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McGaughey, Sara L., Liesch, Peter W., & Poulson, Duncan (2000) An unconventional approach to intellectual property protection:The case of an Australian firm transferring shipbuilding technologies to China. Journal of World Business, 35(1), pp. 1-20.

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AN AUSTRALIAN FIRM TRANSFERRING SHIPBUILDING TECHNOLOGIES TO CHINA

McGaughey, S.L., Liesch, P.W. and Poulson, D. (2000) An unconventional approach to intellectual property protection: The case of an Australian firm transferring shipbuilding technologies to China. Journal of World Business, 35(1):1-20.

Author for Correspondence: Sara L. McGaughey, Department of International Economics and Management, Copenhagen Business School, Howitzvej 60, 1st and 2nd floor, DK 2000 Frederiksberg, Denmark E-mail: [email protected] Tel: +45 3815 3004 Fax: +45 3815 2500

This version 1 September 2003

Abstract1 Risks associated with the dissipation of intellectual property rights of foreign firms transferring technology to China have received some attention in the academic and professional, trade-based literature. An innovative Australian manufacturer and designer of large, high-speed catamaran (INCAT) recently entered into a joint venture with a Hong Kong-based partner (AFAI) to manufacture ferries in China, without any formal, institutional protection of its proprietary knowledge. Key findings uncovered through an in-depth analysis of this case include the identification of novel bundles of firm-specific resources and capabilities that sustain a firm's intellectual property and, ultimately, its competitive advantage in the face of dissipation risks, and a combinative competency of the firm in creating these bundles. This study illustrates a case in which the conventional means of protecting intellectual property need not always be followed to best ensure the firm’s retaining its competitive positioning in foreign markets.

1 The authors wish to thank Jeff Kelly, CEO of the Department of State Development in Tasmania, for sharing his insights concerning the internationalisation of Incat, and the anonymous reviewers of Journal of World Business for useful suggestions on an earlier version of this paper. The insights and advice of Professor Rosalie Tung are also acknowledged with much appreciation. This research was supported by the United States Information Agency for an Asia-Pacific Economic Cooperation grant which assisted in funding a visit to China to conduct interviews at the Panyu shipyard, and a Special Research Grant from the University of New South Wales. INTRODUCTION

One aspect of firm internationalisation that is increasingly attracting the attention of firms, governments and academicians is the risks associated with the dissipation of a firm’s technology and know-how in foreign market operations. This is often cited as an issue of particular concern to foreign enterprises entering countries which have had a history of infringement of intellectual property (IP) rights, including China (Ding, 1997; Vanhonacker

& Pan, 1997). At the forefront of the Big Emerging Markets, China represents an attractive market to foreign enterprises (Cui, 1998). Since the early 1980s, the Chinese ‘open door’ policy has enabled greater flexibility for foreign business activities in China, with the importation of technology and know-how being a primary focus of the Chinese government’s policies (Chen, 1995). Indeed, China's modernisation programs, popularised since 1975 by

Deng Xiaoping, have recognised the critical importance of imported technology transferred from foreign corporations and governments (Tackaberry, 1998). This same philosophy remains today. To facilitate the importation of technology from abroad, it has often been argued that strong IP protection is necessary. The willingness of technology-rich foreign firms to transfer technology to less-developed nations has arguably been jeopardised by the threat of dissipation of IP rights embedded in their products and processes (de Bruijn &

Xianfeng, 1993), although in some quantitative studies the variables chosen to capture the importance of IP protection are insignificant (Ball, Rong & Pearson, 1993; Vanhonacker &

Pan, 1997).

Although China was accepted as a member of the World Intellectual Property

Organisation in 1980, the introduction of China’s patent law in April 1985 was viewed as vulnerable to one-sided interpretation by a number of foreign firms (Chen, 1995).

2 Furthermore, while respect for individual property rights is deeply rooted in the individualism

(Hofstede, 1994) of many western cultures and nations, the collective and group-oriented

Confucian and Marxist heritages of China is at odds with such a belief (Zeller 1999), adding

to the perceived risks for foreign technology-based firms operating in China. China, in

particular, has been identified as having weak IP rights legislation, a very weak level of

enforcement and a very weak overall level of protection, when compared with other developing Asian economies such as Indonesia, Malaysia and the Philippines (Deng,

Townsend, Robert and Quesnet, 1996). Protection of foreign firms’ technologies has, however, been strengthened by Memorandums of Understanding on IP protection between

China and a number of her trading partners. China has also recently demonstrated an

increased commitment to international standards in traderelated areas including IP protection,

as is evidenced by its substantive compliance with the requirements of the GATT Uruguay

Round Agreement on Trade-Related Aspects of Intellectual Property Rights and the

strengthening of judicial enforcement of IP rights and efforts to gain membership of the

World Trade Organisation (WTO).

China withdrew from the GATT, the predecessor to the WTO, in 1949. While China

lodged an application for membership of the WTO in 1986, this has not yet been accepted

due to a process whereby new entrants must finalise agreements with all member countries on

the terms of entry as a precondition to WTO membership. To date, China has concluded

agreements with a number of countries, including Japan, South Korea and New Zealand, but

there are still contentious issues to be resolved with, among others, the United States, the

European Community and Australia. While an agreement with Australia was almost reached

during the last round of negotiations, the Chinese submission was eventually rejected because

it lacked specifics.

3

In July 1999, the US House of Representatives voted to extend China's Normal Trade

Relations (NTR) status for another year, despite the debate over the alleged Chinese stealing of nuclear technology. In the past, the US has been instrumental in blocking China's entry into the WTO. The negotiations between the US and China will continue in September 1999, when Presidents Clinton and Jiang Zemin meet at the APEC summit in Auckland. Opinions on the prospects for China's entry into the WTO in 1999 are mixed.

