I solve China's piracy problem.

A series on the China gold rush.
April 12 2005 6:37 PM

How To Solve China's Piracy Problem

A dozen ideas. Maybe one will work.

My first evening in Beijing, I was lucky enough to secure a meeting with the head of China operations for one of the world's largest media companies. He looked like a kid, and he practically is one. When you're lucky enough to catch an economic wave—as I and thousands of others were with the Internet, for example—professional life happens quick. This executive had first encountered China in college only a decade ago, when he spent a semester in Nanjing. Seeking to bolster his business-school application, he had worked at a consulting firm in Hong Kong and then at a Chinese software company founded by two Americans. The company planned to dominate the mobile-phone infrastructure business, but, on a lark, it also launched an embryonic messaging application. This sideline took over, the company went public, and the executive no longer had any need for business school. So, he took his stock options and China expertise and joined the media conglomerate, and now, in his early 30s, he is a trusted adviser to the moguls at the top.

The executive took me to a Beijing roast-duck restaurant called Hua's. In keeping with one theme of the evening, piracy, Hua's used to be one of the only restaurants on the block. Now so many places in the neighborhood have copied its formula (lanterns, lights, open-air courtyard) that we had to cruise up and down the street to find it.

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Like other multinationals, the media conglomerate is consumed with the awesome challenge of piracy. One way to control the flood of pirated DVDs, for example, might be to trumpet the superior experience of watching movies in a theater. But Chinese movie distribution is so tightly controlled that most movies never hit the big screen. Another solution might be to cut DVD prices by 90 percent, but, at this price—for legal vendors—all profit is then taxed away. One major movie company, TimeWarner, is supposedly going this route—selling movies for about $3 each—but the verdict is still out on whether this will succeed.

This media executive focuses primarily on interactive applications, such as online and cell-phone messaging, so our conversation soon veered in that direction. But at meetings and meals in Beijing over the next few days, the piracy issue came up again and again and again.

In China, piracy is so entrenched that even the pirates complain about it. According to an article by Anne Stevenson-Yang and Ken DeWoskin in the March issue of the Far Eastern Economic Review, Chinese storekeepers who sell fake DVDs for 10 yuan gripe about street vendors selling them for seven. And the street vendors complain about competitors offering two-for-one specials.

But it's not just DVDs that are being ripped off, of course. It's everything. According to some estimates, as much as a third of China's GDP comes from piracy and counterfeiting, including more than 90 percent of the country's software and 95 percent of its video games. In The Chinese Century, Oded Shenkar says that five of six of the "Yamaha" motorcycles in China are fake—in part, perhaps, because Yamaha's parts suppliers sell real Yamaha parts to fake-Yamaha assemblers. The same goes for more than half of China's razor blades, cell phones, drugs, chewing gum, and shampoo. Fast-food uniforms and business processes are copied. Electronic chips are reverse-engineered and modified to allow third parties to write add-ons, creating fake chip value chains. Fake car parts are unwittingly built into real cars—exposing the real manufacturers to liability—and real parts are built into fake products in other industries. Some fakes are crappy: movies with scratchy sound and heads visible at the bottom of the screen. Some are so good that even the manufacturers can't tell the difference. (When "North Face" jackets appear in the Xiangyang Park market, they aren't like North Face, they are North Face.) The new frontier, meanwhile, is export. Some estimate that 7 percent of global trade is now bogus stuff.

Piracy apologists, who occasionally include the Chinese government, often point out that developing countries have a long tradition of such behavior, starting with the U.S. (Charles Dickens was reportedly stiffed for royalties by U.S. publishers). In this view, the U.S. companies are hypocrites: Now that we've stolen IP, polluted the environment, and exploited workers to move up the value chain, we want to ban the practices in other countries (an argument that has some truth to it). The U.S. didn't get really tough on intellectual-property rights, people note, until we had intellectual property to lose, and the common wisdom is that the same will hold true for China. In FEER, however, Stevenson-Yang and DeWoskin suggest that China's situation might not follow this path to legitimacy, in part because the government has so much to gain from the status quo. Shenkar concurs: Whatever form the solution takes, it won't come anytime soon.

So, what are multinationals to do? Here are some of Stevenson-Yang, DeWoskin, and Shenkar's ideas. First, recognize that the value (or at least life span) of intellectual property may be less in the future than it has been in the past. Then, depending on the unique circumstances of each place and industry, fight like hell.

Crank up the litigators, making it painful to pirates to fake your products and thus encouraging them to rip off someone else. Redesign business processes to make it more difficult to steal stuff, and consider what you do lose a cost of doing business. Pay for your own enforcement raids. Don't do China joint-ventures, which function as a siphon tube through which local entrepreneurs suck out ideas, technology, and products. Design your products to have shorter life cycles, thus leaving pirates stuck with warehouses full of outdated stuff. Cut prices, making piracy less profitable. Give away technology in hopes of establishing a standard that you can control. Offer local pricing: Don't force people who make $1,000 a year to pay $250 for an office suite. Shift to a service/support model, and give your products away for free.

One of the most intractable elements of the problem, of course—one that all companies are eventually forced to acknowledge—is that products are not worth what the manufacturers say they are worth but what customers are willing to pay for them. The reason pirated products are so wildly popular is that customers love their value proposition. Even the greatest minds in the antipiracy business can't wait to snag $1 copies of first-run movies and $10 copies of Windows XP—products that, they rightly observe, often play or run as well as versions that cost 20 times as much. With digital products, at least, China's piracy epidemic may prove to be the great profit-margin equalizer. No longer, perhaps, will companies like Microsoft be able to earn 80 percent profit margins—because, sick of feeling gouged, customers are nothing less than thrilled to help rip the companies off.

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