China’s technology standard strategy: more than a standard war?

As a component of its development strategy, China has been creating its own indigenous technological standards. One of the most high profile examples is TD-SCDMA, the Chinese home-brewed 3G wireless network standard, implemented in 2007. Although there were plenty of skeptics, both within China and abroad, of the commercial viability of TD-SCDMA, the Chinese state has demonstrated its strong determination to construct the network based on this standard. China Mobile, the world’s largest wireless carrier in terms of user subscriptions, has been charged with the construction of the TD-SCDMA network. To ensure TD-SCDMA chip fabrication, in 2009, Datang Holding, the primary technology company that is developing this standard, injected USD 171.8 million into financially constrained SMIC, China’s largest pure-play chip fabrication company.

In recent research, Dan Breznitz and Michael Murphree of Georgia Institute of Technology have found that there are thousands of standards being proposed every year in China, and the state enforces hundreds of new standards annually. They argue that the Chinese state has induced domestic corporations and research institutes to join the innovation arms race of technological standard-making with enhanced social visibility, abundant financial support, and lucrative monopoly rents. It seems that the world’s industrial juggernaut is waging a total war on the battleground of technology standards.

Yet some observers have raised doubts about the actual contribution of indigenous innovation to the technology standards war. In several high profile cases of China’s “own” technology standards, foreign technology partners controlled the majority of the patents embedded in these standards. Three global telecommunications leaders contributed up to 66% of all patents used in TD-SCDMA, while Datang, the state appointed national champion, holds only 7.3%. In the case of CHBD, China’s own high-definition blue-ray videodisc technology, the technology alliance formed by Chinese companies purchased 90% of the patents from foreign technology partners, mostly Toshiba, the Japanese consumer electronics giant. Despite the question of whether the Chinese standard is really made in China, researchers like Breznitz and Murphree have also pointed out that competing standards may force Chinese companies to hedge the risk of being marginalized in the market by spreading their already thin R&D expenditure over the development of several lines of incompatible products, which in turn diminishes the possibilities of major breakthroughs.

Does this mean that China’s standard-making efforts are a waste of money? Probably not. The Chinese state and Chinese industry have benefited from this strategy in two ways. The first is the reduced royalties that Chinese industry has to pay to foreign standard owners. Chinese exporters are well known for relying on foreign standardized technology for production, and royalty payments burden their thin profit margins from assembling imported components. A classic example is the Chinese video compact disc (VCD) player industry, which exploded in the mid-1990s, but went into a crash when foreigners tightened their revenue-collecting efforts in the late 1990s. After the introduction of indigenous technology standards, dramatic changes occurred. With the emergence of a credible threat that they would be cut off from the Chinese market, foreign standard owners significantly lowered the royalty payments that they demanded. In some extreme cases such as WCDMA handsets, Chinese manufacturers paid lower royalties than anywhere else. Indeed in most sectors, China does not seek to replace the global standard with the domestic one; instead, it uses the development of an indigenous standard as a source of bargaining power.

The other benefit is the opportunity of engaging in technological learning and technological leverage. The lucrative rewards of holding a state-selected standard have drawn Chinese corporations into the innovation race. For many of these companies, it is necessary for the first time to have a formal structure supporting R&D activities. For fear of losing a large market like China, multinational corporations are also compelled to engage in China’s standard making projects. Local firms thus are provided with ample opportunities to learn from foreign partners by working with them and forming partnerships. A proven example is Huawei, which greatly accelerated its pace of technology development by forming partnerships with global leaders in all three competing 3G-network technologies.

Can Money Buy China Innovative Capabilities?

The Financial Crisis has accelerated the shift of economic power from West to East in many ways: one of them is that more and more cash-strained American and European companies have been looking for buyers from their counterparts in emerging economies, particularly China. Last month, Geely, a Chinese car manufacturer, set a new record by completing the acquisition of Volvo, the Swedish premium car maker, from Ford for $1.5bn. Meanwhile, the largest foreign investment in Germany’s engineering sector for years came from Sany, a Chinese industrial conglomerate. Sany will build a machinery plant near Cologne to gain access to Germany’s rich engineering skills.

For years Western media have been talking about Chinese state-owned enterprises, backed by Chinese state banks, buying strategic assets, such as minerals, oil, and gas, all over the globe. But the newest players in the merger & acquisition game come from more competitive sectors with diversified ownership. Profits from China’s booming domestic market certainly helped companies like Geely and Sany to be in the position to do the acquisitions mentioned above. Remember that not that long ago, in 2006, Sany failed in its bid for Xugong, a state-owned heavy machinery maker, in competition with Carlyle Group, the US private equity firm. This year, Sany is already the market leader in sectors such as concrete pumps, with enough confidence – and cash – to “push into Germany’s heart and soul” (Financial Times, August 11). Indeed, aided by the Chinese state’s “walking out” strategy, which plans to utilize the country’s inexhaustible foreign reserves to help make Chinese companies global players, Chinese companies are increasingly adept at obtaining technological knowledge, managerial experience, and, more recently, global brands through overseas acquisitions.

Never before in world history has a country in the process of development been so deeply involved in offshore acquisitions. East Asian economies such as Japan, Korea, and Taiwan rarely engaged in outward investment at a similar stage in their development. Instead these economies confined themselves to establishing public institutions to help domestic firms to identify, import and absorb foreign technologies, as well as to nurture domestic innovative capabilities. With “walking out” through outward investment, has China discovered a new way, or even a shortcut, to technological advancement and capabilities accumulation?

So far, China’s record of using overseas acquisitions to strengthen its capabilities remains a mixed outcome. Successful stories include Lenovo’s successful integration of IBM’s personal computer business, which not only consolidated Lenovo’s position in the domestic market, but also helped the company leapfrog into being a competitive player in both US and EU market. But there are failures. The high-profile acquisition in 2006 of France’s Thomson by TCL, the world’s largest television maker at that time, turned out to be a waste of time and money. By the time TCL closed most of its facilities in Europe, it lagged behind its aggressive domestic rivals in next-generation flat screen products. Overseas acquisitions of strategic assets can accelerate enterprise growth, but these foreign acquisitions may be at the expense of investments in indigenous innovation.

Last month, China surpassed Japan as the second largest economy in the world in terms of nominal gross domestic product. But it is still too early to say that China has outperformed other East Asian developmental states in building innovative capabilities, through various policy options it experimented including outward investment. China’s GDP per capita is only 1/30 that of Japan. And more critically, when Japan achieved the position of the number two economy in the world in the late 1960s, a group of world-class companies like Toyota, Sony and Toshiba had already emerged. In climbing the technological ladder, corporate China has a long way to go.