With US President Donald Trump stepping up his rhetoric over the trade imbalance between China and the United States and Chinese Premier Li Keqiang responding by talking up the country's advances as a centre of technology innovation, intellectual property is in the spotlight. How do investors, tempted by China's hot startup scene, protect themselves and profit? Consultant Damon Matteo, who advises companies on commercialising high-value innovations and IP assets, gives his perspective on China's IP regime.
Looking backward we see China reaching a nominal GDP second only to the US, built largely on the shoulders of its manufacturing prowess. Looking forward we see China moving swiftly to a cutting-edge innovative economy.
China is at an inflection point; integral to making that transition successfully is realising how value is created, captured and lost in an innovation-based economy. Unlike industrial economies, which tend to emphasise physical capital, an innovation economy relies most heavily upon intellectual capital such as ideas and inventions. How, you might reasonably ask, does a firm translate intangible ideas into tangible value? In a familiar fashion: through a property right, in this case as intellectual property (IP) rights like patents and copyrights.
Take patents: a patent confers a time-limited legal right to block competitors from selling products that infringe the patented invention – a quasi-monopolistic position. If a competitor is thought to be infringing, the patent holder petitions the court to stop the offender and/or receive monetary damages as compensation. Like tangible assets, IP assets can be transacted; patent rights can be sold or licensed, allowing others to make products that employ the patented invention.
Unlike tangible assets, however, IP rights are divisible. Think of the distinction this way: a thousand people can use the same idea of drawing with a pencil simultaneously, but a thousand people cannot use the same pencil to draw simultaneously. This unique quality allows a patent holder to license multiple people, all of who can use the same patent simultaneously for identical or disparate purposes, without limiting anyone’s ability to practice the invention.
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Innovation means high-tech, where the term high applies equally to risk, reward, and competition. In that kind of environment any competitive edge is indispensable.
Chinese courts find in favour of the patent holder more than 60% of the time. Although court damages awards are still quite low (tens of thousands of dollars), IP rights are enforced through injunctions, which bar the sale of products that infringe the patent, which can potentially be devastating to a competitor. And while it’s not quite a sure thing, Chinese courts grant injunctive relief to the patent holder over 90% of the time.
In China the fortunes of patent litigation decidedly favour the patent holder, so developing (or acquiring) a robust IP portfolio well aligned with your market interests is an essential part of any innovation investment strategy. Such an IP portfolio can block a competitor’s market advance, deter or even thwart a competitor from suing you, and in either event helps to ensure any balancing payments flow in your direction.
Given what’s potentially at stake in these litigations, we’re already seeing increased deal flow (and valuations) in the arbitrage of enforceable IP portfolios within China, and between China and the West.
The divisible nature of IP provides another form of leverage and this one flows directly to the bottom line as profit.
Innovators can often leverage a single innovation investment into several alternative revenue streams by licensing the underlying IP to multiple parties while still practicing the patent itself. In fact, I’ve even done deals where those alternative revenue streams far exceeded the value of the original investment proposition – importantly, without disrupting the firm’s own competitive position.
Lastly, a robust IP position acts as a hedge against the initial investment proposition failing – a very real prospect, especially in startups. If a firm’s product fails its IP assets may well have licensing or liquidation value – even if the operating entity itself has none. Residual values are typically best in growing, contested markets such as artificial intelligence and blockchain.
From a buyer’s perspective this type of acquisition can provide very cost-effective access to high-value IP assets, which can help with new market entry, offensive or defensive litigation, or have speculative financial value. The accelerating rise and fall of new innovation-centric firms in China creates both increased appetite and opportunity in this respect.
Innovation is set to figure more prominently in China’s economic success as it moves past its inflection point. By fortifying the advantaged market positions generated by innovation and capturing additional value, we’ve seen that IP is no longer just a legal construct relegated to the courtroom but an indispensable tool in the corporate boardroom and a powerful, versatile asset at the heart of the business of innovation.
About the author: Damon Matteo is the founder of consultancy Fulcrum Strategy that advises companies on the commercialisation of high-value innovations and IP assets. He is also an advisory board member at the Hoover Institution of Stanford University and a course professor at Tsinghua University in Beijing.
