HiPhone or iPhone? Protecting Against China’s Shanzhai Phenomenon

Foreign companies operating in China are continuing to face the risk of others abusing their intellectual property and a legislative system that may not be keeping pace with the innovation of counterfeiters. This is illustrated by the phenomenon of ‘shanzhai’, whereby many companies in China engage in piracy as a means of building brand, scale and profits, which are then used to develop alternative competing products. While protection of intellectual property rights (IPRs) in China has been improving, shanzhai is an example of how enforcement is often patchy and government response is inconsistent. This article seeks to offer some practical guidance to companies seeking to protect their IPRs in China.

What is Shanzhai?

Shanzhai is the term generally used in China to describe counterfeit goods, which range from body soap (Olay to Okay) and detergent (Tide to Tids), to mobile phones and cars, all involving the appropriation of ideas from legitimate well-known brands. The term “shanzhai” can be literally translated to mean ‘mountain village’, which is metaphorically used to describe bandits escaping capture in remote camps. Today, the term is most commonly linked to low-quality factories in southern China that are remotely situated to avoid inspection by authorities. These factories are privately held and staffed with a few to over a thousand employees who mass-produce imitation products daily. One well-known example of shanzhai is that of ‘Future Cola’, a cola-flavoured carbonated beverage bearing similar packaging to that of Coca-Cola, which has grown to become the third-most popular carbonated soft drink in China.

Some believe that shanzhai products reflect Chinese innovation or ingenuity, because the profits from early counterfeiting activities are often used to develop new products. However, others are concerned that the ability of shanzhai companies to engineer products that look and feel like the real thing within a short time period poses a huge threat to innovation in light of the comparatively long lead time required to produce many branded goods. By the time a manufacturer is able to develop and launch a particular product, shanzhai producers may already have commercialised a similar version of the product. As such, shanzhai presents a significant challenge for multinational firms operating and investing in China

China’s IP Regime

China’s IP framework is comprised of the Trademark Law, Copyright Law and Patent Law and its implementation rules, all having been revised at least twice since their first enactment. The latest amendment to the Patent Law of the PRC, the third such revision, came into effect on 1 October 2009. One of the key improvements under the new Patent Law is that an applicant may file patent applications in a foreign country for inventions or creations completed in China (without the need to file in China first), provided that the applicant first obtains a foreign filing licence from the State Intellectual Property Office (SIPO).

Similarly, the revisions to the Trademark Law of the PRC currently being considered are intended to streamline and enhance existing prosecution and opposition procedures, and expand on the type of acts that constitute infringement of registered trade marks and unregistered well-known marks. The latest draft amendments released for consultation by the State Administration of Industry and Commerce on 20 June 2009 also propose significant changes to the law governing brand procurement, and it is anticipated that such revisions will be finalised and implemented in the next two years. Both legislative improvements align with China’s National Intellectual Property Strategy to develop by 2020 an internationally advanced system of creating, using, protecting and managing IPRs.

The Anti-Unfair Competition Law of the PRC also prohibits certain types of conduct, including ‘feigning’ a registered trade mark, or unauthorised use of the name, packaging or decoration (or similar indicia) of a brand that may lead consumers to mistakenly believe that its products are in fact the well-known product. Other conduct includes unauthorised use of an entity/individual’s name leading consumers to mistakenly believe that a product has been formally endorsed, and falsely marking products to misrepresent its authenticity, fame, quality or place of manufacture.

Regulators empowered to enforce China’s IP laws include the State Administration of Industry and Commerce (SAIC), SIPO and National Copyright Administration (NCA), each respectively handling registration and protection of trademarks, patents and copyright. China’s General Customs office also assists enforcement through its commodities registration system, instituted to protect against the trade of imitation commodities.

Parties may take action against IPR infringement through administrative procedures or by commencing a civil suit in the IP Division of the People’s Court, the former generally being less time-consuming and more cost-effective. Upon request, administrative bodies may conduct investigations into the alleged IPR infringement and commence administrative enforcement action in relation to any confirmed infringement. This process generally takes two to three months, and may involve the seizure and destruction of infringing products and the imposition of fines.

