Innovation in China: which localization strategies for European companies?
This article was originally published in Italian in Panorama on 20th Jun 2023.
Please note that this is a courtesy translation of the Italian language article originally published in the Panorama Magazine Issue at: https://www.panorama.it/economia/cina-imprese-europee
The impact that geopolitics is having a profound effect on the stability of China’s business environment, with corporate risk assessments now playing an unprecedented role in strategy-making for European firms in the market.
As the EU considers a ‘de-risking’ strategy towards China, it should recognise that there is no ‘one-size-fits-all’ solution. While European firms and the EU can benefit from China’s innovation ecosystem, it is critical for European policymakers to understand the diverse strategies that Europe’s companies adopt to R&D and technology localisation in China.
Lets take a closer look at the market factors steering a large share of European companies towards deeper localisation in the Chinese marketplace during the ‘de-risking’ strategic push as per the research conducted by the European Chamber of Commerce in China in their recent publication, ‘China’s Innovation Ecosystem: The Localisation Dilemma’.
European Companies’ Reasons for Investing
Firstly, lets focus on some of the positives, European companies see enormous value in doing R&D in China for a number of reasons according to survey respondents. The size of the market (61%); strong local demand/appetite; Multiple selections possible for respondents’ innovative goods/services (47%); and the fast pace of commercial application of R&D results (39%) have been found imperative to driving European companies to increasingly integrate China R&D with their global efforts.
However, the risks of engaging in R&D in China, such as inadequate intellectual property rights protection systems, an uneven playing field for foreign companies and negative sentiment in their home markets towards R&D in China, have acted as a deterrent to some. While such challenges were found to be disproportionately larger for small and medium-sized enterprises and those operating in industries in which investment is not encouraged in China, such as information and communication technology.
Localization
For European companies in China, localising operations is a strategic decision – particularly so with regard to R&D/ innovation activities. Many European companies, especially multinational companies, have already heavily localised their technology for production, which tends to be more focused on the later stages of the development side of innovation. However, the pull of market factors—like China’s flourishing R&D ecosystem and strong consumer base—as well as the push of policy and political factors—like the government’s localisation demands and broader geopolitical tensions—are compelling European companies to further rethink their technology and R&D strategies. To put it simply, integrating into China’s innovation ecosystem is an increasingly high-risk, high-reward strategy.
With that being said, a range of localisation strategies exist for European companies in China:
Strategies & Reasoning
Integrators – Companies that are heavily involved in China’s innovation ecosystem & do extensive R&D in China for both the domestic and global markets. They form close partnerships with a range of actors and collaborate on a variety of issues.
Market-chasers – Companies that recognise China as the key global market for certain technologies, and that this is where ‘real innovation’ is taking place, not only to win local market share but also to stay globally competitive.
Withholders – Companies with a very limited R&D footprint in China due to technology leakage concerns. Their R&D operations in China are primarily for localising products that are developed in their home market.
Niche cultivators – Companies with too few technologies to risk leakage, which keep R&D at home Collaboration is very limited or is not considered at all.
Ultimately, the decision to localize operations comes down the unique traits of the market enticing investors to explore for the potential opportunities, while at the same time, market dynamics can also prevent some companies from onshoring R&D into China (e.g.) market saturation in the booming domestic EV market.
As alluded to at the outset, policy and political factors also drive localisation, mostly in unwelcome ways (weak IPR protection systems (34%); unlevel playing field for foreign companies (32%); and limited or non-existent government support (24%), insufficient local talent (29%) and too much market competition (28%).
Sentiment in the European Union (EU) and the United States (US) towards R&D collaboration with China is also having a negative impact on 52% and 26% of respondents respectively. So much so that one European Chamber member company admitted that their China team now does a comprehensive risk assessment twice a year instead of once every two years as was the norm in the recent past.
Best Practices for Companies When Considering Localization
A starting point for any company would be benchmarking your company against other foreign companies within the integrator/market-chaser/withholder/niche-cultivator framework. Doing so requires critical analysis of where your own company’s technology stands in relation to China-based competitors.
For some, China’s R&D ecosystem will present greater reward than risk. Such companies can tap into the R&D ecosystem through internal R&D operations that are onshored in China. Collaboration partners in core technology, complementary technology and HR cultivation may be right for such companies. However, any R&D collaboration necessitates strict internal security protocols, as well as extensive vetting of collaboration agreements related to IP.
With that being said, for others, the allure of China’s R&D ecosystem will be overshadowed by the risks. Such companies may want to limit localisation of their R&D, even for internal R&D activities, due to technology leakage risks. However, collaboration on complementary technologies and for HR cultivation should not be dismissed out of hand, as such opportunities can maximise opportunities in the market while presenting minimum risk of core technology leakage.
SMEs in particular are advised to adopt a very conservative approach to onshoring R&D and technology into China, as risks are significantly magnified for SMEs with fewer core technologies, the protection of which is harder due to limited resources.
Conclusions
Both the positive and negative factors discussed, among others, pose a dilemma for European companies. The rewards of localising technology and R&D into China are considerable, but so are the potential hazards. It is essential to do R&D in the China market to make the most of the innovation ecosystem and compete for market share with domestic rivals.
On the other hand, protecting IP is becoming more and more important, as in a growing number of industries it is no longer enough to stay one or two generations of technology ahead of local Chinese competitors that are themselves increasingly approaching the cutting edge. As China’s IPR protection system is increasingly maturing in relation to patent filing and enforcement, it is lagging behind in trade secrets protection.
On the political end of potential risks in the market, companies should consider assembling a taskforce to track geopolitical developments and their implications for R&D and technology strategies. This should include personnel from global and regional HQs as well as leaders across corporate departments (operational, management, technology and R&D) to better capture all risks and opportunities.
Curated by: Atty. Carlo D'Andrea, Vice President of the European Union Chamber of Commerce in China
