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US entrepreneurs make a choice: rewards of doing business in China often outweigh risks of losing trade secrets

South China Morning Post 標誌 South China Morning Post 28/1/2019 Jodi Xu Klein, US correspondent
a close up of a football ball © Handout

Growing up in the suburbs of Philadelphia, Chris Alonzo never imagined he would end up training Chinese farmers halfway around the globe how to grow mushrooms. But two years ago, when he met his Chinese partner, he saw an unexpected opportunity that could help his business grow.

China wants to improve its mushroom production and safety. It has the capital, and Alonzo, who operates the largest indoor mushroom-growing facility in the US, has the know-how. In exchange for a minority stake in the joint venture, the 48-year-old farmer agreed to teach Chinese growers how to use a Dutch environment-control system to maintain optimal temperature and humidity to grow mushrooms indoors year round, something the Chinese don’t know how to do.

Alonzo, the owner of Pietro Industries – one of the largest family mushroom farms in Chester County, Pennsylvania – saw an opportunity that could bring his 80-year-old family farm unprecedented market reach and profit.

The project, which will receive more than US$250 million in Chinese funding over the next five years, is projected to produce 200 million pounds of mushrooms a year at new indoor farms in cities of China’s eastern Anhui province – 10 times more than the 19 million pounds of annual output at Alonzo’s farm in Kennett Square.

a group of people standing around a counter in a store © Xinyan Yu

Residents of the Pennsylvania town of 6,000 have heard stories in recent years about Chinese companies stealing American technology, but that prospect doesn’t faze Alonzo.

“I read in the news of what’s going on about forced tech transfers, but it doesn’t apply to us,” he said. “The Chinese won’t be able to steal my knowledge because it’s not easy to learn. I have been growing mushrooms for 25 years, and I am still learning.

“Chips can easily be reverse-engineered. But in agriculture, Mother Nature keeps throwing curveballs at you, and you need to react fast to different conditions every day.”

Terrence Farrell, the Chester County commissioner who introduced Alonzo to Thomas Yang, a Chinese lawyer-turned-entrepreneur in Anhui, agreed.

“Yes, the Chinese can learn how to use the computer system,” Farrell said. “But it’s the sauce that makes the barbecue. And that’s Alonzo’s experience. You’ll have to be able to dip the fingers in and say it needs more cayenne.”

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At first glance, Alonzo’s joint venture has little to do with the Trump administration’s criticism as it calls out China for forcing foreign companies to hand over technologies to gain access to the massive market, or stealing them outright.

It is telling how much US companies are willing to put at stake despite the risk of losing the crucial knowledge that has built their businesses.

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“Technology transfer is a real issue for any US company with leading technologies,” said Dan Harris, a Seattle-based lawyer with the firm Harris Bricken, which represents US businesses in China. “Americans often overestimate how hard their technology is to duplicate and are just so awestruck for selling to China.”

In an increasingly intense race between the world’s largest two economies to dominate technology, the issue of forced tech transfers and related intellectual property theft has been pushed to the forefront. China has always publicly denied the tactics and insisted it has lived up to commitments it made when joining the World Trade Organisation in 2001.

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Many observers think the ability of China and the US to agree on tech and IP issues will make or break the trade talks, which are scheduled to resume this week. Without a deal by Washington’s imposed March 1 deadline, the higher US tariffs that have been threatened could do further harm to the global economy, which is already slowing.

“US companies tend to think they can control their technology,” Harris said. “They’d say I am going to tell the Chinese enough to get them to four. But they were almost always wrong. Chinese can get to eight and start selling the product at half price.”

The US government agrees that American companies are being forced to give up too much in exchange for access to Chinese markets.

In the summer of 2017, US President Donald Trump said in a memorandum to his trade representative that Chinese laws “encourage or require the transfer of American technology and intellectual property to enterprises in China” and that these actions “may inhibit United States exports, deprive United States citizens of fair remuneration for their innovations, divert American jobs to workers in China, contribute to our trade deficit with China and otherwise undermine American manufacturing, services and innovation”.

Harris said: “If you are a tech company, it is a big issue, although we need to acknowledge the scope is exaggerated by what Trump made it to be. When Trump said you can’t do business in China without a joint venture, or you will have to transfer technology if you do business in China, neither of those things is 100 per cent true” because there are other ways to conduct business there.

In sectors such as publishing, media and the internet, which China considers strategic, allowing foreign companies to operate independently is probably a tall order. Businesses in other industries could potentially find other options, including using a distributor or selling directly into China without a local partner.

a group of people posing for the camera © Bloomberg

In a rare example of China’s opening up, Tesla, the American electric-vehicle maker that has been trying for years to build a factory in the country without a local partner, has just done exactly that. Its Shanghai plant is expected to begin partial operations in the second half of this year.

Last month, after the meeting between Trump and Chinese President Xi Jinping in Argentina on December 1, China drafted legislation strengthening its laws on foreign investment to crack down on forced tech transfers.

