So What Is the Current State of Counterfeiting in China?

Having just finished one month as visiting faculty at the School of Management at the Indian Institute of Technology-Bombay, I appreciate more than ever the elusiveness of talking about a setting as complex as India. With over a billion residents, various ethnic and religious groups, and over 20 distinct languages, there is seldom, if ever, such a thing as "India". When it comes to talking about India, context, nuance and focus are central; generalizations are often misguided at best, misleading at worst. I was reminded of this in reading an article in The Economist on brands and counterfeiting in China. Entitled "Pro Logo: Brands in China" (January 14, 2012), the focus of the article being the assertion that "Chinese consumers are falling out of love with fakes".

This tagline is bold stuff indeed. China is often portrayed as the epicentre of counterfeiting. A change in this regard would go a long way to altering the perception of Chinese markets and consumers and provide further evidence of the normative integration of China into the world community. And so the critical question--do recent developments in China, as described in the article, live up to the broad the broad tagline of the article?

In my view, the answer is more "no" than "yes". Just as with India, when one speaks of China, "context, nuance and focus are central; generalizations are often misguided at best, misleading at worst". Fakery may be on the decline in some facets of Chinese life but it is alive and flourishing in others. It also depends on what part of "China" one focuses on. First, the evidence marshalled by the article in support of the tagline that counterfeits and fakes are on the decline in China:

1. The article devotes nearly 20% of its word count to an anecdotal account of a proceeding in which a retailer of pricey imported furniture--named Da Vinci--was fined for mislabelling that its wares are imported where at least some of the goods were made locally. This so-called "murky affair" reveals changing attitudes by the Chinese consumer: "Not long ago, the Chinese shoppers applauded the fakers for saving them money. Now they scorn them. If it's a fake, the well-heeled sneer, you can't flaunt it."  

2. Thus Bain concludes that "demands for counterfeit products is decreasing fast." McKinsey adds that the percentage of consumers willing to buy fake jewelry has dropped from 31% in 2008 to 12% last year. In McKinsey's words. "Consumers are looking for the real thing, and they are increasingly willing and able to afford it." The article does not further elaborate on the sample and populations involved in reaching these conclusions.  

3. A recent survey by the EU-China Chamber of Commerce suggests that concern over counterfeits has declined as a concern by its members. Alas, when nuance kicks in, the story as reported is considerably different: (i). In 2009, it was estimated that 30% of mobile phones were fakes. (ii). The Business Software Alliance estimates that nearly 80% of software sold in China was not genuine. (iii) According to the United States Trade Representative, eight out of the 30 most "notorious" counterfeit markets in the world are located in China.  

4. Cash-short Chinese youth are still in love with counterfeits. It is only with the become "Thirty Somethings" and accumulate some spare cash that they might begin to resist fakes.  

5. One major reason why counterfeiting has "declined" is that companies have learned "to live with fakes", such as setting up branded retail outlets to control distribution or setting up fake-proof "e-coding" for pills. 

Odd is the assertion that fakes are under attack because local brands such as Lenovo and Haier have a greater interest in preventing piracy. I say "odd" because no support is brought to support the claim. There is no evidence that Lenovo and Haier, as examples, are active in this regard in China, nor any proof that attitudes by such companies redound to changed views about fakes by the consumer public. In the world of nuance and context, the tagline--"Chinese consumers fall out of love with fakes"--more accurately yields the following:

1. Among the most affluent consumers, there is some support that brand sensitivity with regard to luxury goods has resulted in hostility to counterfeits. How deep or broad this goes is unclear. In particular, one wonders whether such sentiments apply the further west one goes into the Chinese interior.  

2. Once one leaves the world of luxury goods, counterfeiting still seems widespread. Any decline in such fakery may be more attributable to better coping behaviour by the brand owners that fundamental changes in Chinese consumer sentiment.  

3. Whether the development of local Chinese brands will affect consumer preferences for counterfeits generally remains unexamined. 