In relation to enforcement by way of litigation, prior to being lodged with the People’s Court, applicants may petition for a 15-day provisional injunction against the alleged IP infringement or an order retaining evidence upon compliance with the prescribed requirements. Such approach is in line with World Trade Organisation standards.

Examples of Shanzhai

Shanzhai products generally have very similar appearance and functionality to their original counterparts, and generally involve branded goods. The immensely popular ‘HiPhone’, marketed and sold prior to the formal release of Apple’s iPhone in mainland China, risks being found to have infringed Apple’s IPRs to gain instant market recognition. At its height, about 5,000 HiPhones were sold over three months and dealers were selling out their stock online within a month. Since then, millions of imitation iPhones have flooded the domestic Chinese market, some of which have taken to emulating the HiPhone brand. Recently, to protect its own IPRs, the ‘HiPhone’ name is being registered itself as a trademark with SIPO and public announcement of preliminary verification will be made on 27 December 2009. Presumably, Apple Inc. will consider opposing that registration.
Indeed, part of the shanzhai phenomenon involves companies that start out as copycat enterprises evolving into legitimate businesses with their own IP portfolios in China. The success of such companies is derived not from pure imitation of branded goods but from innovations.

It has been reported that Beijing Tianyu Communication Equipment Co. (Tianyu), which started out making imitation headsets for consumers seeking a lower price point, overtook the market share of domestic manufacturer Lenovo in two years. Domestic battery and automobile manufacturer BYD Company Limited has not only profited from its low-priced imitation products, but is now considered a legitimate car manufacturer in China. Similarly, Hong Kong Stock Exchange-listed Geely Automobile, who most recently bid to acquire Ford Motor Co.’s Volvo unit, launched its own version of a car with a similar appearance to the Rolls Royce Phantom at the 2009 Shanghai Auto Show.

Of course, not all shanzhai companies improve the quality of products. In particular, the issue of product safety is a serious concern and unlicensed products may involve additional risks, due to the use of inferior materials or poor quality control. This was the case with the exploding mobile phone battery that killed an individual in Guangzhou. Motorola and Nokia both denied links to the distributors of the problematic batteries, claiming they were counterfeits.

Reasons for Prevalence of Shanzhai

Shanzhai goods are affordable and enable consumers to acquire the latest designs and extra features that the original branded goods may not possess. This is one reason why imitation cell phones are popular in China. According to research conducted by the Gartner Technology Research Group, shanzhai cell phones account for more than 20% of sales. However, the demand for such products is not entirely domestically driven. From 2006 to 2009, estimates suggest that there has been an increase of close to 300% in the export of shanzhai shipments to satiate demand primarily from developing countries in Asia or Third World countries in South America, the Middle East and Africa.

Shanzhai operators mainly target consumers in small cities or rural areas who wish to adopt upcoming trends at the fraction of the price. As unlicensed manufacturers, shanzhai companies are able to sustain low prices by doing away with license fees, value-added tax, inspection fees by relevant government departments and sales and receipt tax. Costs are further reduced by the absence of marketing and after-sales service. Nowadays, more sophisticated shanzhai manufacturers even receive specialized orders to cater for the niche or even high-end provincial markets.

In Kenya, the ‘Blockberry 9500’, complete with unofficial endorsement by US President Barack Obama, was on sale by the time the President was officially inaugurated. In India, the shanzhai mobile phones having increased its market share to about 30-40%, now competes with well-known companies for Nokia’s pie. In an effort to suppress demand, Indian telecommunications operators have ceased network access to imported mobile phones that do not have an international mobile equipment identity (IMEI) code. The European Equipment Type Certification Center (EETCC) also started to levy punitive charges on Chinese shanzhai mobile phone manufacturers.

