Transferring Technology to Transform China—Is It Worth It?

Business opportunities and PRC government programs encourage foreign companies to transfer technology to China, but doing so may pose significant long-term risks.by Kenneth Jarrett and Amy WendholtTechnology transfer has been a focus of China’s growth plans for decades. This focus became prominent when former leader Deng Xiaoping, inspired by the advanced technology he witnessed during trips abroad, enacted policies in the 1980s that allowed foreign firms to access China’s market in exchange for advanced technology.

Over the past 30 years, PRC leaders have adopted numerous policies to encourage technology transfer. Leveraging foreign interest in its huge market, China’s leaders expected companies to provide access to high-tech products and systems as evidence of their commitment to China’s growth and development. As concerns about climate change and global warming have mounted, China’s technology targets have increasingly focused on advanced technology that could help reduce the country’s carbon emissions. This has added a new dimension—and new arguments made by PRC leaders—to China’s pursuit of foreign technology: Developed countries have a moral obligation to share environmental technology if the world is to avert the threat of catastrophic and irreversible climate change. Such arguments have increased pressure on foreign companies to share advanced environmental technology with China’s domestic industry.

Cost of China’s carbon reductions

Given the high costs associated with reducing China’s carbon emissions, the country’s leaders are eager to secure support from the international community. In september 2009, China’s State Council Development Research Center, a research organization under the National Development and Reform Commission’s (NDRC) Energy Research Institute, and Tsinghua University released a joint study that found that for China’s absolute carbon emissions to peak by 2030 while still meeting the nation’s energy demands, the country would need to invest ¥2 trillion ($293 billion) from 2005 to 2020 in renewable energy. Other organizations provide different estimates—for example, the International Energy Agency estimates that China must invest nearly $400 billion between 2010 and 2020 for emissions to peak by 2020—but the consensus is that the costs will be significant. This is, in part, what drives PRC leaders to pursue technology at the lowest possible cost.

The role that developed nations should play in supporting their less-developed neighbors was a core component of December 2009’s Copenhagen climate change negotiations and was included in the statement of intent that emerged from the talks. Developed countries collectively pledged to provide $30 billion from 2010 to 2012—including $11 billion from Japan, $10.6 billion from the European Union, and $3.6 billion from the United States—to help the developing world cope with the effects of climate change and take advantage of low-carbon technologies. In addition, developed countries vowed to mobilize $100 billion annually by 2020 to help developing countries reduce carbon emissions.

High stakes for companies transferring technology

Despite the global call to action to address climate change, companies must weigh the benefits and risks when considering whether to transfer technology to China. Environmental technology transfer is no exception.

The benefits for Chinese companies are easy to identify: They obtain advanced technology with relatively little capital expenditure, which expedites the process of achieving organic growth, increasing market share, and enhancing profit margins.

Benefits for foreign companies

There are also potential benefits for foreign companies that choose to transfer technology. These include:

• Financial incentives  Foreign companies may enjoy direct financial benefits and indirect soft benefits. The financial benefits, which can be significant, flow from access to China’s immense marketplace. Companies can enhance these benefits by taking advantage of PRC government incentives that encourage foreign firms to transfer technology. When transferring technologies listed in the “encouraged” category of the Catalogue Guiding Foreign Investment in Industry, foreign companies can enjoy numerous central-level tax exemptions or reductions and preferential financing options for large capital expenditures. Companies that qualify as high- and new-technology enterprises, as well as those located in high-tech zones, can obtain additional incentives from the central and local governments (see Box).
• Reputational advantages  Foreign companies can also use technology transfer to demonstrate their commitment to China and alignment with PRC government priorities. Tech-transfer projects often garner significant attention from central- and local-government stakeholders, raising awareness of the company and elevating overall corporate reputation within China. This is especially true for companies within “encouraged” industry sectors—for example, those that manufacture recycling equipment, equipment for large nuclear power plants, and solar air-conditioning, heating, and dryer systems.