Although IP issues have not been a major sticking point in the negotiations concerning

China's entry into the WTO, China's accession to the WTO is likely to be viewed as a

positive step towards mitigating the perception that remains among many technology-

oriented organisations that there is a high risk of dissipation of one’s proprietary know-how

in China. Indeed, China’s 1996 APEC Individual Action Plan outlines a number of strategies

designed to enhance the protection of IP rights should it gain access to WTO by 2000,

including improvements in administrative enforcement, the strengthening of judicial tools

and efforts to further enhance public awareness of IP right protection. Nonetheless, the

ongoing perception of IP-related risks in China is also partly a function of China’s approach

to technology transfer.

China's technology transfer regulations have been written to favour the Chinese recipient firm. For example, the foreign licensed technology typically belongs to the Chinese partner following expiry of a technology transfer agreement, which is generally of less than ten years duration (Bassolino and Tse, 1999). This is the antithesis of a fundamental tenet of western technology licensing, in which the use and disclosure of the IP by the terminating licensee is precluded. In addition, the codified technology that is transferred to a Chinese venture must

4 be certified by a government research and design institute, whose charter is also the diffusion

of technologies to domestic enterprises (Tackaberry, 1998). Consistent with, and perhaps a

consequence of these policies and procedures, are a number of problems that a foreign

investor in China may face, including the counterfeiting of products made in China, the

unauthorised sale of products made under licence, and the unauthorised use of technology

that has been transferred (Wheare, 1996). Illustrating this concern in the Chinese context, the

Chairman and Managing Director of Zhuhai Toria Marine Engineering Co. Ltd., a joint

venture between an Australian and a Chinese firm, described one experience as follows:

I was at a small shipyard in Xinhui on a visit looking for subcontractors. Shortly before

this visit, a city close by had purchased a state-of-the-art high speed catamaran

from a West Australian shipbuilder. To my surprise and horror, I was proudly shown

copies of line drawings and enough structural and mechanical detail to build this first

class vessel there and then (Gibbons, 1996, p. 40).

RESEARCH PURPOSE

The experience of the Managing Director of Zhuhai Toria Marine Engineering is particularly interesting in the context of the recent decision by INCAT Offshore Pty Ltd

(INCAT) – another Australian ship design and construction firm – to enter into a joint venture with Hong Kong based AFAI High Performance Ships Ltd (AFAI) for the construction of ferries in Panyu, China. China boasts a rapidly growing shipbuilding industry, which by the end of the ninth five year plan, which runs until 2000, is expected to take the third place in the world in terms of production volume, and hold ten per cent of the global ship market (Alestron, 1999). The industry in China is dominated by the China State

Shipbuilding Corporation, formed in 1982 as one of the first ‘Chinese-type’ holding

5 companies arising from ministerial restructuring in China's transition from a planned to a

market-oriented economy. The CSSC operates under the guidance of the State Council of

China and is characterised by State ownership, management, and regulation of all aspects of

the industry (Reinganum & Pixley, 1998). CSSC incorporates approximately 25 large and

medium sized shipyards, 60 marine equipment manufacturing plants, 36 research and

development and design institutes, and several colleges and vocational schools. There are,

however, numerous small shipbuilding and repair companies in China, and there exist no

laws specific to shipbuilding. The shipbuilding contract is usually governed by the terms of

the contract between the builder and the owner and, in the event of a dispute, it is usually

referred to the economic contract arbitration commission for resolution (CCH Asia Pte

Limited, 1998). While not specific to shipbuilding, China’s IP laws do not exclude the

shipbuilding industry.

In light of the high level of government involvement and the absence of specific IP

legislation governing the shipbuilding industry, the Australian firm INCAT provides an

illuminating case of an advanced technology firm's apparent willingness to expose itself to

the vagaries of this market. As observed by Jain (1996), although the protection of IP rights is a complex issue deserving of inquiry, business academicians have typically given it only cursory attention. Schultz and Saporito's (1996) exploration of strategies to deter counterfeiting and brand piracy is one notable exception. In particular, in-depth case

analyses that provide rich understandings have not been forthcoming, despite calls for greater

examination and debate of the issues (eg. Jain, 1996; Tackaberry 1998). While reports of

foreign firms transferring technology to and even establishing R&D operations in China

abound in the trade-based literature – including Alcatel, Asea Brown Boveri, Bell

Corporation, Caterpillar, Glaxo, Hewlett Packard, Hitachi, Jeep, Matsushita, NEC, Novel,

6 Philips, Siemens, Toshiba, Volkswagen, Xerox and Yamaha – many fundamental questions

concerning IP protection remain unanswered. Indeed, the prescriptive lists of ‘the dos-and-

don'ts of IP protection’ derived from these studies add little to the existing body of

knowledge (eg. Bassolino & Tse, 1999; Nair & Stafford, 1998).

The present study introduces the events which have culminated in the formation of the

INCAT-AFAI joint venture in China and, in the context of this international joint venture,

rich understandings of INCAT's management of IP issues in China are gleaned. The study is

guided by the research question: how does INCAT manage risks associated with the potential

dissipation of its IP and know-how associated with its joint venture and shipbuilding

activities in China? In addressing this question, concepts from resource-based theory of the

firm (Barney, 1991; Wernerfelt, 1984) are drawn upon to explain INCAT's case and to

provide managers with insights that might be considered in their international ventures in the

newly emerging markets.

METHOD

A qualitative case study is most appropriate to address the specific research objective of

this study given the complexity of the issues to be addressed. At best, a questionnaire-based

approach would offer a superficial overview only of the issues at hand here. The INCAT

case study may be considered an instrumental case (Stake, 1994) as this company was purposely selected for investigation to advance our understanding of and offer new insights into specific issues concerning the management of IP dissipation risks facing an innovative, technology-rich Australian firm operating in China.

