Intellectual Property Investments in Emerging Markets
This entry was posted on 3/10/2010 3:39 PM and is filed under uncategorized.
Intellectual Property Investments in Emerging Markets
Tuesday, 9 March 2010, William Gamble, President of Emerging
Market Strategies
Investing in technology is enormously
attractive. The investment ‘story’ is always the same. A few geeks in a garage
or in a small cubicle of a research university come up with a game changing
technology that is worth billions. Investors all over the world pour money into
developing new technologies usually through private equity vehicles in the hope
of striking it rich. There is an even better ‘story’ being pitched by the
financial industry. This involves the combination of high technology and
emerging markets.
What could be more enticing? The lure of developing markets with millions of
potential customers and hundreds of thousands of well trained engineers and
scientist willing to work for a fraction of what their counterparts require in
more developed country. Even better, the new technologies are near
manufacturing infrastructure, so the new ideas can quickly be made and
marketed. Marketing departments of money managers, hedge funds and investment
banks find this “story” an easy sell.
For example Kevin Czinger, a former Goldman executive, is trying to develop
electric cars. He is following the “Apple model”. “Own the brand, the design,
and the intellectual property” and then go and find who can manufacture the
product reliably and cheaply. So Mr. Czinger has designed an electric car using
innovative technology designed in the US and teamed up with a Chinese company
to build an inexpensive electric car to be sold in the US market.
This sounds like a great idea. The combination of American innovation and Chinese
manufacturing seems unbeatable. I am sure that Mr. Czinger used this story to
raise millions from investors. But there is one problem. You have to have a
legal system that protects intellectual property, which China’s does not.
Google has recently questioned its role in China after a major cyber attack,
which may have been perpetrated by one its own employees. They are not alone.
According to Google there was evidence of similar attacks on “at least” 20
other companies in finance, the media and other sectors. As an employee at one
of Silicon Valley’s biggest companies said, “I worked in China for four years,
and everything gets stolen.”
It’s not that there are not intellectual property laws in China. There are and
they occasionally get enforced. It is also not that the Chinese are somehow
morally deficient. Millions of people around the world in many different
countries through file sharing violate the intellectual property rights of
musicians and other artists.
The Chinese violate intellectual property law because they have economic
incentives to do so and insufficient economic disincentives not to. China is
the source of most of the world’s counterfeit goods. It is estimated that
pirated intellectual property makes up as much as 8% of China’s GDP. The
Chinese government occasionally cracks down on violators of intellectual
property and occasionally Chinese courts do allow foreign firms to win cases in
China. Still since the violations are such a large part of the economy and
since they provide consumers with quality goods at lower prices, there is
little incentive to enforce the laws.
But the short term advantages do not result in longer term growth. Countries
with weak intellectual property law protections can find that their economies
are the most vulnerable. As emerging markets work their way up the development
scale, they can start producing home grown intellectual property. Intellectual
property pirates do not distinguish between the locals and foreigners. They are
happy to steal from innovative and creative people in their own country, which
is why both Chinese and foreign development centers in China will bleed
intellectual property making it harder for China to successfully move up the
value chain.
In addition to ignoring the reality of inefficient legal systems, international
investors and companies have been seduced by another falsehood. There is no
doubt that the cost of labor in emerging markets is a fraction of what it is in
more developed markets. What is not true is that these countries are educating
hundreds of thousands of highly qualified engineers and scientists.
China spends less on its educational system as a percentage of GDP than Uganda.
India does produce twice the number of engineers and computer specialists as
the US, but the quality is very low. According to a recent study only 4.2% of
India’s engineers are fit to work in a software product firm, and just 17.8%
are employable by an IT services company. There are similar problems with the
Chinese education system.
The point for investors is to understand that some of the economic and
financial assumptions that underlie a specific investment or business model in
one country may not translate in another. It is a simple, but important lesson.
It is not just the law itself that changes, but how the law is understood and
applied that changes the incentives and disincentives, As the rules change so
does the game. If you don’t understand the rules, don’t play because you are
going to lose.
