How to protect your intellectual property
when setting up a factory in China

When Bruce Mitchell arrived in China in 2003, he had one mission: expand the global supply chain for Pittsburgh-based Spang & Company, a precision electronics engineering firm. After realizing that a joint venture with a Chinese company wasn’t going to work, Mitchell and his team decided they needed to establish their own wholly-foreign owned foreign enterprise.  But this was his first time setting up any sort of operation in China, and he needed advice. So he surveyed dozens of American firms about their experiences in choosing an industrial park, securing incentives from local government officials, and registering their businesses.

One of the biggest challenges came when he realized he needed to work through a state-approved Chinese company—known as a design institute—to build the factory. What was Mitchell getting his company into? Would his firm’s intellectual property be safe? And how should he choose among the hundreds of design institutes?

Nine years later, he not only answered his questions, but he also wrote a book on the subject: 13 Steps to Manufacturing in China. China Business Review spoke with Mitchell and several US-China Business Council (USCBC) member companies to find out how best to work with design institutes in China (USCBC is the publisher of China Business Review).

What are design institutes?

Similar to engineering design firms in the United States, Chinese design institutes are state-approved companies that review and authorize construction drawings and designs. The institutes, certified by China’s Ministry of Construction, must sign off on every part of a new design, from plant layout to equipment requirements.

Institutes fall into two categories: civil and industrial. Civil design institutes can be state-owned or private, and generally deal with the construction of museums, residential buildings, and athletic facilities. Industrial design institutes are state-owned and work on projects like food and beverage production facilities and high-tech industrial parks.

Institutes are ranked based on their number of engineers, their experience, and the types of technology they use, with grades ranging from A-D for civil institutes and A-B for industrial institutes. Grades are not indicative of quality, but they can signal project limitations based on geography and scope. For example, some institutes are authorized to operate in a wide geographic area, while others are limited to single provinces or cities. As a result, Mitchell recommends that foreign companies use grade A institutes whenever they can.

Mitchell says that he and his company interviewed nearly 10 design institutes of varying size and expertise for his first project. It was a strong recommendation from the local developer who was leasing the building to Mitchell’s company that helped him make his decision.

Looking back, Mitchell stresses the importance of confirming that a design institute has specific expertise in a required field before making a selection. This was an issue when Mitchell discovered his design institute didn’t have a license to design a certain pipeline and had to then outsource the work.

At minimum, design institutes merely sign off on a project’s design. But many offer additional services such as environmental-impact reports and feasibility studies, cost estimates for engineering design, complete design and construction services, and locating domestic equipment suppliers.  Over time, larger Chinese firms have developed more comprehensive services while smaller ones have started to focus on niche services.

What challenges do they pose for foreign companies?

Although using a Chinese design institute is ostensibly a simple process, many foreign companies have faced challenges when working with design institutes, including poor service, theft or misappropriation of intellectual property (IP), and being forced to procure from specific vendors. Companies must have clear and effective communication with Chinese design institutes, setting requirements about IP and trade secret use, procurement, and quality.

The biggest challenge for foreign companies in working with design institutes, according to USCBC member companies, is theft or misappropriation of IP, particularly trade secrets. This is especially true when design institute personnel are not full-time employees of the institute, but are instead outside “experts” hired on a part-time or contract basis. Many of these experts work full time for local businesses or universities, and some are even shareholders in local companies, creating a clear conflict of interest.

IP infringement isn’t always malicious, though. USCBC member companies say it can sometimes stem from design firms’ desire to quickly tackle future projects. One USCBC company executive says he doesn’t believe Chinese design institutes actively try to steal or leak trade secrets. He says instead that these institutes learn a plant’s processes in order to more efficiently manage future projects.

Poor quality can also be an issue at some design institutes. In most cases, quality depends on the level of specificity a company provides the design institute, say USCBC member companies. Providing high-quality, detailed information to the design institute from the outset almost always results in better construction.

In addition to signing off on project design, many institutes can also help procure equipment, such as pipes, plates, injection molds, and other manufacturing and construction machinery. But USCBC members say to take such suggestions with a grain of salt: the design institute might recommend a supplier unable or only poorly able to meet the needs of the foreign company.  In one case involving a USCBC member, a large Chinese design institute made the firm procure machinery from a subsidiary with no experience building it. Although the US partner pushed back, it ultimately agreed to the request.

How should foreign companies overcome these challenges?

Companies must be certain that the design institute understands the project’s requirements and is capable of completing them. Frequent communication that sets clear expectations is crucial to a project’s success. One company cautioned that some design institutes—particularly small ones—oversell their capabilities. Before any agreements are made, companies should verify a design institute’s qualifications and ask about previous work done for other foreign multinational companies.

Designing and building manufacturing facilities is a complicated process with many parties. Each party, although committed to completing the project, is self-interested, say USCBC member companies. It is therefore paramount to coordinate efforts to achieve the project’s goal. This is a particular problem when working in a different language and culture. Merely having a translator is not enough, as he or she may lack the requisite engineering vocabulary. This can result in long, unclear conversations among parties, according to Mitchell.

“I’d be in a design review meeting and the Chinese side would talk with the translator for several minutes. Then the translator would give a one-sentence or even a single-word response in English,” Mitchell says. “It’s very helpful to have a general manager or staff member who is Chinese in these conversations.”

In the case of procurement, many USCBC member companies recommended asking design institutes for multiple options for equipment suppliers. This allows the company to choose the best option rather than being stuck at the mercy of one supplier who may have little experience making the needed equipment.

To protect proprietary information, USCBC member companies recommend that foreign companies do the following:

— Emphasize in business negotiations, written contracts, and ongoing communications with design institutes that design information should not be shared with outside colleagues, and that unauthorized use of design information is considered to be trade secret infringement;

— Sign a non-disclosure agreement (NDA) written in Chinese and tailored for enforceability in China before information is disclosed;

— Take steps to limit the possibility that design information and documents can be duplicated, scanned, or shared with outside parties. One way is by using colored paper—pink was suggested—for printing sensitive materials, to make sure that photocopied versions of the document appear unreadable;

— Explain clearly and frequently that project information is not to be shared with other companies or used in future projects; and not share any more sensitive information than necessary with a design institute.

Moving in a positive direction

USCBC member companies surveyed all say that Chinese design institutes are improving their quality and becoming more professional. Interactions with foreign companies have helped Chinese design institutes gain a clearer understanding of and an improved ability to meet expectations. Expanding into markets outside China has also helped design institutes become more flexible.

Increasing professionalism among Chinese design institutes does not resolve all challenges associated with working with these institutes, however. Companies that set clear requirements about IP and trade secret use, procurement, and quality should be able to mitigate many of these problems, helping all parties meet deadlines and budgets, while protecting valuable information.

Mitchell says that effective and frequent communication with his Chinese counterparts was essential to achieving success, as was having a Chinese speaking engineer on staff. Buy-in from Mitchell’s entire organization, including top management, also ensured that the project made steady progress and received financial support, he says.

About The Author:  Dan Markus is business advisory services manager at the US-China Business Council’s Washington, DC office.