China’s transformation into a global patent powerhouse – challenges and trends

China has been the focus of intense scrutiny from IP watchers in recent years. The rest of the world has observed, speculated and played a part in the development of China’s market and IP system. Understanding the driving force behind it is imperative for companies that wish to participate in China’s market. Yet rarely do companies consider China’s progression and its market trends from the point of view of Chinese companies, even though it is these companies that continue to sculpt the landscape with their patent filings, acquisitions and litigation.

On the one hand, Chinese businesses wish to expand their global presence. On the other, they need to defend themselves against both foreign and domestic competitors in order to maintain their market share within China. As the market becomes more fiercely competitive, maintaining a robust patent portfolio is becoming both a defensive and offensive strategy for companies. As such, China has become a patent filing factory, as well as the world’s purchasing powerhouse, with the help of various government-backed programmes. Patent portfolios have become a type of new business licence and building an armoury of them is a now a prerequisite for companies before they venture into other territories. Even with the massive funds which are being poured into Chinese companies to file and acquire patents worldwide, Chinese innovators continue to face patent litigation threats from operating entities, as well as from non-practising entities (NPEs). In protecting the rights of Chinese companies, the Chinese government has funded IP consortium entities to acquire global patents. Further, government regulators are starting to flex their muscles by investigating unfair business practices involving anti-competitive patent licensing. As increasing numbers of companies enter China to chip away at the market share of domestic companies, this will inevitably lead to more litigation, as well as a more developed Chinese IP legal system, with increasingly stringent regulations.

Market lockdown

While businesses in the rest of the world are eagerly seeking entry into China, Chinese businesses are expanding outwards, looking for new markets, global recognition and world-class expertise and talent. However, Chinese firms are being challenged in these markets by patent litigation and risk being forced out altogether. Companies from China generally have three options if they wish to compete in other countries.

First, they can enter the market with little to no patent portfolio and face potential patent infringement litigation head on. While this strategy saves the time and cost of developing or acquiring patents, it also carries a substantial risk of future litigation. The Delhi High Court ruling in Ericsson v Xiaomi is a timely reminder for Chinese companies of the importance of owning quality, standard-essential patents (SEPs) if litigation is not to become the norm of doing global business. According to International Data Corporation (IDC), Xiaomi’s rapid growth captured 13.7% of the mobile phone market share in China in the fourth quarter of 2014, ahead of Apple at 12.3% and Huawei at 11%. The five-year-old company can sell large quantities of products, which makes it a threat to its competitors. However, Xiaomi’s plans for expansion into India, Turkey, Russia and Brazil were abruptly halted by Ericsson, as a result of its patent portfolio not being up to scratch. Nonetheless, this strategy of entering a market without much of a patent portfolio may still allow for small victories with great rewards. For example, in December 2014 the Delhi High Court allowed Xiaomi to sell certain products with Qualcomm chipsets in India. Within three months, according to IDC, Xiaomi had captured 4% of the mobile phone market share in India.

A second strategy is to build a patent portfolio internally. This forward-looking approach is crucial for long-term growth, but requires strong R&D capabilities, as well as patent portfolio management skills. Since the patent application process takes an average of three years in the United States and an average of two years in China, Chinese companies must plan several years in advance for R&D, as well as for time to undergo the patent application process before entering a target territory. For example, Alibaba was actively strengthening its global patent portfolio several years before its initial public offering in the United States. According to Patentcloud.com (www.patentcloud.com), Alibaba has over 3,800 active patent grants and applications globally. More Chinese entities are filing patents in offices worldwide. As IP5 Offices (www.fiveipoffices.org) reported in 2014, the US Patent and Trademark Office (USPTO) received over 17,000 patent filings and the European Patent Office (EPO) over 26,000 originating from Chinese entities – a 17.9% and 18.2% increase on 2013, respectively.

Of course, not all Chinese companies have invested heavily in the development of quality patents. Most firms today apply for US or EU patents simply by translating their Chinese patents into English. This process creates concerns over patent quality and allows for patents to be invalidated if challenged. Chinese companies are beginning to realise that this is an issue and have increased their IP resources by outsourcing the development of quality patents abroad, instead of simply translating existing patents. The global industry may begin to see new quality patents being generated by Chinese applicants within the next three to five years.

The third strategy is to purchase quality patent portfolios from well-established sources. While this may yield quick results, it can be costly. Although not as time consuming as applying for patents, purchasing patents requires time for portfolio evaluations. The Chinese government has alleviated much of the cost for companies purchasing patent portfolios through subsidies. In April 2014 IP licensing and management firm Unwired Planet announced the sale of 142 third-generation (3G) and long-term evolution mobile patents to Lenovo for an aggregated consideration of $100 million. The acquisition further extended Lenovo’s mobile phone patent portfolio. Alibaba has also purchased over 100 US patents in recent years, such buying sprees having become a clear trend for Chinese companies. However, with reports of botched patent purchases, companies are keeping a closer eye on deals and spending more on evaluating patents. Chinese companies will require more quality connections to suppliers of patents in the United States, the European Union and Japan, as well as talented professionals to accurately evaluate patent portfolios.