7 Data were collected through semi-structured interviews with the Managing Director and

the Legal Director of INCAT in Australia, and members of INCAT’s network, including the

Managing Director of Liferaft Systems Australia, a supplier to INCAT. The CEO of the

Department of State Development in Tasmania, Australia, also provided valuable insights into various aspects of INCAT’s internationalisation. These interviews were conducted between November 1997 and May 1998 and lasted between 30 and 90 minutes, often with a subsequent tour of the shipyard or facilities. The Managing Director of INCAT’s Hong Kong based joint venture partner, AFAI, and the Assistant General Manager of the Chinese

Shipyard were interviewed at the shipyard in Panyu, Southern China in July 1998. Follow-up interviews were conducted periodically at the INCAT Shipyard, with the last in August 1999, and communication with INCAT management via telephone when points of clarification arose during data analysis was ongoing. These multiple interviews and communications formed an important part of the triangulation process (Miles and Huberman, 1994), in addition to secondary data in the form of company documents, publicly available information

about the company such as media reports, and informal interviews with other INCAT

managers. As all interviews were conducted between November 1997 and August 1999 while

operations in China unfolded, inaccuracies in the data associated with hindsight have been

minimised.

THE INTERNATIONALISATION OF INCAT

Established in 1978, INCAT has been a dominant player in the world market for high-

speed car and passenger-carrying aluminium ferries for the past decade. It has designed and

manufactured an innovative range of catamarans, growing from 31 employees in 1988 to

approximately 1000 full-time employees at present. Being ranked 107 in the list of

8 Australia's top 500 private companies (Business Review Weekly, 1999), INCAT’s 1996/97

turnover of approximately AUD150 million (USD98 million) rose to AUD218 million

(USD142 million) in 1998/99.2 INCAT estimates it has now built around 50 per cent of the high-speed car and passenger carrying ferries currently in operation worldwide. Despite the

scale of operations, INCAT remains a private, owner-managed organisation that evolved from other boat building companies, including the Sullivans Cove Ferry Company (SCFC).

As shown in Figure 1, SCFC was formed in 1972, in , Australia, and concentrated on the construction of conventional steel mono-hulled vessels. After the successful construction of the first high-speed catamaran ferry in 1977, based on a design which resulted from a partnership between INCAT’s Managing Director and a -based naval architect,

INCAT was formed to build and market these catamaran ferries in 1978. The first order was an AUD700,000 (USD456,000) Greek request for two boats. The company was thus ‘born global’ (McKinsey, 1993), having a strong export orientation from the outset as described by

INCAT’s Managing Director:

It was not an accident that it was known as International Catamarans Pty Ltd

... the reality was that we set out on the export path right from the beginning.

[Insert figure 1 about here]

Although the 1979 Greek order was subsequently cancelled, INCAT’s domestic and international expansion continued. Between 1978 and 1982, INCAT built approximately ten vessels for the Australian market, quickly tapping into a vast market for cruise and tourist boats in Australia and offshore oil rig boats in Asia. Unable to fill orders, INCAT licensed yards to build vessels in Australia, New Zealand, Hong Kong, Singapore, the United States

2 All US dollars are calculated on the exchange rate of 65.1:1, as at August 15 1999.

9 and the United Kingdom, sometimes taking an equity interest in the venture. In some

markets, such as the United States, licensing was the only viable means of gaining access in

the face of impediments to exporting created by the level of protection the United States

provides to this industry. Foreign licensing arrangements thus preceded INCAT’s first

international export by approximately five years.

In 1983, the company embarked on a program of research and development to improve the

performance, stability and passenger comfort of its vessels, resulting in the construction of its

first commercial wave-piercing catamaran. The innovative feature unique to the wave-

piercing concept is the sharp spear-like bow of each hull, designed to cut cleanly through

oncoming waves. This design was improved upon over the next few years and in 1986 an

AUD8 million (USD5.2 million) order from England for two vessels was INCAT’s first

export from Tasmania. Since then, larger vessels have been constructed for export each year.

In 1990, INCAT revolutionised ocean-based transport with its first car- and passenger-

carrying catamaran. Subsequently, the company has refined two innovative and very

successful high speed ferry designs – a large wave piercing catamaran and a smaller ‘k-class’ catamaran vessel suited to more sheltered routes. It is this k-class catamaran which is the subject of INCAT’s joint venture in China with AFAI High Performance Ships Ltd (AFAI) of

Hong Kong, a previous licensee.

FORMATION AND OPERATION OF THE INCAT-AFAI JOINT VENTURE

In mid-1995, INCAT decided to develop an offshore production arrangement with another shipbuilder, prompted by several factors. First, global demand for its high-speed passenger and vehicle ferries was continuing to far exceed the production capacity of its Tasmanian

10 shipyard. Second, the Australian Government announced in July 1996 that it intended to

abolish the shipbuilding bounty from mid-1997 (later extended). The bounty was first

implemented to help the Australian shipbuilding industry compete with overseas rivals, and

Australian shipbuilders contend that Australian-built ships will struggle to be cost competitive if it is removed. Third, INCAT was disadvantaged vis-à-vis some of its

international rivals because of the substantial cost it incurs in delivering new ships to distant

northern hemisphere buyers, making production activities in the northern hemisphere more

attractive. A number of shipyards expressed strong interest in a joint venture with INCAT,

with the company receiving offers from shipyards in Sweden, Malta, China, England and the

US. In 1996, INCAT chose to enter into a joint production program with its former Hong

Kong licensee, AFAI High Performance Ships Ltd (AFAI) for the construction of its ‘k-class’

catamaran at AFAI's shipyard, AFAI Southern Shipyard, in Panyu, Southern China.

According to INCAT’s project manager in China, this is a joint venture between AFAI,

which owns 49 percent, and Southern Shipping with a controlling 51 percent.