Risks

Despite these benefits, foreign companies face significant risks when they transfer technology to China.

• Intellectual property rights (IPR)  Inadequate IPR protection is at the top of the list and continues to plague companies doing business in China. Intellectual property can fall into the hands of a rival company, or a local partner could appropriate the intellectual property and set up a rival business. Weak IPR enforcement is regularly cited as a major problem for companies operating in China and as a barrier that restricts the types of activities companies are willing to undertake. According to the most recent US-China Business Council member survey, nearly one-third of businesses reported that China’s level of IPR enforcement affects their co-manufacturing and licensing decisions and their interest in conducting research and development in China (see the CBR, November-December 2009, Survey Reveals Cautious Optimism).
• Market access  Many foreign companies fear that once their technology has been successfully transferred to a domestic firm, they will find themselves permanently shut out of the China market. It is difficult to quantify the severity of this problem, but some PRC policies appear aimed at increasing domestic industry’s share of the high-tech market, especially within the environmental technology sector. China’s drive for indigenous innovation, a major policy initiative that aims to spur domestic innovation to transform China from a low-tech, manufacturing-based economy to an innovation- and knowledge-based economy, calls for Chinese companies to adopt and improve upon imported technologies (see Box).
• Legal effectiveness  Firms deciding whether to transfer technology to China must consider the effectiveness of China’s legal institutions. The fair, even, and predictable implementation of rules, regulations, contracts, and standards is a necessary condition for firms to conduct business effectively. The absence of effective legal institutions is frequently raised as a challenge for firms operating in China. The World Bank’s Worldwide Governance Indicators project has consistently ranked China in the forty-fifth percentile with respect to rule of law, and as the following case studies will demonstrate, this weak legal environment affects foreign business operations.

Technology transfer in action: Two case studies

Two recent tech-transfer projects and their outcomes provide insight into the potential risks and rewards for conducting technology transfer in China.

Beijing-Tianjin high-speed railway

In 2005, Siemens AG and China CNR Corp. Ltd. (CNR) were jointly awarded a contract to construct 60 passenger trains for the high-speed railway that links Beijing and Tianjin. The new railway, roughly 115 km long, provides a fast and efficient connection, cutting travel time between the two cities to about 30 minutes.

CNR invited Siemens to bid on the contract jointly, with the condition that Siemens transfer key technology to CNR during the project. Siemens and CNR won the joint contract, estimated to be worth $919 million, for the provision of 60 units of its wide-body passenger trains capable of seating 600 passengers and traveling 300 km per hour. Construction of the first three trains began in Siemens’ German plant, with the remaining 57 made in China at CNR’s Tangshan Locomotive and Rolling Stock Works in Hebei. Siemens also provided technical training for more than 1,000 of CNR’s technical staff at its German facilities.

The project was completed successfully and went into operation before the 2008 Beijing Olympics, receiving wide-spread media coverage and government support: PRC President Hu Jintao rode the train as part of an “inspection tour” in June 2008 and called the project a “milestone in the history of China’s railway development.” PRC Vice Premier Zhang Dejiang, Minister of Railways Liu Zhijun, and the Chinese Communist Party secretaries of Beijing and Tianjin attended the opening ceremony on August 1, 2008 and praised the venture.

Following the project’s completion, Siemens’ market penetration in China increased tremendously. In 2008, the company won concessionary bidding projects from Beijing International Airport to provide its baggage handling system and was selected to provide trains for three new subway projects the same year. The company’s total China sales reached ¥57.0 billion ($8.3 billion) in fiscal 2008, up 19 percent over the previous year. In 2008, China was listed as the “most significant growth market for Siemens.”

Despite these successes, however, Siemens faced significant challenges competing with domestic players for later government rail projects. In March 2009, Siemens announced that it had been awarded a $1 billion contract to provide 100 high-speed trains for China’s Beijing-Shanghai high-speed railway. Following the announcement, China’s Ministry of Railways denied the existence of the deal and insisted that Chinese technology would be used in the project. The ministry claimed that the deal was awarded to CNR and insisted that any deal reached with Siemens originated from Chinese companies. Ultimately, CNR was awarded the contract valued at ¥39.2 billion ($5.7 billion), but Siemens will likely provide components worth $1 billion.