As has been seen with Alibaba, Chinese companies are beginning to take a multi-pronged approach by adopting more than one of these three strategies abroad. It looks likely that this trend will continue to increase as competition heats up both domestically and abroad.

Wild West

Synonymous with the phrase found on every iPhone – “Designed by Apple in California, assembled in China” – China has long been recognised as a world powerhouse for manufacturing, but until recently has rarely been associated with innovation. However, China’s telecommunications industry is helping to boost the country’s reputation as an increasingly competitive global innovator. The 2015 CES Innovations Award was won by Chinese company Estar Technology Group for its holographic takee1 smartphone. Chinese firms are continuing to evolve from being seen as copycats of technology to true innovators. Meanwhile, in the United States, the number of NPEs and NPE litigations against Chinese companies is rising fast. Chinese businesses focusing on high-tech industries have been prime litigation targets for NPEs. According to a report published by PricewaterhouseCoopers, in 2013 NPEs filed 67% of all new patent infringement cases in the United States and the threat they pose is now spreading across the world.

A Chinese company’s patent portfolio may not always be effective in defending against an NPE’s patent infringement action. NPEs produce no goods and as such do not face the same risk of patent infringement actions from Chinese companies. Even with a robust patent portfolio, Chinese companies still run a risk of litigation from NPEs if they expand into other territories. More of the company’s funding must thus be spent filing costly invalidity actions against an NPE’s patents or else settling the infringement case by giving into the NPE’s demands. To Chinese companies, NPEs from the United States are viewed as hinderers of global innovation. In Vringo v ZTE, Vringo – an NPE headquartered in New York with only 27 employees – has filed patent infringement actions against ZTE in the United Kingdom, Germany, the Netherlands, France, Romania, Australia, Malaysia, India and Brazil. Even with a global portfolio of 40,901 patents, ZTE was unable to prevent Vringo from obtaining injunctions against certain ZTE products in several jurisdictions.

Similarly, Unwired Planet – using its acquired Ericsson 2G, 3G and 4G SEPs – filed infringement lawsuits against Huawei in London and Dusseldorf in March 2014. Unwired Planet has also sued Taiwan mobile phone giant HTC in Germany.

These cases by NPEs against Chinese companies reflect an evolutionary shift which has been taking place in recent years – a reversal of roles, whereby Chinese companies view the United States as an adversary of innovation.

The growing amount of NPE litigation threatens not only Chinese companies, but also companies from neighbouring countries. Realising this problem, and in an attempt to protect domestic businesses, China, Japan, South Korea and Taiwan have all developed their own state-funded patent aggregation entities. China’s Ruichuan IPR Funds was established in April 2014 to protect Chinese companies from litigation within Greater China and abroad. It has already made patent acquisitions in the mobile and smartphone industry; members include Xiaomi and TCL, which both stand to benefit from Ruichuan’s patent pool as they expand into other countries. However, due to the nature of NPE tactics, Ruichuan may continue to encounter difficulties protecting Chinese companies.

Initiating an invalidity action against an NPE is another formidable defensive measure – although it can prove equally, if not more costly. To fend off NPE suits – which often rely on trivial patents – Chinese companies must develop strategies for swiftly invalidating patents asserted by NPEs while controlling the budget. One option may be to establish a robust in-house team with expertise in this area. Another growing trend is to utilise software systems to facilitate risk management, as well as prior art searches.

Having their cake and eating it

While Chinese companies seek to expand into other countries, they must continue to maintain and grow their domestic market share by defending themselves against domestic and foreign competitors. The increasing need to build Chinese patent portfolios is driving Chinese businesses to focus on patent applications and acquisitions. According to Patentcloud.com, the USPTO and the IP5 Offices database, the number of patent applications filed in China in 2014 was 928,177, compared to 618,330 in the United States and 325,989 in Japan. The State Intellectual Property Office in China reported the world’s largest number of patent filings, while previous application hotspots such as the Japan Patent Office reported a 4.2% decline. The number of patent acquisitions has also increased in China. With government-backed funding for patent filings and acquisitions, Chinese companies have been aggressively filing and acquiring patent portfolios, including SEPs, as these play an important role in capturing market share. SEPs with patent families in the United States, the European Union and China are ideal targets for Chinese companies keen to expand their market share in both China and other jurisdictions.

