Monday 8 June 2009

IP Rights and Chinese Producers: You Live and Die by the Jump Shot

If readers will please forgive me, I want to begin these comments with another sports saying, this time from basketball. It is a basketball truism that "you live by the jump shot, you die by the jump shot." In other words, you can work harder to try and get that safe shot close to the basket, or you can prefer the easier route of shooting at the basket from further away. If it works--fine, but if your shot is off, your are courting disaster.

This saying came to mind when I read a view that appeared in the May 16th issue of The Economist of the book by Paul Midler, "Poorly Made in China: An Inside Account of the Tactics Behind China's Production Game." The title well-describes the contents of the book as reviewed. One paragraph of the review particularly caught my attention:

"In a further effort to create a margin, clients from with strong intellectual-property protection and innovative products are given favorable pricing on manufacturing, but only because the factory can then directly sell knock-offs to buyers in other countries where patents and trademarks are ignored. It is, Mr. Midler says, a kind of factory arbitrage."

With all due respect, I find this comment a bit puzzling. In particular, it seems to me that the observation confuses the issue of strong or weak IP protection with the industrial organization framework in which IP is deployed. I have little doubt that the current IP regime in China falls woefully short of the IP regime in other, particularly developed countries. But to say so, no matter how true the statement is, misses the point. After all, even in the countries with the most "advanced" IP protection systems, there is a long history of manufacturers being challenged for unauthorized over-production which is then sold by the manufacturer for its own account.

Once we recognize this point, then we can see that the problem described by the reviewer is not precisely an issue of strong or weak IP protection, but rather the extent to which the owner of the IP rights chooses to rely on third parties to translate the IP into a competitive product. As David Teece of U-Cal Berkeley famously instructed us over 20 years in his classic article, "Profiting from Technological Innovation" (Research Policy 15(6), pp. 285-305), innovation can be divided into two components--the appropriability regime, roughly identical with IP rights, and complementary assets, roughly the some total of manufacturing, design, distribution and other assets that enable an innovative development to be translated into a competitive product.

At the margin, an extraordinarily strong IP right could simply trump a consideration of complementary assets capabilities (in which case the strong IP/weak IP dichotomy might be relevant). In practice, however, IP rights usually need effective complementary assets to create a competitive product. While the owner of the IP right could in principle vertically internalize its complementary assets position, this is a rare situation. More typically, complementary asset capabilities require turning to third parties, sometimes to the ultimate advantage of the third party. This is the case even in a developed country with strong IP protection.

With this in mind, one can view the rush to the so-called "China price" as a risk, sometimes more calculated, sometimes less calculated, taken by the owner of the IP rights that he can minimize the ultimate threat posed by the foreign (here: Chinese) provider of the complementary assets. Seen in this light, reliance on "China's Production Game" is akin to the basketball saying which opened this blog posting. Like his basketball counterpart, as long as he continues to enjoy the price advantage of Chinese production, he and his corporate team can enjoy competitive success. But it is also possible that he will ultimately be done it by his reliance on his Chinese producer. After all: "you live by the jump shot, you die the jump shot", in basketball, and also in the production commercialization of IP rights.


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