Could Its Leisurely Innovation and “The Vietnam Alternative” Dull China’s Edge?

Could Its Leisurely Innovation and ‘The Vietnam Alternative’ Dull China’s Edge?

If the cost of doing business in China goes up due to increasing wages and a more muscular currency, will companies start going to other countries where the costs are more attractive? Come to think of it, why aren’t they? No longer satisfied with being just the source of cheap and robust manufacturing, China says it has jumped big into the technology innovation game with a stated policy of moving up in the global value chain. What does that mean for the U.S. which owes so much of its leadership position to its list of the world’s most creative companies?

The widely read China Law Blog, led by Dan Harris and Steve Dickinson of Harris & Moure PLLC, tackled these questions in recent posts in which they straighten out some of the recent commentary about China’s current position in the world economy.

Harris says many articles have predicted that the end of “cheap China” will bring to a halt foreign companies going there. “That has barely happened at all,” Harris wrote, pointing to a Reuters article which reports that, for the third year in a row, foreign direct investment, or FDI, in China will exceed $100 billion.

“Essentially,” Harris said, “FDI has slowed a bit, but is still massive and all of the talk of companies going into places like Indonesia or Vietnam has been, to a large extent, just talk. This is what I have been seeing as well and I have to admit that it is NOT what I have been predicting . . . I am particularly surprised at how so few of my law firm’s clients have moved over to Vietnam, especially those in industries like clothing, shoes and pet toys where to me it makes complete sense for them to do so. I am even more surprised at how few of our new clients going into Asia for the first time are looking to countries other than China for their manufacturing.”

Vietnam’s ‘Soft Infrastructure’

Harris & Moure represents clothing and shoe companies doing business in China, and Harris thinks the reason companies continue to focus on China is simple: “These companies do not know how to go into any country other than China.”

Harris says even when a Chinese company provides a U.S. company with bad product and the two get into an excited dispute, and even though the U.S. company “has heard great things about Vietnam,” the U.S. company strikes a deal and still keeps working with the Chinese company.

“So why does the U.S. company not go to Vietnam?” Harris asks. “Simply because it lacks the people in its organization with any Vietnam expertise and because there is no clear and easy path for SMEs [small and medium enterprises] to get into Vietnam. The path is less than clear because Vietnam lacks a ‘soft infrastructure’ of well–known and highly regarded experienced consultants with offices in the United States. Vietnam also lacks a network of people . . . in the United States who can talk of their Vietnam experience.”

Innovation

Harris’s partner, Steve Dickinson, wrote in a recent post that while China wants to move up the supply chain ladder, it is challenged when it comes to fostering technology innovation. “The Chinese authorities want China to transform its industrial model from a low value added/low level technology model to the opposite. To combat stagnating economic growth and the threat of energy and resource restraints, government policy is to try to effect this change as quickly as possible,” Dickinson wrote.

But to do this China needs cutting-edge technologies, and relying on foreign innovations will be problematic, Dickinson wrote. The cost of acquiring foreign technology will be too high and “China will become progressively more dependent on foreigners, which conflicts with China’s current drive to become an independent, ‘stand alone’ world power,” the Harris & Moure partner wrote.

“As part of its 12th Five Year Plan, China has therefore embarked on a domestic innovation program. The fundamental concept is that Chinese companies will independently develop the technologies required to drive China to its new, high–tech future. There are many limitations on the ability of companies in any country to become innovators in the technology realm. The factors can be broken into two basic components: capacity for innovation (intangible) and corporate spending on research and development (tangible).”

China’s Investment in Innovation Uninspiring

Booz & Company’s 2012 Global Innovation 1000 study shows how China stacks up globally, Dickinson said, and demonstrates how China “has a long way to go in all areas of innovation.” The Booz study lists the 10 most innovative companies in the world, eight of which come from the United States, led by Apple. Korea’s Samsung and Japan’s Toyota rounded out the list. No European company nor any company from the BRIC countries— Brazil, India and Russia—made the list. “The list shows that when it comes to the intangible side of innovation, the United States remains the overwhelming leader in the area of technical innovation,” Dickinson concludes.

“The Study shows that not only are Chinese companies nowhere to be seen in the intangible side of innovation, they also are nowhere to be seen on the investment side. Simply stated,” wrote Dickinson, “Chinese companies do not spend a significant amount on innovation.”

In a regional showdown, China looks good, with 47 companies in the top 1,000 compared to India’s nine. China’s total expenditure is $14.8 billion while India’s total expenditure is only $1.5 billion. Compared to the rest of the BRIC countries, China is far ahead in innovation spending.

“However, a closer look at the [Booz] data shows that China remains far behind the developed world. Consider first the total amount of investment. China’s 47 companies in the top 1,000 spent a total of $14.8 billion on R&D in 2011. This is substantially less than the amount spent by the top two individual companies in the top 1,000 and it is less than 10% of that spent by the top twenty as a group. Equally important, China’s commitment to spending is decreasing rather than increasing,” Dickinson said, again citing the Booz report. “China increased its spending by over 27% in 2011. However, this was a decline from the 38% increase in 2010.”

Substantial Change Would Buck Trend

“The numbers therefore show what anyone who works in China would expect. China’s capacity for innovation remains far behind the developed world and there is little prospect for substantial improvement in the future. The reasons are simple. On the intangible side, Chinese companies have little capacity for internally generated innovation. On the tangible side, Chinese companies do not invest substantial amounts on innovation. The trend in both these areas suggests that this pattern will not change in the near future.”

All of this means that the opportunities in China for foreign owners of technology are considerable,” Dickinson wrote, but could be blunted if China’s courts will not protect the ownership rights of foreign owners of technology and if Chinese companies will “pay the price to acquire the first-tier technology required.” Dickinson isn’t optimistic. Based on his 30-year experience watching Chinese government and business performance, he said it is not clear that these obstacles will go away.

“There is no question about China’s demand for technology. The question is whether there is a commercially reasonable market to meet that demand. The challenge for all interested parties—foreign companies with technology, Chinese companies seeking technology, Chinese courts and governments, and even the lawyers doing the technology deals—is to do our part to make the answer a yes rather than a no. We cannot wait for the Chinese side to do it all on their own.”