After working in the automotive industry in Germany for the last 2 years there is one remark I often hear Germans say about China: “Chinese can copy, but they cannot innovate“. Due to the fact that China has remained isolated from the rest of the planet for decades, it is understandable that the country’s struggle has been to acquire technology in any and every way possible. Intellectual Property Rights (a.k.a IPR ) violations is just one of the many ways that the country has found to try and close it’s technology gap.

It is common to see many Westerners attributing these violations to some ethical or cultural standards on the part of the Chinese people, but I myself know that violations like these happen in any part of the world – also in developed countries like Germany. Negative statements about the character of an entire people is hardly the solution to a problem of this dimension. I mean, let’s face it, China was already mastering medicine and inventing gun powder while we were still jumping from tree to tree like monkeys. Who says China can’t innovate?

Anyway…before this gets into a anthropological or moral discussion, let’s look at some of the reasons of why and how China became the “knockoff” villain of the world. But before we talk about knockoffs, let’s understand what really characterizes a knockoff product. According to the Urban Dictionary a Knockoff is a copy or imitation, especially of an expensive product.  According to Jack Perkowski (ex Wall Street banker and CEO of ASIMCO)  – In his book Managing the Dragon, IPR issues occur most frequently with products that meet three criterias, where the last criteria is particularly important:

  • High selling price relative to manufacturing cost.
  • Easy to manufacture.
  • Sold in the retail market.

So let’s put this theory to the test shall we? Walk around any fake market in China and you will soon notice that some of the most abundant merchandise there are Louis Vuitton handbags, Mont Blanc pens, Lacoste polo shirts and of course, DVDs. All of these products are branded products of high price, they are also easy to manufacture and guess what? They are sold in the retail market.

Although this explains why these products are counterfeited, it does not explain how or what facilitated this in the first place. Well, here is how. In any market products are either sold form Business to Business (B to B) or from Business to Consumer (B to C). In general, B to B products will be much harder to fake, since the customer is a company and will usually be purchasing much more than the product itself. Long term technical  support, quality, management systems and product updates are usually also sold within the package.  Also, in B to B transactions, price doesn’t usually play the main role. In this case quality and reputation is what stands out the most.

In B to C transactions, on the other hand, price plays a principal role and the whole deal is likely to occur only once. This is especially true in countries like China with a large financial disparity.

According to Perkowski, the main culprit for China’s huge IPR violation issues is China’s distribution system itself. Other than in developed countries, China’s distribution is highly fragmented and as a result B to C transactions are purely one-time B to C transactions. In countries like the United States, these processes have long been consolidated and even B to C transactions carry a strong B to B element.

Back when China’s economy was centrally planned, all distribution of goods was done by the government itself and distributions was thus highly concentrated. When Deng Xiaoping opened the economy in the late 70s, many business men in China saw an opportunity to explore the trading and logistic business. It wasn’t long until distribution businesses began popping out everywhere in China. These were essentially small to medium sized businesses, which over time gained substantial market share and brought down the larger state-owned distribution system. To make matters worse, consolidated foreign companies were not allowed to engage in any distribution activity until 2001 when China entered the WTO.

Lack of law enforcement and the short-term view in which many of the Chinese company owners led their businesses, resulted in a market that is only interested in price, not quality. There was never any fear of legal consequences to distributing and selling counterfeit and low quality products. This, allied with the fragmented nature and chaotic character of the distribution world in  China,  was the perfect setting for proliferation of fake goods.

In developed countries like Germany or the United States, the proliferation of knockoffs becomes much harder due to the strong B to B element present in B to C transactions. Huge companies like Amazon, Media Markt and Staples have consolidated their own distribution system guaranteeing quality and low price. Needless to say, they have also put many corner stores out of business. So when you walk into a Walmart and buy a pack of Duracell batteries, Walmart is giving you the guarantee that those are real Duracell batteries. If they are not, then legislation will hit them hard. This legal obligation is strongly reinforced by law and  keeps the customer protected, while subjecting the suppliers to conditions similar to selling B to B.

This is so much true and becomes even apparent when we look at what is happening in the Internet.  With the rise of the digital age, anyone can access anything and download whatever they wish. This means that distribution of virtual goods (like music and video) has again become fragmented, giving rise to piracy and the huge IPR issues discussed in the media these days.

Now going back to the question of whether China can innovate or not. I strongly believe that China can, will and must innovate. China is a country of continental dimensions, boasting the largest population on the planet. Every obstacle it faces is unique and every solution it finds to these obstacles is an innovation in itself. Everything from technology to governmental policies is an experiment, since it has most certainly never been done before by anyone. At least not in this scale.

In the last years the government has desperately tried to turn China into a technologically advanced nation, producer of high value goods. Many entrepreneurial ventures have been facilitated and access to capital is also slowly improving. These incentives will most likely give wings to innovation and I personally cannot wait to see some of the great ideas that will be coming out of cities like Beijing and Shenzhen and Shanghai.