These conclusions are interesting because they reflect the diverse currents that characterize Chinese attitudes to counterfeiting. It is a shame that The Economist did not satisfy itself with giving expression to these various factors rather than seeking to shoe-horn its discussion into an overly broad and misleading view of the subject.

How much is your IP management worth?

The best way to ensure that creative management
staff know what each other are doing is to make
them share the same computer ...

Via Mary Adams (Principal, Trek Consulting LLC and author of Intangible Capital) comes a web-based tool that she developed for the IPR Plaza ("a multidisciplinary portal that provides free-of-charge qualitative and quantitative information on intangibles"). It's called the IP Management Quick Scan [yes, it is a descriptive title, but since this scan lives on a free-to-use portal there may be little advantage in conjuring up an imaginative name to register as a trade mark] and, Mary explains, it measures the potential success of the commercialization a piece of IP within a business. She adds:

"I find that a lot of attention in the IP world is focused on licensing and valuation strategies outside of a company’s core business. But in reality, most companies plan to commercialize IP themselves. And they need the right intangibles—people, knowledge, processes, partners and networks—to pull it off". 

The Quick Scan is 20 questions long and takes just a few minutes to complete. Do let Mary know what you think after taking the Quick Scan here. You can reach her by email here.

Trading in patents: Italian institute seeks data -- can you help?

The IP Finance Institute is the unit of the Italian University Politecnico di Torino which focuses on the economics and financial aspects of intellectual property. As a non-profit organization, the IP Finance Institute promotes and develops know-how transfer, research initiatives and projects relating to IP as an economic asset and its use in IP-based financing solutions.

One of the Institute's current research projects seeks to shed light on the dynamics of patent transactions, on the rationale behind the use of marketplaces for IP rights and, in particular, on the reasons for selling patents by auction. Part of this project has been structured to discover how the issue is perceived by the involved companies.

To this end, the Institute has composed an online survey designed for representatives of companies which actively trade patents (in particular at auctions), in order to collect direct evidence. Participants can access the questionnaire -- which is in Engliah -- by clicking this link.

The survey is expected to take approximately 10 minutes. All of the submitted data will be treated anonymously and in aggregated form for academic research goals and will not be transferred to any third party. At the end of the project the results will be shared with all the participants and will be published.

Will they taste different now? Pringles brand changes ownership

Fellow blogger Nikos Prentoulis (a long-standing member of the MARQUES Class 46 blog team) was invited to comment on a recent transaction that has attracted considerable interest in the popular press - the acquisiton by the Kellogg Company of the Procter & Gamble Pringles brand.  Says Nikos:

"The brand community has been buzzing over recent news of the deal struck between P&G and Kellogg regarding the take-over of the Pringles brand. Kellogg will buy Pringles for US$ 2.7 billion in a transaction which will make Kellogg No. 2 (second only to PepsiCo as reported by Reuters) in the global snack food market. The deal apparently marks P&G’s exit from the foodstuff market. 

Pringles is reportedly the fourth-largest brand of snacks in the world, with 2.3 percent of the market, according to Euromonitor International. In the United States, it ranks eighth with 2.5 percent. 

Although one would not expect Pringles to taste different after the assignment, the transaction raises a number of interesting issues: 

• The added-value for the owner of a ‘stand-alone’ famous brand – and its competitors 

• The marketing dilemma of the new owner – should one ‘freshen up’ the brand to tailor one’s own (i.e. those of his marketing team) perceptions of the brand and/or reflect the new owner’s brand/product philosophy or should the brand be left to sell itself? 

• How could consumer perception of the brand/product change after the transfer? Would consumer behavior toward the brand/product change, even in the absence of any ‘tampering’ by the new owner? 

• Can other brands of the new owner benefit from such a deal (either through use of the newly acquired brand’s repute in market where such brands are not strong or even through the ‘media buzz’ concerning the new owner)? 

• Finally, will they introduce a new Pringles taste?"

Growth in the UK media and tech sectors: a good idea, but how?