Figure 5. Market share in China for top five mobile device manufacturers for Q3 and Q4 2014

Source: IDC

The increasing emphasis on obtaining quality Chinese patents is essential to Chinese businesses’ continued domestic growth. By building up a Chinese patent portfolio, domestic and foreign competitors are prevented from entering or being forced out of the Chinese market. Mindray, a Chinese medical device provider, initiated a series of patent infringement lawsuits against its Chinese competitors. In July 2014 it scored an important victory against EDAN Instruments, a domestic competitor. EDAN was ordered to pay Mindray Rmb1 million (approximately $161,000) for patent infringement, one of the highest amounts awarded in this sector in China. Defending against foreign competitors, Shanghai Zhizhen Network Technology – developer of a technology called Xiao I Robot – enjoyed a short-lived victory in a patent infringement action against Apple’s Siri. Zhizhen sued Apple in June 2012 and the initial review found in its favour. However, in April 2015 the Beijing Higher People’s Court upheld Apple’s appeal and overruled the earlier decision.

Weak patent claims may be the reason for a ruling of non-infringement or patent invalidity. Chinese companies with strong patent portfolios stand a better chance in court against foreign competitors. As the competition becomes increasingly fierce, many more Chinese companies will follow in the footsteps of Mindray and Zhizhen in defending their product’s market share in China against both foreign and domestic competitors.

Figure 6. Market share in India for top five mobile device manufacturers for Q4 2014

Source: IDC

Bringing antitrust challenges has become an increasingly popular strategy for Chinese firms trying to break up patent thickets. In February 2015 San Diego-based Qualcomm agreed to pay Rmb6.08 billion ($975 million) in fines as part of a settlement with China’s National Development and Reform Commission, which found that Qualcomm had violated China’s Anti-monopoly Law when it refused to sell its products to businesses that had declined to license Qualcomm’s patents. Qualcomm had also refused to provide a list of patents to its licensees and demanded royalty-free grant-back licences. Further, the licensing terms included a non-challenge clause prohibiting customers from challenging the validity of Qualcomm’s patents – in many jurisdictions, non-challenge clauses are considered anti-competitive. As part of the settlement terms with the commission, Qualcomm will remove the relevant terms from its licence, pay the fines and calculate future royalties based on 65% of a phone’s selling price, instead of the price of the whole product. Qualcomm makes a substantial portion of its profits from patent royalties from mobile device manufacturers such as Huawei and ZTE. Approximately half of Qualcomm’s 2014 revenue of $26.5 billion came from China. By enforcing anti-monopoly regulations against Qualcomm, China has demonstrated that its competition laws will be a major force that shapes patent practices in the country.

Figure 7. Patent lawsuits in China between 2006 and 2013

Source: SIPO National IP Strategy

Carry on wayward

As Chinese companies continue to expand into Western markets, it looks likely that they will continue to aggressively file and acquire patents to avoid future litigation. In the same way, the USPTO and the EPO are likely to continue to see a strong upward trend of patent filings from Chinese entities for the next couple of years. Valuable patent portfolios that are being sold in the market stand a good chance of finding their way into the hands of Chinese companies. Patent filings in China will also continue to increase and significantly more patent suits will be filed, causing Chinese IP law to evolve at a faster pace to accommodate this rapidly changing environment. According to People.cn, since the first patent infringement action in 1988, the Chinese courts have tried over 20,000 patent infringement lawsuits. The average amount awarded at first instance in 1988 was Rmb5,000 (approximately $805); 20 years later, in 2009, the highest amount reached Rmb309 million ($48.5 million).

As part of its five-year reform plan, the Supreme People’s Court has established and is continuing to improve its specialised procedures to fulfil the need for IP adjudication. Specialised IP courts have been established in Beijing, Shanghai and Guangzhou to handle the increasing amount of litigation. Under regulations issued by the Supreme People’s Court, the IP courts have original jurisdiction over complex technology cases, including those involving patents, technical trade secrets and trademarks. Within the first four days of the Beijing IP Court’s operation, 28 actions had been filed and after the first quarter, more than 220 actions had been filed – a near-tenfold increase. With the establishment of specialised IP courts, companies from all over the world are filing patent litigation in China, demonstrating that the IP system is indeed evolving and improving the Chinese IP enforcement system to accommodate these rising levels.

Chinese patent quality will also improve as competition intensifies. Although stipends from the Chinese government have encouraged a flood of global patent filings, including filings for low-quality patents, increased emphasis on intellectual property in China is now apparent. The government’s investments in this area are shifting from a quantity-based to a quality-based incentive system, encouraging Chinese businesses to develop innovative technologies. A number of industries will begin to realise an increased number of quality patents filed by Chinese companies within the next three to five years. For Chinese companies to compete in this ever-growing market, they must improve the quality of their patents. The government also provides assistance to Chinese companies through government-backed IP consortiums, which will continue to build their global patent portfolios to protect their Chinese members. Increasingly stringent IP laws and regulations are being developed to ensure that Chinese companies are treated fairly. The Qualcomm settlement with the National Development and Reform Commission sets an important precedent for discouraging antitrust violations. China’s market is cultivating fierce competition and the country will become a prime battleground for future patent litigations.