Why NPEs are necessary for China to dominate its domestic chip industry

About ten months ago, I predicted that China was on a quick path to grow its domestic chip industry.  This forecast did not require rocket science, since the Chinese government, in 2015, set a goal to increase its production of semiconductors used in China to 40 percent by 2020 and to 70 percent by 2025.  This was remarkable given that at the time, Chinese production for its domestic market was only about 5-10% of the semis used in China.  But it looks like the Middle Kingdom is well on its way to accomplishing those goals.  As announced last week, state-owned Tsinghua Unigroup is investing $30 billion in a memory chip fab in Nanjing.

I rarely post anything of any real political nature, but I did want to point out that China wanting to capture the lion’s share of its own chip market makes a lot of sense.  For China, it is a legitimate national security issue.  Keep in mind that semiconductors run every computer, smartphone, or electronic device — including those that run national security and defense applications.  Imagine what would happen if China made 95% of the semiconductors that run the United States’ national defense.  The US government would scream that the sky is falling and immediately act to change this.  China has the right to protect its country and its people.  China justifiably wants to have a good share of its own chip market.

Obviously, there are also financial reasons for this.  For example, China’s smartphone market is the world’s largest ( interestingly, India is second, in front of the US).  Apple sells more iPhones in China than anywhere else.  Qualcomm gets 53% of its revenue from China.  China needs to keep more revenue from its mobile industry.

Since this is, after all, a blog focused on patents, what does all of this have to do with patents?  The answer lies in how China will achieve its lofty 40% and 70% semiconductor domestic market share goals by 2020 and 2025, respectively.  As noted, China is making huge capital investments.  This will lead to less “brain drain” from China to the West, as well as outright increases in innovation in this space.  Further, China will provide financial supports for domestic companies to outcompete foreign competitors.  But this will not be enough.

We will likely soon begin to see more antitrust actions by the Chinese government.  But this, too, will be insufficient.  Patents and patent enforcement will provide the necessary supplement to ensure China dominates its own market.  (Again, because Intel is now connected to China, this will help them if not flourish, at least survive in, China.)  The problem is that most of the best-quality Chinese patents are owned by non-Chinese entities.  Other than the Chinese tech behemoths such as ZTE and Huawei, Chinese technology companies, including Tsinghua Unigroup, do not own many patents relative to their foreign counterparts, and the patents they do have are not as good as those owned by foreign competitors.

The current lack of quality is nothing to be ashamed of.  China has generated a huge number of patents in a very short time.  In fact, more than 1 million patent applications were filed in China in 2015, but 96% were filed only in China.  This is changing quickly before our eyes, but for now, the best Chinese patents are those that are originally filed in the US, Europe, or Japan and then later filed in China as a counterpart to these foreign filings.  China has moved faster in patent protection and innovation than any country in the history of the world.  But to achieve more consistent quality, the Middle Kingdom needs a few more years as it shifts from quantity to quality.  This move is akin to the growth path of many technology companies around the world, including the US.

For instance, when I was senior patent counsel at Red Hat, the company had completed a period of tremendous patent growth.  Unfortunately, because many of these patents were on operating system technology, and unlike Red Hat, its competitors do not freely provide source code, much of the portfolio was of dubious value due to the inability to determine infringement.  During my time there, and in the time since, Red Hat’s portfolio has matured from a numbers-based portfolio to more of a quality-based one.  But this did not happen overnight, and neither will it for China.  But it will happen, and it will happen quickly with the emphasis and support currently provided by the Chinese government.

If most Chinese patents owned by Chinese entities are are of lower quality, then how can China use patent litigation to chase away foreign companies to support and grow domestic businesses, especially in the semiconductor industry?  The answer is Non-Practicing Entities (NPEs).  Whether they are called NPEs, licensing companies, Patent Assertion Entities (PAEs), patent trolls, or any other pejorative term, these businesses have decades of experience in licensing, monetizing, litigating, and enforcing patents.  They are fertile ground for advice regarding patent enforcement and strategy for a country and its technology leaders that may be incredibly bright and business-smart, but with little experience in the patent realm.  I recently had an article published in the Chinese state media detailing how NPEs can support innovation and technology companies in China.

Further, NPEs are uniquely positioned to help China by attacking foreign entities to clear the way for Chinese companies by exerting pressure in ways that only NPEs can.  Even if Chinese semiconductor companies had the necessary patents and experience to engage their foreign competitors, they would risk retaliation from these foreign parties.  NPEs, on the other hand, can unilaterally attack foreigners without fear of retaliatory patent suits.  Although there are a few of antitrust issues, I do not believe that NPEs that act in the best interest of China should, or will, be attacked by the NDRC or any other antitrust agency in China.  Indeed, by being a good “friend of China” NPEs will be exactly what China needs:  an agent to help enact the goal of China to dominate its domestic industries in semiconductors and other fields.