Despite the seemingly positive outcome, this case illustrates the PRC government’s preference for domestic technology and the hurdles that foreign companies may face when sharing their technology. It also suggests that a jump in sales that seems to follow an accommodating approach toward technology transfer may be short-lived. At the same time, the transfer of technology helped Chinese manufacturers compete internationally: Siemens now competes with China South Locomotive and Rolling Stock Corp. to provide electric locomotives to Poland.

Goldwind wind-turbine manufacturing

Xinjiang Goldwind Science and Technology Co. (Goldwind), one of China’s largest domestic wind-turbine manufacturers, began as a research institution. After undergoing a complete restructuring to become a wind-power company, it now accounts for roughly 20 percent of the domestic market and ranks tenth-largest in the world.

Goldwind’s transformation into a global wind powerhouse has relied on financial and technological support from foreign and domestic governments and industry players. In 1989, Bonus Energy A/S, a Danish wind-turbine manufacturer, partnered with Goldwind and transferred the technology to construct 150 kW wind turbines. In 1996, the German government provided financing to develop 600 kW wind-driven power-generating sets and Germany-based Jacobs Energie GmbH licensed its 600 kW wind-turbine technology to Goldwind, transferring the technology as part of China’s National Key Technology and Research Program in 1997. In 2001, Repower Systems AG, another German wind-turbine manufacturer, licensed its 750 kW wind-turbine technology to Goldwind.

Goldwind and the other domestic wind-turbine manufacturers also owe much of their success to supportive PRC government policies. In addition to providing financial support, over the past several years, the PRC government has enacted policies that give preferential treatment to domestic wind-turbine manufacturers. A 2005 NDRC policy required 70 percent of the content of the turbines to be produced domestically for a company to be considered for concessionary bidding. To maintain their eligibility, foreign firms began manufacturing in China.

The effects of this policy have been noteworthy. According to the European Chamber of Commerce’s European Business in China 2009-10 Position Paper, “the world’s most competitive wind-turbine producers continue to be excluded from national concession bidding projects,” and no foreign wind-turbine manufacturer has won a concession tender since 2005. In 2004, foreign-made wind turbines accounted for 75 percent of the Chinese wind-turbine market, according to the Global Wind Energy Council, Greenpeace, and Chinese Renewable Energy Industry Association. By the end of 2008, China’s top three domestic wind-turbine suppliers—Sinovel Wind Co. Ltd., Goldwind, and Dongfang Electric Corp.—alone accounted for nearly 60 percent of the market, according to China International Capital Corp. estimates. Though China recently eliminated the 70 percent requirement as part of an agreement it made during the July 2009 US-China Joint Commission on Commerce and Trade meetings, much of the damage has been done.

Goldwind’s story illustrates how technology transfer and capital support from foreign parties may not open doors to the China market. Goldwind’s meteoric rise, leveraging all possible resources to evolve from a research organization into a dominant domestic player, was made possible through its partnerships with foreign corporations and governments. Despite the supportive role they provided, these foreign partners have been rewarded with substantially decreased market share and restricted access to domestic projects. The foreign companies that supported Goldwind have almost no presence in China now. Though it is nearly impossible to quantify the effect of these policies on market share, or whether other factors—such as improvements within Chinese companies themselves—played a role, it seems likely that these policies have benefited Chinese companies at the expense of their foreign counterparts in the China market.

Recommendations for foreign companies considering technology transfers

Foreign companies operating within industries prioritized by the PRC government, including the environmental sector, generally view technology transfer as the price of entry rather than as an option. Companies should therefore carefully evaluate the potential risks and rewards before deciding to transfer technology.