The INCAT-AFAI association began in the late 1970s when the Managing Directors of

INCAT and AFAI met. Established in 1949, AFAI recognised the growing need in China for

ferries in the 1970s, and subsequently started building INCAT’s high speed aluminium ferries

in Hong Kong under a licensing agreement, with the first boat constructed in 1982. Nair and

Stafford (1998) observed that the development of trusting relationships must precede any

Chinese business transaction. The arrangement continued for eight years from 1982 to 1989

inclusive, with no formal licensing agreement ever being signed. As explained by the

Managing Director of AFAI:

It was basically a ‘Gentleman’s Agreement’. There was a licensing contract,

but we never signed it … You can never get the words right.

11

The trust and cultural understanding that had developed between the two companies through the previous licensing arrangement in the 1980s was a significant factor in INCAT’s decision to enter into the current arrangement with AFAI. Buckley and Casson (1996) note that cultural distance can pose a significant obstacle in the management of joint ventures – more so than in arm's-length licensing agreements. Cultural distance or, more broadly, psychic or business distance has been a central explanatory factor in much of the behavioural research on internationalisation, and can be reduced through experiential learning (Johanson

& Vahlne, 1977). This learning was clearly important in INCAT’s decision to enter a joint venture with the Chinese family who owns AFAI, with the Managing Director of INCAT viewing the alliance partner favourably because of “... the attraction of doing business with people we had done business with in the past” and because the family who owns AFAI “... are Chinese [who are] highly educated in the Western ways.”

Part of AFAI's knowledge base concerning ‘Western ways’ is also derived through other joint ventures in which it is currently involved, including two with the Australian Halverson

Group relating to the construction of fibreglass vessels. Although part of the shipbuilding industry, these joint venture partners of AFAI are not currently direct competitors of INCAT.

AFAI is also engaged in a venture with the Guangzhou Maritime Shipping Bureau for the operation of ferry services. The Guangzhou Maritime Shipping Bureau is the major supplier of coastal shipping services in the Guangdong Province and operates under the Ministry of

Communications. According to AFAI’s Managing Director, the Guangzhou Maritime

Shipping Bureau also controls AFAI’s joint venture partner in the Chinese Shipyard,

Southern Shipping.

12 The establishment of the shipyard in Panyu in 1993 was prompted by the rapid growth of high speed catamaran transport on China’s Pearl River Delta in recent years. This opened up a niche market which meant AFAI gained valuable skills in the areas of repair, maintenance and conversion of high speed ferries, as well as developing an intimate knowledge of the market. Hong Kong investments in general have been highly concentrated in the Guangdong

Province adjacent to Hong Kong, particularly in the Pearl River Delta region (Hayter & Han,

1998). Numerous companies related to the marine industry conduct business in this region, some of which are sub-contractors for AFAI. These State and private sector networks within

China established by AFAI are of great significance for its foreign partners. Guanxi relationships, or relationships of reciprocity and obligation, are the ‘life blood’ of the Chinese economy and business connections, and have been shown to have a significant positive effect on the performance of foreign investments in China (Luo, 1997). INCAT recognises the benefits of linking up with a well-connected Hong Kong shipbuilder to gain access to the

Chinese and other Asian markets, as expressed by INCAT’s Legal Director:

To some extent you can’t get into a local market unless you know someone

locally. Having the boat built in China with a Chinese family operated

company opens up the whole market to us.

Under the INCAT-AFAI joint production arrangement, INCAT is responsible for the design of the vessel and supplying the Chinese shipyard with the major machinery and prefabricated components such as engines, generators, water jets, electronics and seats for its smaller ‘k-class’ of catamarans. INCAT’s significant buying power and favorable trading terms makes it an attractive partner, providing lower component costs than AFAI might otherwise be able to attain. Production in China further strengthens this buying power.

These components are then assembled by Chinese workers at the Panyu shipyard in China.

13 INCAT is also obliged to provide its technical assistance with respect to building techniques

and technology specific to ‘k-class’ vessels. AFAI is responsible for supplying the labour to

build the hull of the vessel, and for managing the construction of the vessel and the yard.

Thus, although INCAT has no equity interest in the Chinese shipyard, the alliance with the

Hong Kong based AFAI provides an indirect route into China whereby it can take advantage

of the lower costs of production and the high quality of workmanship undertaken by the

Chinese shipyard. The INCAT-AFAI joint venture also enables INCAT’s Tasmanian

shipyard to gain economies of scale by specialising in the production of the large wave-

piercing catamaran, while the Chinese yard concentrates on the construction of the smaller

‘k-class’ vessel. The joint venture partners have registered a company in Hong Kong,

INCAT AFAI (HK) Limited, to market and contract the catamarans built at the Chinese

shipyard. These vessels, although constructed in China, are aimed at the wider international

market. The potential marketing advantage of AFAI's relationship with the Guangzhou

Maritime Bureau, should INCAT wish to penetrate the ferry market in China, cannot be

overlooked.

The new arrangements between AFAI and INCAT are an extension of their previous

licensing agreement. Under the present arrangement, however, INCAT has greater control

over the manner in which a vessel is constructed because it is a part-owner of the vessel, and

is financing and supplying a large amount of equipment and components for its construction.

The vessel must be constructed in accordance with INCAT’s specifications and the Chinese

shipyard must adhere to the construction methods that are employed at INCAT’s Tasmanian

shipyard. These construction and technical skills have been transferred through the ongoing

involvement of INCAT’s Australian project manager expatriated to China for the duration of

the joint venture agreement, in addition to the temporary expatriation of between 12 and 20

14 INCAT employees from Tasmania at various stages of construction and visits to the Panyu

shipyard by at least six of INCAT’s sub-contractors. While managers of AFAI have visited

INCAT’s Tasmania shipyard, no training of the AFAI Southern Shipyard employees has been undertaken in Australia. This increased control overall, in addition to AFAI’s high skill levels, helps overcome a specific concern about INCAT’s potential liability for an unseaworthy vessel which has not been built correctly by a licensee.