From the pen of Charles Kerrigan (a partner at Olswang LLP and a former member of the IP Finance team) come some observations about media and technology finance which have been recently published in Financier Worldwide.  The IP Finance weblog is pleased to reproduce them here, with a few comments from this blogger:

"Achieving growth in the UK media and technology sectors

Commentators have suggested a broad range of solutions to the problems of the UK economy at the start of 2012. With a number of solutions from which to select it would be interesting to consider if there are links between them and sectors of the economy which could benefit in particular. Let us start by looking at some of the suggestions.

Financial commentators and the government generally seem to agree that small and medium enterprises (SMEs) in the UK should be given the best possible support at this time [dissenting voices are hard to find in terms of principle -- though there is debate as to what that support should be]. Project Merlin, the commitment given to the government by RBS, Lloyds, Barclays and HSBC, has set targets for lending with the aim of ensuring that banks do not repair their balance sheets at the expense of doing new lending business. In addition, the government plans to help lending to small businesses with national schemes. Late in 2010 the government committed £2bn to the Enterprise Finance Guarantee. Companies with annual revenues of up to £25m can apply to banks for loans of up to £1m, 75 percent of which will be guaranteed by the government. The Chancellor had previously announced a credit easing scheme, the National Loan Guarantee Scheme, designed to reduce the average interest rate on loans to small businesses by 1 percent.

There is a general view that the UK economy should be rebalanced in favour of manufacturing [this can either be seen as a positive statement, or as a retreat from an overheated service economy with excess capacity]. The Financial Times recently asked the question: how can the UK capitalise on its manufacturing strengths and eliminate weaknesses? The point of question was to note that while UK manufacturing may have a small share of global production by its historic standards, the share is nevertheless significant by reference to the country’s size. On the other hand, it was noted that rebalancing will not be entirely driven by the government and businesses must help themselves, including taking advantage of the credit schemes available.

Smaller manufacturing businesses in particular are undercapitalised and find it difficult to attract finance. One of the difficulties that manufacturing businesses currently face is that demand is depressed by the fact that economic recovery has not been consumer-led in the same way as in previous recoveries. It is likely that this will generally remain true as consumers seek to repair their own balance sheets over the next couple of years. Yet it is clear that the right products still attract discretionary consumer spending. Retailers’ post-Christmas reporting has demonstrated a clear group of winners among niche and online businesses.  In 2011 Apple became, for a period, the largest company in the world by market capitalisation. Incidentally, this must be the surest example of the truth that perception lags reality as, even in the age of Twitter, the world’s largest company has been able to maintain its anti-establishment image.

Apple is also becoming the most significant beneficiary of another broad trend. Many businesses are now engaging with the challenges of the consumerisation of the workplace, most obviously dealing with the demands of employees to use their own devices at work. IT directors these days all have stories to tell of pressure from employees to swap the office Blackberry for their personal iPhone rather than carrying two devices. The likely eventual outcome of this will be that corporates will provide employees with a budget to enable them to buy their own devices and accommodate these to the systems operated by the company. This will have an obvious effect that technology businesses which have been built to serve the corporate market will be challenged by providers of consumer technology. Businesses with experience in marketing themselves and with products that appeal direct to consumers should be taking advantage of this trend.

This should be good news for small, innovative media and technology companies which include manufacturers among them. They can market to consumers directly and the right products will attract discretionary spending either from the consumers’ own pockets or from their employers’.

Let us therefore look at the link between UK government support for funding SMEs and the opportunity for those technology businesses during the coming year. Large and small businesses in media and technology are doing the same thing: creating and protecting intellectual property (IP). IP has huge value and huge potential but it is intangible, a creature of a piecemeal legal system including copyrights, trade marks, patents and others. It is another area on which the coalition government has recently focused. In May 2011 an independent report commissioned by the government was released. ‘Digital Opportunity: A Review of Intellectual Property and Growth’ was published by Professor Ian Hargreaves with the aim of suggesting ways in which changes to the UK’s intellectual property framework could stimulate the economy. The report recommended that intellectual property law should be updated in a number of ways and it seems that it will be implemented at least in part by the government. The report did not directly address challenges posed by the current economic climate and, in particular, how banks view and lend against IP [Hargreaves was also very much more focused on copyight -- as the 'digital opportunity' part of the review's title might imply -- than on some other IP rights, and the time-frame within which it was delivered meant that not only bank lending against IP rights but many other IP issues could not be directly addressed].

