Four must-dos to ensure IP and R&D success in China

Monday, November 14, 2011 | Posted by: Grant Thornton
Categories: China , Thought leadership | Tags: China, intellectual property, R&D, IP, intellectual capital, research and development

More and more UK businesses are taking advantage of research and development (R&D) opportunities in China, both to access its increasingly sophisticated talent pool and to focus research on one of the fastest-growing global markets. What actions are being taken by UK businesses in China? And what is on the must-do list for those wishing to move intellectual capital to China successfully?

Our report, Harnessing intellectual capital in China – the next major opportunity for UK businesses is available for download and has the full story. Or read on for an online summary.

Key findings
China is becoming a major global research and IP centre, being the third highest patent-filer in the world, with businesses able to access 1.5 million science and engineering students – five times the US and the UK combined – graduating each year from Chinese universities

An increasing number of UK companies are capitalising on China’s new research and development-friendly environment and accessing this capacity – in 2010 UK companies filed over 2,000 patent applications in China, and according to a recent survey, 59% of UK companies with a presence in China say that they want to increase the R&D activity there

Early investments were made by ICT, telecommunications and software firms, but the latest wave is in the pharmaceutical and energy (including green energy) sectors, with SMEs playing an increasingly important role

However, building R&D capacity and developing intellectual property in China often presents challenges on multiple levels, many of which will be unfamiliar even to old China hands.

The key to successfully harnessing the capacity is to ensure structural, regulatory and IP protection matters are properly addressed at the outset, and undertaking thorough due diligence.

The ‘must-do’ list
While investments should be considered on a case-by-case basis, four items should top the agenda for companies wishing to expand their intellectual property in China, whether through setting up research centres or transferring intellectual property into China.

1. Determine the optimal structure
Harnessing intellectual capital in China can be achieved in a number of ways:

• setting up research centres;
• entering into joint venture arrangements with Chinese third parties;
• transferring or licensing existing intellectual property into China.

It is important for companies to review their supply chain and determine the precise levels of activity to be transferred to China, due to the significant operational, financial and legal implications.

For example, some companies have developed novel ways of combating intellectual property theft, such as spreading procurement among a number of vendors, which makes it more difficult to rebrand or reverse-engineer an original product. Others have created business models that discourage theft. Microchip designer ARM Holdings, for example, takes some of its fee on a royalty basis, reducing the incentive for piracy.

2. Manage the regulatory environment
Bureaucracy and regulatory issues have been identified as the biggest challenges facing businesses expanding in China. If not managed correctly, these issues can result in delays in the transmission of funds at best, and fines and expulsion from China at worst. Conversely, there are some excellent incentives.

Companies should pay particular attention to the following issues:

• Ensure they use the most appropriate type of legal entity and that the business licence matches the activity being undertaken.
• Assess the optimal holding structure for their Chinese operations. Recent changes to the double tax agreements  between the UK and China and Hong Kong have changed the landscape markedly.
• Check that appropriate documentation is in place and agreed in advance with the Ministry of Commerce, tax bureaux and financial regulators to ensure easy flow of capital to and from China.
• Plan to take maximum benefit from the numerous tax and other incentives for high-tech activity.
• Take a local rather than national approach to building research capacity in China because the Chinese IP market is so large, varied and fast evolving.

3. Carry out due diligence
Human resource issues and language barriers are identified as another key challenge to successful implementation of a China strategy. It is important to do proper due diligence on potential partners and key employees, and align partner and key employee rewards with the global goals of the organisation, for example through long-term incentive plans or shared ownership.

4. Protect your IP
A final significant concern is protecting IP, which involves careful due diligence and appropriate structuring. Although Chinese IP laws and protections have been strengthened in recent years, intense competition, the fragmentation of the legal system and the sheer brazenness of some infringers mean protecting IP demands extreme vigilance.

When to act?
With so much complexity involved, it may be tempting to wait until China offers a more secure environment for IP assets. However, the opportunity cost could be high.

The potential advantages are huge, and not only in terms of salary arbitrage and tax incentives. As China becomes the single largest world market for many products, companies able to develop products locally will have two advantages: they will be better at meeting consumer needs and they will be faster to market. Not only that, many companies say that the risks of doing R&D in China are becoming easier to manage.

Research often functions like a stock option – paying off unpredictably but multiplying the initial investment when it does. Waiting while the competition levers its research budget in China could put you at risk if one of its larger research teams makes that all-important breakthrough first.

Your next steps…
To read more about IP protection and the other issues raised here, we recommend you download the full Harnessing intellectual capital in China report.

For a further discussion, information and help with expanding into China, contact our China-Britain Services Group – we are a multi-disciplinary team located in the UK, mainland China and Hong Kong, and we have bilingual staff fluent in English, Mandarin and Cantonese. With a network of 10 offices, 65 partners and 1,500 professionals across China, Grant Thornton is well versed in helping clients break into the Chinese market.

Nick Farr
Partner and Head of China Britain Services Group
Grant Thornton UK LLP
T +44 (0)207 728 2691
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Image: (CC) Tomasz Stasiuk

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