While control has increased, so has the commitment of resources by INCAT and associated risk levels. INCAT has agreed to bear all costs in relation to the supply of equipment and components to AFAI until the vessel is eventually sold. Under the present arrangement,

INCAT receives no transfer fee and no royalty payments for the technology and know-how that it supplies to AFAI. Thus, in contrast to the former licensing arrangement, INCAT is exposed to financial risk if construction or sale of the vessel is delayed. This risk is not insignificant. Each ‘k-class’ vessel being constructed under the new arrangement is worth approximately AUD26 million (USD17 million), whereas the vessels which were built under the previous licensing arrangements in the early 1980s were worth approximately AUD2-3

million (USD1.3-2 million). This risk is somewhat mitigated by the shortterm duration of the

contract: it obliges INCAT to supply components and services for the construction of only

one vessel (hull number 8) at the Chinese shipyard, although the mutual understanding was

that at least three vessels will be built under the agreement. One reason for this short-term focus is that INCAT views its collaboration on the first boat with AFAI as an experiment and, under the contract, both INCAT and AFAI had the option of reviewing the arrangement after the completion of the first vessel in March, 1998. In reality, the review took place in January

1998, with a decision being made to begin construction on the second boat. As of August

15 1999, INCAT still describes the arrangement in China as being successful and stated that

joint production will continue provided demand for the ships is maintained.

Another key feature of the INCAT-AFAI joint venture contract is its brevity of detail. In

contrast to a typical international licensing agreement (Buckley & Casson, 1996), it does not

specify exactly what technological expertise each partner will contribute to the joint venture.

Neither INCAT nor AFAI has attempted to restrict the contribution of each partner under the

current arrangement as explicitly as might be expected, with both parties agreeing to

contribute, within reason, whatever is necessary to construct ‘k-class’ vessels for the world

market. While this arrangement offers a degree of flexibility and adaptation (Buckley &

Casson, 1996), such an agreement only works if a relationship based on trust exists between

the parties.

An approach to contracting that is based more on trust between INCAT and AFAI than

explicit legal instruments is evidenced, to some extent, by the decision of the parties to not

sign the current agreement, as was also the case with the earlier licensing agreement. As

expressed by the Managing Director of INCAT: “... we are more or less trusting [AFAI] to do their half of the bargain,” reflecting not only trust but perhaps also elements of guanxi. AFAI also emphasises the importance of trust and guanxi, placing less emphasis on explicit written contracts in the management of an alliance involving technology transfer than might be typically expected in Australia or the US. The Managing Director of AFAI explains:

This is where you need to approach a different thinking… Often if you want

to honour [an agreement], you will not sign [the contract]. The person who

would not honour it probably would sign it.

16 While the actual process of drafting the unsigned agreement may have facilitated the

development of trust and understanding, the long-term relationship between INCAT and

AFAI appears to have been pivotal to the operations of the venture. The apparent level of

trust and understanding is not, however, underpinned by unbounded faith and alignment of

perspectives. A primary motive for AFAI’s refusal to sign the new agreement, for example,

was a perception expressed by AFAI’s Managing Director that the contract was “… too one

sided…[INCAT] wanted to give minimal for maximum.” Similarly, the Managing Director

of INCAT qualifies the relationship in acknowledging that “... we have been a little reserved

with the Chinese in that they are building a craft that is not our mainstream craft.”

INCAT'S MANAGEMENT OF INTELLECTUAL PROPERTY

That the technology transferred to the China-based venture does not involve INCAT’s mainstream design reflects a level of risk aversion in INCAT’s dealings with its Hong Kong partner, the Chinese shipyard and, more broadly, the Chinese market as a whole. Despite this implicit recognition that its technology and its know-how in ship design and construction are

important firm-specific resources, INCAT’s management does not appear overly concerned

about defining its intellectual property in a legal sense in order to protect it in the global

marketplace. While INCAT has invested significantly in computer technology and

established electronic links with the AFAI shipyard in China which enable communication

via email and the electronic transfer of drawings and other documents, it has not engaged in

conventional modes of protecting its intellectual property, such as the registering of patents or

designs. In fact, INCAT has not even registered a trademark to protect its name and logo.

While this ‘informality’ could perhaps be attributed in part to the fact that INCAT is a

17 private, owner-managed company, INCAT’s organisational structure – which includes a legal

director – suggests otherwise.

Although many smaller organisations with limited resources may be discouraged from the

financial and managerial investment required to maintain adequate IP protection through

legal mechanisms, this also does not appear to be INCAT’s motivation for not engaging in

such activities. INCAT does not express significant concerns about the risk of dissemination of non-patented knowledge through its ‘contractual’ relationship with AFAI, despite being

aware of such risks. This apparent lack of concern over the possibility that its current partners

in the Chinese marketplace may one day choose to copy INCAT’s designs or manufacturing

processes and compete can, to some extent, be attributed to the existence of trust and guanxi

between INCAT and AFAI. Indeed, these concepts have been elevated to central importance

in much of the extant literature exploring technology transfer to and foreign investment in

China (Luo, 1997; Tsang, 1998). Even this, however, is not sufficient explanation for

INCAT’s approach. As noted above, both INCAT and AFAI qualify their relationship: it is

not characterised by unbounded trust, and trust and guanxi can be both built and eroded.

