How to Win the China Piracy Battle

Companies must take a business, not a moral, approach by adding value to legitimate products so consumers will want to reject counterfeits

by Shaun Rein

Intellectual property rights is a hot topic for President Bush. Recovering the money lost by large multinationals such as Nike (NKE) and Microsoft (MSFT) in China would go a long way toward reducing the trade surplus with the U.S., which hit a whopping $85 billion in May.

Some of the numbers are startling. The Business Software Alliance estimates that in 2005, 86% of all software used in China was pirated, accounting for a $3.9 billion sales loss. Meanwhile an estimated $60 billion a year's worth of counterfeit goods are exported out of China, ultimately ending up for sale on U.S. street corners.

With counterfeiting a huge concern, companies must look at new ways to address the problem and protect intellectual property rights. With signs that China's consumers and its government are taking intellectual property issues more seriously, companies with a smart approach to China can prosper.

A Matter of Economics

First, multinationals should try to stop the piracy by taking a business approach rather than a legal or moral one. They must become less moralistic about intellectual property theft by the Chinese. While they do have the legal high ground, their current posturing does little to stop the pirates or generate revenue from legitimate sales.

The problem is more a matter of economics than of a morally corrupt Chinese populace. As the disposable incomes of Chinese consumers continue to grow, brand loyalty gains currency, and domestic Chinese companies begin to lose revenue to pirates, intellectual property problems will be solved in much the same way as they were in Taiwan and Korea. Smart multinationals will make sure they are in a strong position to reap the benefits in China.

One positive sign is that Chinese are in many ways no different from other consumers. Millions are entering the ranks of the middle class, and they want to look the part of the urban aristocrat. If they cannot afford genuine items they turn to touts on the street hawking fake Louis Vuitton, Tiffany (TIF), Montblanc (CFR.VX), Rolex, and Polo (RL) items. But as Chinese consumers become increasingly sophisticated, the situation is changing. Now consumers can value the difference between a real Giorgio Armani tie and a fake one.

Counting On Cachet

My firm, The China Market Research Group (CMR), conducted one-on-one interviews with consumers in Shanghai, Guangzhou, and Beijing. We found that consumers prefer to buy genuine articles if they can afford to pay for them. The majority of aspiring respondents said that they are buying some real products and then completing an ensemble with fakes.

Many young women making $400 a month said that they are willing to save three months of salary to buy a thousand-dollar Gucci (GUC) handbag or shoes from Bally. One 23-year-old female respondent said, "Right now I can't afford to buy a lot of real Prada or Coach (COH), so I buy the fake items. I hope that in the future I will be able to afford the real thing, but right now I want to look the part."

A 27-year-old woman working at a multinational admitted that she did buy fakes but said, "If you wear a lot of fake clothing or have a lot of counterfeit bags, your friends will know, so you are not fooling anybody. It is better to have the real thing." As long as companies make an effort to develop the cachet of their brands, they do not need to worry about pirates making copies of their products.

All the signs say the situation will continue to improve as spending power rises.