UK banks have always preferred to lend against real property. It can be valued against comparables in the market, produces predictable income streams from long leases and doesn’t go anywhere if the bank’s loan is not repaid and so can be the subject of enforcement proceedings. Since we now have a generation of bankers and regulators who have overindulged in lending against real property, perhaps the next generation will pay more attention to intellectual property. Intellectual property poses challenges, however. It is difficult to value and valuations are only carried out by a small number of specialist companies. Cashflows are generally less certain since no cash is generated while products are in development and the products have increasingly short shelf lives. Because IP is intangible it may lose value if the business which develops it fails [for the lender, the established consumer goods trade mark is about as good as it gets, though in the United States the greater willingness to take risks appears to make patents, and income streams from proven successful patent-based products, a  more attractive security than on this side of the Atlantic].

IP is also technical and complex for a lender. An example will demonstrate this. In order to take security over a domain name (e.g., xyz456.com), it is necessary to take security over a number of different types of IP. First, the trade mark in the domain name itself; secondly, the copyright in the material uploaded onto the site; thirdly, any software or computer code relating to the domain name; and fourthly, some degree of control over the servers to avoid an unpaid system provider switching off the site. Added to this complication is the fact that this analysis must be repeated in every jurisdiction in which the domain name has value. Banks are certainly engaged with these issues. They understand valuations and security and they are extremely keen to lend and be associated with the winners in the new economy. It is also helpful that we have recently seen IP retain value even where the businesses that own it find it difficult to maintain their standing with consumers. Nortel Networks and Motorola have both recently sold patent portfolios for good prices [the high prices fetched by the respective portfolios has led to the suggestion that their collective, strategic, convenience and/or psychological value might have been an attraction in addition to their regular market value].

The quickest way to achieve growth in the media and technology sectors of the UK economy is to make it easier for banks to lend to businesses which operate in the sectors. While the wider economy has a debt problem the same cannot be said for these sectors. They include many high profile, cash rich and young companies. The government appears to be showing itself to be up for the challenge. The schemes to improve lending to SMEs and the identification of the digital economy as critical to the success of the UK are evidence of this. What is now needed is an attempt to link the two together. IP is not user-friendly and this will be a drag on SMEs and banks. Steps are being taken in this regard and, as well as the Hargreaves Report, the progress towards a unified patent system in Europe is welcome. It is inevitable that changes to the IP landscape will be as piecemeal as the landscape itself. Nevertheless, the government should maintain a clear focus wherever possible on simplifiying of the types of IP and facilitating diligence and security over IP by harmonising and improving the rules on registration.

Any review of IP should specifically take account of lenders and the credit easing schemes should be directly linked to the process. Banks have a role to play here and any success will be to the benefit not just of the banks but also of the media and technology sectors and the wider UK economy [but regular and meaningful dialogue between IP-based borrowers and banks has been difficult to establish -- as readers of this blog will probably be aware. Part of the problem is that banks have one thing; everyone knows what it is and everyone wants to borrow or make it.  Lenders come from a variety of IP-based sectors in which their intellectual assets are different and behave in wildly different ways. This means that banks always have a lot more to learn than do borrowers; but they are often seen as conservative and reluctant to commit time and resources to an ever-changing subject of study unless they can see a clear objective which can be achieved]. This is a goal worth working towards".