Furthermore, the concepts of trust and guanxi provide only limited insights of how risks

associated with the dissipation of IP to those outside the joint venture arrangement may be

mitigated. While the confidentiality clauses in the contract outlining the INCAT-AFAI

alliance are intended to prevent unauthorised disclosure of INCAT’s proprietary information

to third parties, INCAT recognises the limited extent of practical protection provided by such

clauses. This possibility of technology dissemination is strengthened by the investment of

Guangzhou Maritime Shipping Bureau in the Panyu Shipyard, as it operates under the

government's Ministry of Communications. Insights into INCAT’s unconventional approach

to intellectual property protection can perhaps best be gleaned through a resource based view

18 of the firm.

COMBINATIVE COMPETENCY IN MANAGING INTELLECTUAL PROPERTY ISSUES IN

CHINA

INCAT's seemingly unconventional approach to protecting its IP can perhaps best be

explained by the nature of INCAT’s bundle of firm-specific resources and capabilities that

sustain its IP and, ultimately, its competitive advantage in the market place. Barney (1991)

identifies four criteria for resources to support capabilities that create a sustainable

competitive advantage. They must be (1) valuable or rent producing; (2) rare; (3) difficult to imitate; and (4) non-substitutable. Indeed, the sustainability of the first criterion is largely

contingent upon the other three. That is, the value of a resource to a firm in terms of

providing a superior return or advantage is diminished if the resource is also owned or readily

obtained by actual or potential competitors (i.e. not rare or firm-specific), there are few barriers to imitation (Remelt, 1984), or if the resource is vulnerable to substitution (Dierickx

& Cool, 1989). One key factor that enhances the rareness, inimitability and non- substitutability of INCAT's resources is their causal ambiguity. Causal ambiguity refers to a situation where the cause or source of the competitive advantage is difficult to identify

(Barney, 1991; Kamoche, 1996). INCAT's bundle of firm-specific resources and capabilities includes an emphasis on innovation, an on-going commitment to clients, and a reputation for safety. All three are underpinned by the entrepreneurial acumen of INCAT’s managers.

An Emphasis on Innovation.

INCAT’s failure to secure its intellectual property rights by use of the legal system is partially explained by its emphasis on continual improvement and technological

19 development. INCAT believes that the intensity of its research and development activities

will sustain its technological superiority, as the Managing Director explains:

We haven’t really worried too much about [theft of intellectual property]. We

work on the theory that whatever [competitors] are stealing, they are stealing

yesterday’s work anyway.

INCAT also discounts the threat of competition because of the nature of the industry in

which it operates. The company is required to provide a significant amount of data and

technical information to its joint venture partner and it has undertaken to allow AFAI full and

unfettered access to any part of the INCAT yard for the purpose of the technology transfer

(INCAT-AFAI Contract, 1996). However, INCAT’s disclosure of its proprietary technology

is limited in that it is not required – nor expected – to provide its partner with the background research upon which the data and technological information are based. As the Managing

Director of INCAT explains:

Just having a set of plans, although it might look valuable, is not of great value

without having all the back-up information. You can build the ship but then

you can’t sell it [on the international market] unless you have all the

information.

All vessels sold by INCAT in the international market contain a complete set of plans in

both paper and electronic form which explain fully how the vessel was built. This

information can be easily duplicated, making it very difficult for INCAT to protect its

proprietary rights to this information using the legal contract, or to seek redress under law.

In fact, only a small proportion of the total package of technology being transferred by

INCAT to its joint venture partner could be protected by IP laws. Much of the proprietary

information being transferred is not registered with any public agency (such as the Australian

20 Industrial Property Organisation) or is non-registerable. Missing from the public domain is,

however, a vast array of essential knowledge, both codified and tacit.

The codified information safeguarded by INCAT includes the principles underlying the design features of INCAT’s vessels. This information is critical when making alterations to a design to accommodate requests for customisation. Instances where competitors adopting

INCAT designs have altered certain parameters to meet customer preferences only to discover that the increased weight of the boat reduced its speed considerably, to the dissatisfaction of the customer, have entered ‘INCAT folklore’. In contrast, the Managing

Director of INCAT is credited by the Chief Executive Officer of the Department of State

Development in Tasmania with the ability to accurately assess the implications of a customer’s request and design requirements vis-à-vis the ship’s performance ‘on the back of an envelope.’ After determining the effects of a desired change, INCAT is able to inform the customer and redefine other specifications where necessary, thereby avoiding dissatisfaction with the end product due to incongruent expectations.

This attribute draws not only on the codified mechanical principles underlying INCAT designs, but also on tacit knowledge accumulated through years of experience. Tacit knowledge is knowledge that is implicitly grasped or used but has not been fully articulated, as epitomised in the know-how of a master craftsman (Chesbrough & Teece, 1996). Because this knowledge is deeply embedded in individuals or companies and is often difficult to articulate, it tends to diffuse slowly, and only with effort and the transfer of people. Such knowledge may not be vital to the production of a standardised product, but it becomes critical in adapting a design to customer requirements and the marketing of the vessel.

21 On-going Commitment to Clients.

INCAT’s ongoing commitment to clients, embodied in organisational systems and routines,

minimises the risks associated with a competitor manufacturing INCAT’s vessels, and

provides a marketing advantage. A particular advantage INCAT holds is its ability to provide

maintenance assistance through its computerised design system. When a client experiences a

failure in a component of the vessel, INCAT is able to design a plan to solve the problem and

forwards this electronically to the customer, thereby minimising costly down-time for the

customer. The computer-aided design process both builds and is enhanced by INCAT’s

intimate knowledge of each vessel. INCAT attempts to track the life and fortunes of each

vessel, even through changes of ownership. This activity not only enhances the company’s

reputation for customer service and commitment to its product, but provides valuable

opportunities to learn of the vessels’ flaws or weaknesses over time. Embodied in both

codified and tacit stocks of knowledge, this learning is then transferred to future designs and

innovations. This is particularly important with regard to safety features.

Reputation for Safety.