But whether the law will be fully enforced remains a question. Since 2010, China has committed to eliminate aspects of its technology transfer policy on at least eight occasions.

“The problem with China is the law is there but the enforcement is not,” Harris said.

Will China’s new forced technology transfer law satisfy US concerns?

The lack of enforcement can cause problems when a US company files a lawsuit in China. In many instances, the cases are stalled by the local justice departments. And sometimes suits are never filed because the Chinese, the majority owner of the joint venture, refuse to take action.

The Chinese have also been known to ask their American partners to sign patents and intellectual property over to the joint venture so the US firm loses ownership of the technology in China.

In a March 2018 report by the Office of United States Trade Representative (USTR), instances of forced technology transfer and failure to protect US intellectual property were cited. The report then triggered the US to impose tariffs on US$60 billion of Chinese exports and marked the beginning of a tit-for-tat trade war.

According to the USTR report, “China has adopted policies deliberately designed to force foreign multinationals to transfer strategically sensitive technologies to indigenous Chinese firms.”

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For many US companies that have been exposed to such tactics, it is not worth speaking up for fear of being kicked out of a market that has become a significant source of revenue.

“You can say American companies have a choice,” Harris said. “But the choices are between would you rather spend three years in jail or a week in solitary confinement. Neither looks particularly good.”

But for many business owners, the decision has been made: the short-term profits that come from doing business in China are worth the loss of their long-term tech edge.

Harris said: “The practice continues because, as we now say in the trade, too many companies go to China leaving their brains at the gate.”

The outcry about forced transfers has heightened awareness, however, and has affected some recent deals with China.

Novocure, a US health care technology company that produces cancer treatments, struck a licensing deal in September with Chinese tech firm Zai Lab to distribute the new therapy in China. The US partner received US$15 million upfront, with future payouts from royalties on sales from 10 to 15 per cent, said Bill Doyle, Novocure’s executive chairman.

“It’s a fact there are issues between the two countries. That said, the marketplace evolves fast, and we have to take the world as it is when doing deals,” Doyle said. “Our goal is to minimise the risks.”

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After nine months of research and interviews, Novocure chose Zai Lab, a Shanghai-based and Nasdaq-listed start-up, as its Chinese partner.

Doyle, a Wall Street veteran, took a page out of his investing playbook – utilising shareholders’ power to keep management accountable. The choice offers Novocure a level of transparency that would not be possible with a Chinese partner not listed on a US exchange.

Publicly traded in the US, Zai Lab is required to release earnings every quarter, making hiding numbers – a way to get out of paying the American partners – difficult to do.

“Although state-owned Chinese companies may have the advantage to get our therapy approved with the local authority faster, we believe the internationally educated management team and a global-facing firm make [Zai Lab] is a better fit,” Doyle said.

“If they get a reputation for stealing the technology or tricking their partner, then they are not going to do another deal with anyone else.”

Doyle, however, acknowledged the difficulty in navigating China. Novocure’s venture with Zai Lab is the only international partnership for the company, which also does business in Germany, Austria, Switzerland and Japan.

“China is different,” Doyle said. “We were advised strongly to work with a local partner because we would have to interact with the local government. Can we go solo? Theoretically, yes. Practically, no.”

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In general, “companies are vulnerable to loss of intellectual property, particularly trade secrets, during licensing processes”, said Jacob Parker, vice-president of the US-China Business Council, a group that represents the interests of US companies – including Coca-Cola and Microsoft – in China.

Parker, without naming the company or sector, said that during a recent licence approval process, a Chinese authority asked a US company to provide specific temperature and pressure information beyond usual international standards.

“This information would make it easier for a competitor to learn details about a production process,” Parker said. “Providing information outside the scope puts companies’ trade secrets at risk.”

In other cases, Chinese competitors have been named to the approval panel with broad authority to request trade secrets under the auspices of a review, Parker said.

a person standing in front of a group of people posing for the camera © Courtesy of Chris Alonzo

The China Dashboard, an economic tracking tool developed by the research firm Rhodium Group with the Asia Society Policy Institute, showed that in 2018 – a year in which Chinese reforms went backward in most areas – only one indicator moved forward: innovation.

“It goes to show you how much Beijing has been betting on technology,” said Dan Rosen of Rhodium. “But the question is whether this advancement came at the cost of the rest of the world.”

Alonzo, the mushroom farmer, might point out that agricultural technology is different. In his Pennsylvania county, the farming life can be tenuous. One out of every four mushroom farms didn’t survive the last 10 years, he said, proof that just knowing the technology is not enough to be successful.

He acknowledges that his Chinese partner, whom he considers trustworthy, has the upper hand in their deal. If the Chinese decide to move on without him or short-change him on payments, there is little he can do.

“I don’t know what is going to happen in the long run,” Alonzo said. “But if the technology is transferred and I am no longer needed, I still consider it a huge success.”

This article originally appeared on the South China Morning Post (SCMP), the leading news media reporting on China and Asia. For more SCMP stories, please download our mobile app, follow us on Twitter, and like us on Facebook.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.

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