First, companies must understand the PRC government’s short-term priorities and long-term industry goals. Government priorities can be a double-edged sword: They create business opportunities for foreign companies, especially in areas where China lacks desired technology, but also flag areas where China hopes to develop its own national champions. China’s government has a proven track record of meeting its long-term objectives, and companies must bear this in mind as they develop their own business plans and strategic objectives.

Second, foreign companies should begin with a thorough evaluation of the long-term risks and opportunities that technology transfer could pose to their business. This includes possible theft of intellectual property and emergent domestic competition. Many companies have sought to comply with such policies by offering skills training and capacity building that supplement rather than compete with their core competencies. Such tech-transfer arrangements meet the demands of the PRC government while building, rather than reducing, market opportunities. But in industries where the government is the primary customer, including rail and energy infrastructure, government decisionmakers may consider such secondary tech-transfer plans inadequate. Companies operating in those industries are left with few options other than continual innovation to stay one step ahead of Chinese capabilities. For foreign companies confident that they can innovate more rapidly than their Chinese partners, a strategic alliance with a Chinese company may be a viable option.

Lastly, companies should let the PRC government know that its current policies do not create a sustainable model for innovation. Technology transfer may address China’s short-term gaps, but until China creates the right business environment for innovation, its high-tech industries will lag behind those of developed countries. Expanding special protections for domestic companies might appear to be an attractive option for Beijing, but such policies will only disadvantage China in the long term.

Conveying such views while protecting one’s commercial interests is no simple matter, but it is possible. Industry coalitions provide a degree of protective cover and underscore that a specific concern is widely felt. Companies can also work via the US government. A recent example is the letter sent by 19 business associations to five US cabinet members on China’s indigenous innovation policies on January 26, 2010. Making the US government aware of the business community’s views is an essential first step if US government officials are to make effective use of existing bilateral channels, such as the Strategic and Economic Dialogue and the Joint Commission on Commerce and Trade.

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Key Incentives for High- and New-Technology Enterprises

Enterprises that qualify for high- and new-technology enterprise (HNTE) status are entitled to a preferential enterprise income tax (EIT) rate of 15 percent—10 percent lower than the normal EIT rate. To qualify, an enterprise must have acquired intellectual property critical to its products or services through independent research, transfer, donation, or acquisition within the last three years. In addition, at least 60 percent of the enterprise’s revenue must come from high- and new-technology products and services, as defined by a product list released by the PRC State Administration of Taxation. Other provisions place restrictions on the number of non-technical staff at the enterprise, the portion of staff engaged in research and development (R&D), and R&D spending.

Other incentives include

• Subsidized loans from the PRC Ministry of Science and Technology for HNTEs’ initial public offerings, the construction of national high- and new-technology parks, and Chinese companies “going abroad”;
• More than ¥370 billion ($54.1 billion) in economic stimulus allocated for investment in HNTEs;
• An exemption of the first ¥5 million ($732,000) in tech-transfer revenue from EIT, and a discounted rate for any additional revenue;
• A deduction of 150 percent of R&D expenses from EIT tax liabilities; and
• Additional tax incentives for industries that the PRC government has targeted for development—such as software and integrated-circuit production.

—Kenneth Jarrett and Amy Wendholt[/box]

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Drive for Indigenous Innovation

China’s efforts to advance its domestic technological expertise and redefine the country’s role in the global economy center on its “Drive for Indigenous Innovation” program, which includes numerous policies to stimulate domestic innovation. According to the program, indigenous innovation contains three components: “original innovation” (yuanshi chuangxin) through organic technological development; “integrated innovation” (jicheng chuangxin) by combining existing technologies in new ways; and “re-innovation” (yinjin xiaohua xishou zaichuangxin), which involves the adoption and improvement of imported technologies.

—Kenneth Jarrett and Amy Wendholt[/box]

[author]Kenneth Jarrett is vice chair of APCO Worldwide Inc.’s greater China region and is based in Shanghai. Amy Wendholt is associate director in APCO Worldwide’s Beijing office.[/author]