How markets become efficient (answer: they don't)

A staggering amount of effort has been spent -- and wasted -- exploring the idea of market efficiency. The notoriously malleable efficient markets hypothesis (EMH) claims (in its weakest form) that markets are "information efficient" -- market movements are unpredictable because smart investors keep them that way. They should quickly -- even, "instantaneously" in some statements -- pounce on any predictable pattern in the market, and by profiting will act to wipe out that pattern.

I've written too many times (here, here, here, for example) about the masses of evidence against this idea. It's not that predictable patterns don't attract investors who often act in ways that tend to wipe out those patterns through arbitrage. Part of the problem is that investors often act in ways that amplify the pattern (following trends, for example). Moreover, there are fundamental limits to arbitrage -- "the markets can stay irrational longer than you can stay solvent." Still, the EMH stumbles onward like a zombie -- dead, proven incorrect and misleading, yet still taking center place in the way many people think of markets.

I found an illuminating new perspective on the matter in this recent paper by Doyne Farmer and Spyros Skouras, which explore analogies between finance and ecology. This analogy is itself deeply suggestive. They note, for example, how the interactions between hedge funds can be useful viewed in ecological terms -- funds sometimes act as direct competitors (the profits of one reducing opportunities for another), and in other cases as predator and prey or as symbiotic partners. But I want to look specifically at an effort they make to give a rough estimate of the timescale over which the actions of sophisticated arbitragers might reasonably be expected to wipe out a new predictable pattern in the market. That is, if the market for whatever reason is temporarily inefficient -- showing a predictable pattern -- how quickly should it be returned to efficiency? How long is the time to relaxation that the EMH claims is "instantaneous" or close to it?

The gist of their idea is very simple. Before you can exploit a predictable pattern, you first have to identify it. If you're going to invest money trading against it, you need to be fairly sure you've identified a real pattern, not just a statistical fluke. If you're going to invest somebody else's money, you have to convince them. This takes some time. The stronger the pattern, the more it stands out and the less time it should take to be sure. Weaker signals will be hidden by more noise, and reliable identification will take longer. Looking at how much time it should take to get good statistics should give an order of magnitude of how long a pattern should persist before any smart investor can begin reliably trading against it and (perhaps) erasing it.

Here's the specific argument, expressed using the Sharpe ratio (ratio of expected return to standard deviation of a strategy exploiting the pattern):

This makes obvious intuitive sense. If S is very large, making the pattern obvious, more deterministic and easier to exploit, then the time over which it might be expected to vanish is smaller. Truly obvious patterns can be expected to vanish quickly. But if S is small, the timescale for identification and exploitation grows.

As Farmer and Skouras note, successful investment strategies often have Sharpe ratios of about S = 1, so this gives a result of about 10 years. [This is the result if one makes the analysis on an annual timescale, with the Sharpe ratio calculated on a yearly basis. If we're talking about fast algorithmic trading, then the analysis takes place on a shorter timescale.]

So, 10 years is the order of magnitude estimate -- which is a rather peculiar interpretation of the word "instantaneous." Perhaps that word should be replaced in the EMH with "very slowly," although that somewhat dampens the appeal of the idea: "The EMH asserts that sophisticated investors will very slowly identify and exploit any inefficiencies in the market, tending the erase those inefficiencies over a few decades or so." Given that new inefficiencies can be expected the arise in the mean time, you might as well call this more plausible hypothesis the PIMH: the perpetually inefficient markets hypothesis.

And their estimate, Farmer and Skouras point out, is actually optimistic:

We should stress that this estimate is based on idealized assumptions, such as log-normal returns – heavy tails, autocorrelations, and other effects will tend to make the timescale even longer.... As a given inefficiency is exploited, it will become weaker and the Sharpe ratio of investment strategies associated with it drops. As the Sharpe ratio becomes smaller the fluctuations in its returns become bigger, which can generate uncertainty about whether or not the strategy is still viable. This slows down the approach to inefficiency even more.