Safety issues concerning high-speed ferries have gained significant attention, particularly

following recent ferry disasters in Europe involving conventional ferries, such as the Estonia

disaster of 1994. INCAT employs an innovative marketing tool to illustrate the safety

benefits of its vessels. Following an incident at sea involving other passenger ferries, INCAT computer-simulates the disaster under the same conditions, but with an INCAT vessel replacing the original vessel. These results – which apparently show invariably the INCAT vessels’ ability to avert the disaster or minimise the potential damage and risks – are then distributed to interested parties worldwide. Once again, it is INCAT’s accumulated knowledge which enables it to provide this demonstration of worth, and each such modelling

22 further enhances its stock of knowledge and feeds the innovation process. INCAT’s

participation in international marine advisory boards and its network of suppliers, many of

which specialise in individual safety components, also contributes to the company’s stock of

knowledge and innovations concerning the advanced safety features on its vessels, as well as

its marketplace reputation in this regard.

INCAT's avoidance of institutional means of IP protection in China may thus be explained

by the implicit protection afforded through its ability to combine and uniquely configure

interdependent resources and capabilities relating to innovation, client commitment and

safety, in which its proprietary technology and know-how is embedded and renewed. While there may be some leakage of codified portions of INCAT’s proprietary knowledge, such as the copying of designs that has occurred elsewhere in the past, this seemingly unique configuration creates both production and marketing advantages. The ability of a firm to bundle resources into configurations generating capabilities that sustain IP and, ultimately, competitive advantage, reflects a combinative competency of the firm. The resultant bundle of capabilities are protected by their causal ambiguity. Hart (1995) argues that resources contributing to causal ambiguity are typically invisible or tacit resources based upon accumulated experience or learning by doing, as acknowledged by INCAT’s Managing

Director:

What we do have is mostly in our heads and it is a sort of intellectual property

which is far more valuable than being on paper.

23 ENTREPRENEURIAL ACUMEN, TACIT KNOWLEDGE AND CAUSAL AMBIGUITY

The bundle of firm-specific resources identified as being the source of INCAT’s competitive advantage in the international marketplace can be largely attributed to the nature of tacit information, and the inherent security and fortune in our ability to know more than we can tell (Polanyi, 1966). Knowing more than one can tell ensures that some know-how cannot be fully codified, with property rights retention not requiring formal protection through institutional mechanisms. The know-how becomes evidenced, often, as entrepreneurial acumen. Even with complete codification of technical know-how, innovative firms are now finding means other than formal IP protection to minimise the risks of dissipating core competencies. For example, another Australian boat-building enterprise,

Computer Design Marine, has successfully developed computer software which destroys itself immediately upon its having guided a cutter which has cut and checked a panel for pre- fabrication into boat assembly offshore (Ascent Technology Magazine, 1998).

In an era characterised by information intensity and knowledge creation as core to the firm’s establishing a bundle of firm-specific resources upon which it can leverage an international advantage, convergence to standardised forms of technology management in internationalisation clearly need not happen. Hedlund (1994) argued that the interplay of tacit and articulated knowledge and the dialogue at and between individual and organisational levels suggests new insights into sources of dynamic competitiveness and firm heterogeneity. While the literature has been replete with the imperative for technology-rich firms to ensure protection of their core assets through formalised IP protection, some innovative firms, such as INCAT, appear to be doing otherwise. Hedlund (1994, p.87) observed “... several strategic apexes” emerging in the nature of the firm with “... shifts over

24 time” and “... several ordering principles” at play. Differing constellations of firm resources and capabilities enhance this heterogeneity and can be largely attributable to the individuals involved.

INCAT’s seemingly unconventional management of technology in its internationalisation

can, to a large extent, be traced to the entrepreneurial acumen of its founder and managers.

Increasingly, knowledge creation and its application is being seen to offer firms a competitive

advantage (in all markets, both domestic and international), and the role of individuals in

these processes is being highlighted (McGaughey, Welch & Welch, 1997). The importance

of knowledge of the market gained through business experience has been recognised in the

literature (e.g. Eriksson et al., 1997). The ability of skilled persons to deconstruct

information from their business environments in the form of observables (data) and non-

observables (relationships between variables), and through a process of information

translation and reconstruction to create useable knowledge from this information, has been

identified by Liesch and Knight (1999) as a key to understanding the success of smaller

firms’ internationalisation ventures. It can perhaps be extended to large firms with smaller

firm characteristics such as owners operating as managers, which is the case with INCAT.

The nature of the information search processes and the worldly experiences of these

individuals is fundamental to the paths particular firms will trace in their internationalisation

(Dodgson, 1993), ensuring further causal ambiguities.

Interactions with networks of suppliers, distributors and customers clearly are integral to

the quality and nature of the information, in the form of data observables and relational non-

observables, internalised by key individuals in the firm (Nonaka & Takeuchi, 1995). The

Managing Director of one of INCAT’s suppliers, Liferaft Systems Australia, attests to the

25 acumen of INCAT’s Managing Director and his ability to assemble information for reconfiguration into leading edge innovation:

Fast ferry builders are placing a lot of emphasis on weight reductions – the lighter they

make these things, the faster they go and the less fuel they burn ... [The managing

director] has always been very, very weight conscious which has probably put him

ahead of the pack in a lot of ways. And now, a lot of his opposition builders are just

really waking up to the fact that they do have to save weight to make these things work

... He’s extremely innovative and he’s a pioneer in the industry.

The entrepreneurial acumen of key individuals and their stocks of knowledge developed over time in technology-rich firms which are successfully internationalising highlights a causal ambiguity in firm internationalisation and the source of competitive advantage. This is likely to ensure some protection for the technology-rich firm from potential competitors in the

Chinese market, and rivals attempting to replicate a successful internationalisation path.