Government Action to Date

In March 2009, China’s National People’s Congress debated the issue of shanzhai. Some dismissed shanzhai goods as inferior counterfeits whilst others advocated tolerance given the benefits the products bring to Chinese society. With the central government of China at odds on whether shanzhai products should be wholly eradicated, it is not difficult to understand why local authorities may sometimes be viewed as being lenient on shanzhai companies. There are also examples of local communities that benefit from the shanzhai phenomenon. Shenzhen, perhaps the birthplace of imitation mobile phones and products, and Yiwu in Zhejiang province can be seen to have greatly benefited from the shanzhai phenomenon. Both cities thrive as main retail centres of shanzhai products and both economies are fuelled in part by the sale and good of imitation goods.

However, with mounting international pressure to more strictly enforce its IP legislation, China’s government authorities have recently been intensifying efforts to clamp down on cases of infringement. In 2005, the NCA and the Ministry of Public Security (responsible for China’s police force) jointly shut down 810 illegal websites that infringed copyright. The shanzhai search engine named “baigoohoo.com”, which integrated search results from the three main engines Baidu, Google and Yahoo in three separate columns, was part of this raid. In 2006 and 2007, China’s Custom Office detained 207 million and 330 million IP infringing commodities, respectively.

In 2008, it was reported that SAIC and its local counterparts investigated 56,634 cases of alleged trademark violations and seized 19.63 million illegal trademark labels, destroyed 22.87 million items of infringing products and imposed RMB 467.4 million in fines. Over 137 cases and 145 suspects were handed over to judicial authorities for prosecution of criminal violation. That same year, in what was recognized by the General Administration of Customs as a top-ten IP protection case, Gongbei Customs worked with Epson to stop exports of shanzhai Epson printer ink cartridges.

More recently, in July 2009, Deputy Prime Minister of the State Council and the Shenzhen government conducted a 15-day door-to-door investigation into shanzhai products. The crackdown resulted in a highly publicized conviction and imprisonment of four individuals who sold pirated copies of Windows XP online. In a similar copyright infringement case concerning Windows XP, the Suzhou Huqiu District Court sentenced the producer of unauthorised copies of Windows XP to three years of imprisonment and a fine of RMB 1 million. In Yiwu, the local government empowered its Quality and Technical Supervision Bureau to take action against the shanzhai phenomenon.

What Multinationals Operating in China Should Do

From a commercial perspective, companies should regularly review their product offerings in China and pursue registered IP protection for essential product features (or trade indicia) to strengthen their ability to prevent shanzhai products from entering the market.

From a practical perspective, utility models and standard patents can provide protection for up to 10 and 20 years respectively from filing. Utility models have a lower inventiveness threshold requirement than standard patents, which makes them less susceptible to invalidity attack. Utility models are granted quickly after filing, but the patentee will need to obtain a patent assessment report from SIPO before the utility model can be enforced in China. The report can be obtained at any time during the life of the utility model (e.g. delayed until infringing activity is found). Designs can protect a product’s distinctive visual appearance, and can be useful for dealing with products that are exact copies of an original product. In this regard, companies should seek professional advice prior to filing to ensure that the scope of IP protection adequately covers obvious variations and possible future improvements to the product’s features or functionality.

In addition, companies should conduct thorough due diligence on potential suppliers and avoid public disclosure and commercial use of new ideas before filing for IP protection. When disclosure is imminent, companies should file for IP protection as soon as possible to secure a priority date (or filing date). The parties may also wish to enter into confidentiality agreements clearly delineating use of shared confidential information.

Further, companies should actively monitor the market for infringing activity and take immediate action when infringing activity is identified to avoid, for example, difficulties with evidence collection should the infringer shut down operations and relocate.

Finally, companies can combat the shanzhai culture by establishing a rapport with local IP enforcement agencies and educating them on the real effects of IP infringement on businesses. Such a strategy may extend to partnering with local authorities to further educate the public.

By taking these steps, firms can well prepare themselves to deal with the risks posed by shanzhai, which looks set to become a growing threat to businesses seeking to protect their IPRs in China.

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