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International intrigue

By WEN DAO (Business Weekly)
Updated: 2006-03-13 15:06

It's halfway across the world and couldn't be more culturally removed from the Chinese mainland, but local business executives have become well acquainted with eastern Texas over the past few years.

Courts in the district are known for their strict protection of intellectual property rights (IPR), which is why they are quick to accept such cases, especially when domestic network equipment manufacturer Huawei Technologies faced a court dispute there with US competitor Cisco Systems for infringing on its IPR in 2003.

Huawei has caused huge headaches for Cisco by selling cheap, high quality products in the United States. A settlement was finally reached with the US manufacturer in 2004 and stopped selling the questionable products in the United States.

The case sounded an alarm for Chinese companies, however, many of which are competing in global markets. These enterprises are frequent targets in legal disputes with foreign competitors over alleged IPR infringements.

Domestic pioneer

However, the Eastern District of Texas holds special significance for Deng Guoshun, chief executive officer of Netac Technology Co Ltd. The firm was the first Chinese enterprise to launch legal action against a US firm in the court over claims of patent infringement.

"Chinese companies often used to suffer from IPR lawsuits, but we were the first to sue a US company for IPR infringement," says Deng.

The domestic flash memory product manufacturer brought New Jersey-based competitor PNY Technologies to the federal courthouse in Texarkana, Texas over claims that its patent, registered in the US Patent and Trademark Office in December 2004, had been infringed upon.

The company's "electronic flash memory external storage method and device" patent requires any company producing external devices using flash memory to license the technology from Netac.

PNY is the second largest flash memory product manufacturer in the US$2 billion US market. Netac asked PNY to halt sales of several products and pay a significant penalty based on estimations of the size of the US market and PNY's share in it, the company statement says.

"Our losses in the United States are quite heavy, so we had no choice but to bring PNY to court," says Deng.

He adds that there are as many as 50 companies in the United States producing or selling flash memory products under their own brands. This potentially violates Netac's patent, including Apple's famous iPod and SanDisk's flash memory products.

Deng says his firm would continue asking a number of US companies to honour its patents.

The suit is the first case raised by a Chinese technology company against a US firm in the United States. It demonstrates the increasing technological strength and IPR awareness among Chinese enterprises.

The World Intellectual Property Organization reports that 2,452 patents from China were registered with the organization in 2005, a 43.7 per cent rise from the previous year. Although applications from China only accounted for about 5 per cent of those from the United States and one-tenth of those from Japan, the growth rates were more than 10 times that of Germany and almost 12 times that of the United States.

"When Chinese enterprises enter international markets, it is almost inevitable that they will have conflicts with competitors, so they need to know the rules and use them to protect their interests," says Zhao Chunshan, secretary general of the China Intellectual Property Society.

He believes Netac will encounter a number of difficulties in the suit, but it will be a solid beginning for Chinese companies and even for Netac. The worst-case scenario will still provide valuable publicity for the firm, and will lay a solid foundation for its entry into the US market.

IPR network

Netac is one of the few Chinese companies with a comprehensive IPR network. The company has registered more than 250 patents, most of which are registered on the Chinese mainland. Some have also been registered in Taiwan and the United States.

Netac's IPR network is so comprehensive that almost every flash memory maker on the Chinese mainland theoretically has to license technologies from it.

"Those IPR efforts of five years ago show Deng's vision. Many companies did not even know what IPR were back then," says Hu Zuochao, vice-president and secretary general of the Patent Protection Association of China.

Netac filed a lawsuit against Beijing Huaqi Information Digital Technology Co Ltd and its distributor in a Shenzhen court in 2002, where Netac is based. In June 2004, Hauqi was ordered to stop sales of its flash memory products, but Netac was not granted its demands for 1 million yuan (US$120,000) in compensation.

Huaqi is one of Netac's top domestic competitors. It asked the court to overthrow Netac's patent, and the issue is still ongoing.

The case did send a warning to many other flash memory manufacturers, however. Netac also sued Taiwanese firm Acer, but both parties reached a settlement. Netac even received several manufacturing contracts from Acer afterwards.

Deng says about 10 firms have reached agreements to use Netac's production facilities to manufacture components. This list is reported to include top international companies such as IBM, Samsung Electronics, Dell, Toshiba, and several big Taiwanese electronics manufacturers.

Two months after winning the battle against Huaqi, Netac filed another suit in a Shenzhen court against Sony Electronics (Wuxi) Ltd in Wuxi, East China's Jiangsu Province. The charges were similar, with Netac asking for 10 million yuan (US$1.2 million) in compensation.

Sony tried to challenge the jurisdiction of the Shenzhen court but was rejected. The court has yet to reach a decision due to a number of complications in the case.

Deng, who used to work in the Singapore branch of Dutch manufacturer Royal Philips, says Philips' aggressive IPR strategy could offer an example of how IPR can also be used as commodities to generate profits.

"Entry into international markets should not only be limited to sales of products," says Deng.

"IPR can also bring profits to us."

Philips, is known for its active investment in China, but also for its leading role in bringing Chinese CD and DVD makers to court and for stopping their sales to overseas markets. It represents the interests of a group of international patent owners to charge royalties. It has already licensed optical patents in China with 255 licensees, mainly for CDs and DVDs.

Deng says revenues from IPR, including royalties and manufacturing contracts, account for 20 to 30 per cent of the company's revenues.

Netac sold more than 3 million flash memory products last year and had revenues of less than US$100 million.

The costs of this business are also quite high. Deng says Netac spends about 10 per cent of its revenues on research and development, as well as legal expenses. In the PNY case, these costs can be extraordinarily high for a company of Netac's size.

Netac hired Boston-based Morgan Lewis & Bockius LLP, one of the top 10 law firms in the United States, as its representative in the US suit.

The company declines to reveal the exact cost of the suit, but says such cases with prestigious law firms usually cost more than US$5 million.

The case is not the only evidence of Deng's foresight. His optical drive replacement plan is particularly aggressive. When flash memory disks were first invented, it was believed they could replace computer floppy disks.

Flash memory disks, with their higher reliability and larger storage capacity, could eventually render floppy disks obsolete.

Deng has since applied flash memory technology in CD and DVD drives. The ideas have been patented on the Chinese mainland and in Taiwan, and may eventually be expanded to other countries.