IMPLICATIONS AND CONCLUSIONS

The case selected for investigation in this paper, INCAT, was purposively chosen to advance our understanding of and offer new insights into specific issues concerning the management of IP dissipation risks facing an innovative, technology-rich Australian firm operating in China. In response to the research question posed, a key finding of this paper – contrary to what might be expected – is that INCAT does not view the counterfeiting of its vessels, the unauthorised sale of its products made under licence or the unauthorised use of technology that has been transferred as risks warranting formal IP protection through, for example, patents or registered designs. Indeed, this approach to the Chinese market is not unique, but an approach taken by INCAT worldwide. As the company does not emphasise

26 the risk of a former partner or competitor in China reproducing its vessels, INCAT’s less-

than-orthodox means of protecting its intellectual property may seem, at first glance, to be at

variance with the literature which stresses the importance of formal protection of IP. Indeed,

to an observer, and even a rival firm, INCAT might be perceived to operate a risky strategy

of IP protection.

This firm operates in a particular industrial sector that is characterised by the nature of the

product it manufactures and the market demands which must be met. The product embodies

sophisticated advanced technologies, and is a complex product. The market demands

customisation for specific needs, innovation to accommodate changing production

requirements, the maintenance of an on-going service commitment to clients to minimise, for

example, costly down-time, and an assurance of safety as disasters can be devastating.

INCAT’s proprietary know-how is thus not tied solely to codified IP, but includes firm-

specific resources and capabilities that enhance its ability to continuously innovate and

market the product, many of which cannot readily be defined or protected by legal

mechanisms and are difficult to duplicate because of their causal ambiguity arising through

their foundation in tacit knowledge accumulated over time. Thus, while trust has been a key

factor in INCAT's choice of joint venture partner and remains implicit throughout the

relationship, the unconventional approach to IP protection pursued by INCAT is not

necessarily trust-dependent. It is the nature of the bundle of resources in which the firm's

proprietary technologies and know-how are both embedded and renewed, and a combinative

competency in creating these bundles that furnishes INCAT with a sustainable competitive

advantage in its international markets.

27 In addition, this firm's ownership structure could explain, at least in part, the nature of the

risks that this firm is prepared to accept. INCAT is a private, owner-manager organisation.

The owner-manager has special and particular attributes which establish the bases for the tacit knowledge underpinnings to this firm's causal ambiguities. Such tacit knowledge is not easily reproducible. Furthermore, entrepreneurs are characterised by their own particular levels of risk acceptance. INCAT’s owner-manager does not perceive the absence of formal

IP protection as a high risk approach to its operations in China. To others, however, the risks borne by INCAT might well be unacceptable. It is likely that these risks will not be acceptable to firms which are publicly-owned, for example, as stakeholders in these firms will generally possess risk preferences that are more conservative than are those of INCAT's managing director and owner. Such risk preferences could direct the more risk averse firm to select formal institutional means of protecting IP over those unconventional means identified here. The question of how applicable INCAT’s less-than-orthodox approach to IP protection is for other firms thus arises.

As was identified in this study, it is unlikely that other firms in this same industry are able to replicate INCAT's behaviours. Causal ambiguities grounded in tacit knowledge amassed over time have been identified as an explanation of this one firm's IP protection. The specific set and mix of factors which sustain and protect INCAT's IP is unlikely to be reproducible by other firms in this same industry or by firms in other industries. It is possible, even likely, that the manner in which INCAT operates in this industrial sector is not replicable in many other firms, particularly in those manufacturing less complex industrial products or consumer goods and services. This does not, however, preclude other firms operating in industries with similar characteristics (for example, highly customised and complex products) from creating their own causal ambiguities, and employing a non-orthodox mode of IP protection as

28 demonstrated by INCAT. Such a strategy would seem especially valuable where legal

mechanisms are not deemed sufficiently strong, as in the case of INCAT, or when employed

in conjunction with more orthodox institutional mechanisms. Importantly, the experience and strategies of INCAT highlight the (often overlooked) value of entrepreneurial acumen

and know-how as key firm-specific assets and their role in mitigating some of the apparent

risks associated with investing offshore in emerging markets such as China.

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32 FIGURE 1

Key Events in the History of INCAT First INCAT-AFAI fast ferry constructed in China and chartered in Europe 1998 Wholly owned sales subsidiary established in Denmark First 91 meter WPC Cat-Link V Formation of INCAT/ Sandline joint venture to operate ferries 1997 First 86 meter WPC Silica Jet built by INCAT in Hobart, Australia 1996 International joint ventures established with Hong Kong licensee, AFAI, in Hong Kong (marketing) and China (production) First 81 meter WPC Condor 12 exported to United Kingdom 1994 First 78 meter WPC Stena Sea Lynx II exported to United Kingdom 1990 First car and passenger ferry, the 74 meter WPC Great Britain, exported to the United Kingdom and awarded the Hales Trophy for the fastest crossing of the Atlantic by a passenger ship 1988 Shipbuilding activity relocated to larger site 1986 First overseas export from Australia to United Kingdom, followed by New Zealand, Argentina, Denmark, Norway, Sweden, Korea, Canada, and Italy over the ensuing years 1985 First WPC, 28 meter Spirit of Victoria 1984 Prototype for wave piercing catamaran (WPC) tested 1983 Design of the wave-piercing concept New shipyard built in Hobart 1982 Licensing of companies in Australia, Hong Kong, New Zealand, Singapore, United Kingdom and United States to build INCAT vessels 1981 First Aluminium Catamaran, 20m Fitzroy Flyer 1979 Export order from Greece of AUD700 000, later cancelled 1978 International Catamarans Pty Ltd formed to build and market the Clifford/ Hercus designs 1977 First steel catamaran ferry sold 1976 Partnership formed between INCAT’s managing director (Robert Clifford) and Sydney naval architect Philip Hercus 1973 First monohull ferry sale 1972 Sullivans Cove Ferry Company formed YEAR KEY EVENT

33