, which seems like you’re just paying someone for nothing. So why pay it?”

I was intrigued: Here’s one intangible thing — guanxi — that is highly valued and another — IP — that is not. I got Bunnie on the phone to explore my hypothesis, that counterfeits can play a role in innovation.

At the core of our conversation was the concept of guanxi, which has no exact English language counterpart. It’s broadly defined as a complicated, highly integrated network of hierarchical and friendly relationships, tacit mutual commitments, reciprocity, and trust. Some people familiar with the concept of guanxi claim that it doesn’t exist as such in the West. Others disagree, citing professional reputation as a kind of Western guanxi.

Crucial to understanding guanxi is knowing how profoundly modern Chinese values are shaped by Confucianism, with its strong sense of the family bond. This deep cultural value goes beyond our Western idea of family, with far-reaching and often unexpected (to the Westerner, anyway) results. In China, Huang explained, factories that make the same kinds of products are generally located right next to one another. As he put it:

“At a deep level the family line is strongly emphasized in a culture. When you look at how factories come together — there is a bit of a family feeling to it. This guy worked at my factory, but then left to start his own factory. Even though he competes with me, we have a relationship and I’ll help him out if needed.

“Guanxi governs the relationships between a group of professionals in the same industry. It’s the relationship you have with these professionals — including your competitors — in your industry, where the people work together to cooperate and support each other. It’s a kind of ‘you scratch my back, and I’ll scratch yours’ for mutual benefit over the long term.”

Having your competitor right next door might seem like an IP protection nightmare, but it has its benefits.

Guanxi and Innovation in Modern China

Bunnie explained how this typically might work. Say there are two competing factory owners that have guanxi between them. Factory Owner #1 has a customer with a difficult problem, and can’t solve it by himself. So he calls on Factory Owner #2 to come take a look. Factory Owner #2 might examine the schematics, walk the factory floor, and discuss possible solutions directly with factory owner #1 — all without signing an NDA or any other form of IP protection. No money is exchanged, even though Factory Owner #2 is clearly sharing his expertise with Factory Owner #1. Bunnie explains:

“The guanxi networks actually benefit the Western companies. Even though there’s no NDA signed, we may share IP to accelerate the troubleshooting of difficult problems, and that benefits the end customer.”

This is why it can be difficult to track details on the supply chain. Factory innovation is happening in real-time.

“If you take an idea and lock it up for 20 years, no one can use it — that’s not how you do innovation. That’s why there is innovation in China, you can talk to people and learn from each other. In the US, because of the IP rules you can’t.” — BH

The Future of Intellectual Property

China is maturing as a culture, a nation, and a global economic force. To date, China has benefited from borrowing IP (to put it in the most positive light.) The question is, might this be a natural stage of industrialization? In this model, everyone borrows from everyone else at first. But as industries mature, they begin to value protection over open exchange. There will come a time — sooner rather than later — when China will want to protect the IP they develop. And when that happens, China will develop their own unique IP rules, which will inevitably be different from European and American IP law. As Bunnie put it, “China will evolve a set of rules, but they will be China’s rules.”

After my conversation with Huang, I am convinced that counterfeiting activities can have a positive impact on innovation. That doesn’t detract from the very real negatives. Counterfeits can hurt both individuals and larger economies, and we need protections from physical dangers, such as contaminated infant formula, as well as social factors such as counterfeit goods made using slave labor and conflict materials.

“Counterfeiting is a problem until you learn how to benefit from it. Yes there is a loose culture of sharing and IP, so that when you are trying to make something and can’t figure it out, you can get help.” — BH

China’s role as factory to the world has value not just in its production output, but also in its brain trust and production know-how. We need to acknowledge this innovation mindset because when it comes to solving hard manufacturing problems, it’s guanxi not IP that gets the product to market.

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