Of course, as I mentioned above, this analysis depends on timescale. Take t in years and we're thinking about predictable patterns emerging on the usual investment horizon of a year or longer, patterns exploited by hedge funds and mutual funds of the more traditional (not high frequency) kind.  Here we see that the time to expect predictable patterns to be wiped out is very long indeed. If 10 years is the order of magnitude, then it's likely some of these patterns persist for several decades -- getting up to the time of a typical investing career. Hardcore supporters of the EMH should learn to speak more honestly: "We have every reason to expect that predictable market inefficiencies should be wiped out fairly quickly, at least on the timescale of a human investment career."

All in all, this way of estimating the time for relaxation back to the "efficient equilibrium" suggests that the relaxation is anything but fast, and often very slow. The EMH may be right that there likely aren't any obvious patterns, but more subtle predictable patterns will likely persist for long periods of time, even while they present real profit opportunities. The market is not in equilibrium. And with no mechanism to prevent them, new predictable patterns and "inefficiencies" should be emerging all the time.

What's going on in Greece

Numerian, one of the most insightful financial bloggers I know, gets to the bottom of the markets' surge in the wake of the Greek passage of the new "austerity" measures:

For now, stock markets are happy because they get their periodic injection of heroin – oops, make that “liquidity” – to keep the game going. The game is the one we have all lived through our whole lives – the one where capitalism continues to grow by taking on more and more debt, until now every country is at the point where only the government is big enough to take on the enormous amounts of new debt necessary to keep paying principal and interest on the old debt. At least some countries are: the United States, the UK, Germany, France. Greece of course lost that privilege several years ago, and now even big borrowers like Italy are allowed into the markets only for very short term maturities.

The game, in short, is about over, choking to death on too much debt, kept on a resuscitator by politicians and central bankers who know the public has no way to stop them from raising trillions of dollars or euros with new bond issues. Only the market can stop an out-of-control debtor. Greece has found that out, Italy and Spain and Portugal are close to finding that out, and the UK and the United States are on the list, being no more virtuous than the Greeks. Once the government can no longer borrow, default in some form is inevitable, and austerity follows. The Greeks have austerity handed to them by the Germans; everyone else will be able to choose their own forms of austerity, as different economic and social forces fight with each other in a country that has run out of borrowing capacity and must live off the taxes it is able to raise.

If the stock market had a long term view, it would think about these things. It would look at Greece as a combination horror story and warning sign. Instead, the stock market lives for the day only, and for now the debt binge continues, and the fix of easy credit is being pumped into the financial system once more. Let the celebrations continue.

The value of 22 Year Old French Fries

There are some court decisions which make your stomach turn. Generally they involve scandals involving food hygiene - Germany is currently gripped by reports of mouse pooh and cockroaches in one of Bavaria's major bakery chains (Müller). An English summary available here. It's rare that such decisions have an IP angle (although the value of the Müller bakery brand has probably plummeted in value with every report in the press or on TV) Whilst the average Münchner (as the good inhabitants of Munich) are known was discussing how often she or he brought bread from the local Müller shop, the Upper District Court in the Bavarian capital was pondering the value of two 22 year old french fries (or chips to those of UK/Australian heritage). EUR 2,000 (in other words EUR 1,000 each).

Now - this author quite likes eating chips (preferably with fish) and generally prefers them to be quite fresh. He's not entirely sure how good 22 year old ones would taste. However, these chips which occupied the legal eagles in Munich formed the basis of a piece of art which showed two chips arranged in the from of a crucifix (photo here).

German artist Stefan Bohnenberger developed the sculpture for the Munich Gallery Mosel & Tschechov and the piece was displayed in a one man show in 1990 (see catalogue). Bohnenberger later parted ways with the Gallery and asked for his chips back. He got the original gold piece returned to him, but the samples were no longer available (presumably either eaten at an earlier stage - or placed in the rubbish bin). Hence the dispute - just what is the value of some old chips. Fortunately a witness was found who would have been prepared to pay no less than EUR 2500 for the chips - had they been offered to her. The court - in its generous way - found that EUR 2,000 was about the right level of compensation.

Apparently the gallery owner still has some older chips should anyone be interested....