Business Case Studies, Executive Interviews, Kai-Alexander Schlevogt on Emerging Markets

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Executive Interviews: Interview with Kai-Alexander Schlevogt on Emerging Markets
February 2008 - By Dr. Nagendra V Chowdary

Prof. Kai-Alexander Schlevogt
Professor of international strategy and leadership at the National University of Singapore (NUS) Business School. He serves as Program Director of the Nestle Global Leadership Program, delivered in association with London Business School.

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  • Could you please elaborate on China’s track record of protecting intellectual property rights?

    China is definitely not a safe haven for intellectual property. Piracy and counterfeiting are widespread. Contract manufacturers routinely produce additional batches of branded goods and sell them cheaply in the underground economy. There is an entire industry churning out illegally copied movies, music and software. Pirates routinely record new releases of blockbusters in foreign cinemas and make them instantaneously available in the Chinese market. Sometimes, you can even see part of the audience in the lower part of the movie frame – courtesy of the pirate cameraman! Chinese websites offer virtually all copyrighted intellectual resources you can imagine. It is also quite telling that department stores in China do not allow customers to take pictures inside their premises. The management fears that copycats will imitate the store format. During special occasions, when foreign dignities flock to China, the authorities crack down on vendors of pirated goods. But as soon as the event is over, the sellers are back on the street and policemen pass by without taking any action – apart from possibly inspecting the offering with a view of purchasing it!

    Despite all the understandable anger about such flagrant violations and glaring disrespect for the rights of others, it is useful to take one step back and look at the big picture. The Western approach of protecting intellectual property, such as patenting, is only one of many possible ways of governing the creation and diffusion of ideas. It is empathetically not the Holy Grail for building a creative economy. In a nutshell, the West tries to stimulate innovation by granting the inventor a temporary monopoly on the exploitation of his ideas. Patents, for instance, have proved to provide people with powerful incentives to develop new ideas. But, alas, they limit the diffusion of innovation. Monopoly prices lead to a lower level of demand than would be the case in perfectly competitive markets. This can give rise to highly undesirable outcomes. For example, many people are dying in poor countries because they cannot afford the premium priced drugs that would cure them.

    In case of software companies, some may profit from increasing returns. For example, the more people are using an operating system, the more applications will be developed for it, which in turn attracts more users. Such reinforcing loops make it ever more difficult for competitors to catch up. The monopolist might be tempted to rest on his laurels, which slows down progress.

    Patents even can be disadvantageous for the holder. First, he must disclose the details of his invention to the authorities. To keep their valuable formulas secret, some companies decide not to patent them. Instead, they put in place secure internal processes for transmitting the knowledge fromone generation to the next. Besides, the patent holder needs significant resources to enforce his rights everywhere in the world. In practice, this is often impossible. In view of these difficulties, many companies regard patents primarily as signals of innovative prowess, destined to charm investors, rather than as useful tools for protecting ideas.

    Besides, every cloud has a silver lining. Paradoxically, in China, the victims of piracy may actually profit in the long run. For example, the operating system Microsoft Windows became the de facto standard in China, because many people used pirated versions. Without widespread illegal copying, the software might not have gained such supremacy there, since it would have been too expensive for ordinary citizens. Likewise, fashion labels became famous owing to counterfeiting, among other things. Companies would have needed to spend vast amounts of money on advertising to gain such a large mind share in China. If there will be stronger legal safeguards in the future, these firms are likely to capitalize on past violations of their intellectual property rights.

    In conclusion, it is high time to reconsider what is the best way to stimulate and diffuse innovation in different circumstances. The current distribution of value between inventors, commercializing entities, customers and other stakeholders is arbitrary. It is not aGod-given lawthat IPR owners should earn economic rents. One alternative approach would be to reward inventors with a one-off payment, after which the innovative goods and services can become available in the market at perfectly competitive prices.

  • You mentioned that piracy is quite prevalent in China. What can companies do about it?

    First, it is important to determine the root causes of piracy in China. According to my research, such violations are not only due to cultural factors, but, more importantly, to the prevailing incentives for both consumers and producers. Whenever the circumstances favor piracy, people are likely to succumb to the temptation, no matter where they are located. Many Westerners eagerly downloaded music for free from file sharing services such as Napster. A gadget with features comparable to Apple’s IPhone became available about one month after the launch of the original. According to industry insiders, the electronic manufacturing services (EMS) company that build the IPhone leaked its technical specifications to as many producers as possible, hoping that in the end nobody could be singled out for piracy.

    Let us examine the incentives at work in China. It is very difficult to convince customers through rational argument that they should pay a significant economic rent to a quasimonopolist for software instead of buying counterfeits without legal risks. Likewise, many contract manufacturers do not see any reason why they should refrain from producing for the blackmarket to gain extra revenues without incurring the costs of developing intellectual property.

    Most people only change their behavior when it leads to undesirable consequences. Companies that want to protect their intellectual property have to spoil the piracy bargain. First, they should lobby for better legal safeguards. It should be noted that crying out in China will not help multinational companies very much. It is more effective to convince their home governments to exert pressure on China to punish both the creators and users of illegally copied products. In the past, without facing the risk of retaliation, it was rational for the Chinese government to turn a blind eye on piracy and counterfeiting. The economy benefited from the inexpensive diffusion of innovation. Besides, since China did not generate much intellectual property, it did not need to fear violations of its rights. Moreover, foreign companies should join hands to improve the legal environment instead of clandestinely celebrating attacks on their peers. Firms also can hire private detectives to trace down pirates and pass the information on to prosecutors.


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