Ford motors and counterfeiting in the chinese automotive industry

Ford motors and counterfeiting in the chinese automotive industry Ford Motor Company (Ford) is an auto company that manufactures and sells autos and parts globally. Similar to many other corporations, Ford has invested manufacturing efforts in China, because China is now the worlds largest auto manufacturer and auto market. Given this huge opportunity, there are numerous companies looking to reap financial profits by producing counterfeit parts. The global counterfeit auto parts market was estimated at $16 billion in 2008  [i]  . For Ford, counterfeiting not only represents lost financial sales but also brand degradation and product liability risks. While robust growth in auto sales may be fueling the fake components market, the battle against manufacturers and distributors of counterfeit auto parts, specifically Ford auto parts is not new. Ford has been waging an ongoing aggressive campaign against counterfeiters since the early 1980s. Despite its efforts, there continues to be a battle as according to the automaker, counterfeit and pirated auto parts remains a problem that is putting the publics safety at risk and costing about $1 billion US annually. Since joining the WTO, the Chinese government has been placing increasing emphasis on intellectual property rights (IPR) to help encourage foreign investment in the country. However the strength of these IP laws and enforcement has not been robust as penalties are weak and do not deter counterfeiters. As Ford continues to invest and grow within China, we propose the following recommendations to address the counterfeiting issue. First, Ford should refine its internal firm strategies through security packaging innovations and a certification process, increasing education to consumers, aligning employee incentives through benefits and penalties, and continuing with the inspections. Next, Ford needs to pursue external political and legal strategies with key stakeholders, such as the industry coalition, insurance partners, the Chinese government, and the WTO. These strategies should focus on aligning incentives to develop more robust policies around counterfeiting penalties and enforcement. 2 Overview of the Counterfeit Automotive Industry in China For decades, piracy and counterfeiting problems have affected the economy. The global market for counterfeit car parts is estimated to be worth approximately $16 billion USD in 2008 (which accounts for roughly 3.2% of the global counterfeit market) and is growing roughly 9-11% per year.  [ii]  As the counterfeiting and piracy market is becoming more and more attractive to organized crime (it offers similar profits with a significantly lower probability of prosecution and penalties), criminals are making significant investments in counterfeiting. Counterfeiting and piracy activities have flourished in developing economies and gradually diminish as emerging markets achieve higher levels of prosperity and global integration. Today, industrial counterfeiting and piracy run rampant throughout emerging markets such as China. It is in fact, the worlds largest offender of IP theft and industrial piracy. According to MEMA, China is responsible for the exportation of 80% of the counterfeit goods seized at U.S. borders.  [iii]  The E.U. also estimates that 5-10% of all replacement auto parts in circulation are counterfeit.  [iv]  Furthermore, a recent study by the Commercial Times found that 56% of auto users in China have found counterfeit parts on their vehicles. Several unique characteristics make the Chinese market distinct from other counterfeiting regions. With Chinas sheer size and growing integration into the global supply chain, counterfeiting and piracy issues originating from this region have become a global problem (affecting not only local Chinese companies but also multi-nationals). Given significant socioeconomic disparities among different regions within China, the progression and convergence towards a middle income will likely be slower, fostering an environment in which counterfeiting and piracy will thrive for the foreseeable future. Furthermore, Chinas customs and traditions have historically accepted industrial piracy further stimulating growth. As the counterfeit market in China grows, increased investment has allowed counterfeiters to strengthen the sophistication of their operation. Counterfeiters now have inside information on new vehicles and specification changes before the new car is even on the market. Counterfeiters can produce exact copies of products, packaging and documentation and sell it under a competing brand name. In 2004, General Motors (GM) filed a lawsuit against Chinas Chery Automobile Company for the alleged piracy of its Spark vehicle to create a replica branded Cherys QQ. GM showed that the two vehicles were nearly identical with respect to exterior body, interior design and key components. (See Exhibit 1). In a study by the U.S. Chamber of Commerce and the Coalition against Counterfeiting and Piracy, counterfeit part sales are costing Ford about $1 billion per year. However, it is the physical dangers and risks associated with using or installing counterfeit parts that may be the most costly. Counterfeit auto parts are a huge consumer safety problem with serious potential to injure auto technicians and end-consumers. In addition to severe financial and safety implications, counterfeiting destroys the brand reputation of legitimate companies. Legitimate companies are often blamed or brought to court to take responsibility for the negative repercussions of counterfeit products. With China surpassing the U.S. to become the worlds largest auto market (achieving sales growth of 46% to 13.6 million), it will be difficult for auto original equipment manufacturers (OEMs) to ignore the Chinese market particularly since by entering the Chinese market, significant advantages may be leveraged (e.g. inexpensive labor, rapidly growing emerging market).  [v]  Currently, roughly 800 foreign auto parts suppliers operate in China, including most of the top 50 multi-nationals. And as the Chinese auto market continues to grow, instances of IP theft are likely to increase as well. It will become even more important for large multi-nationals such as Ford to take action and to protect itself from IP risks. 3 Impact of Counterfeiting and Piracy on Ford Motor Company in China A Background on Ford Motor Company in China Ford began manufacturing autos in the early 20th century. With $146.3 billion in revenues in 2008, Ford is now one of the worlds largest makers of cars and trucks. Its brands include Ford, Lincoln and Mercury and Ford receives more than half of its sales outside of North America.  [vi]   In the Asia-Pacific region, Ford operates under several investment holding companies including Ford Motor (China) Co., Ltd., Ford Motor Research Engineering (Nanjing) Co., Ltd., Ford Automotive Finance (China) Co., Ltd., Changan Ford Mazda Automobile Co., Ltd., Changan Ford Mazda Engine Co., Company and Jiangling Motor (Stock) Co., Ltd. Roughly 9% of 2008 global sales may be attributed to the Asia-Pacific region which includes China. Ford sold slightly more than 300,000 units in China in 2008 and 2009 sales exceeded 440,000 vehicles (annual growth of 32%).  [vii]  In China, Ford has several joint ventures including joint ventures with Jiangling Motors Corp and Changan Ford Mazda Automobile Co. These joint ventures provide it with three shared production platforms in China and also share factories in Nanjing and Chongqing. With China overtaking the U.S. as the worlds largest auto market last year, Chinese auto factories are running at full capacity. According to Ford, the two facilities it has with Changan Automobile Co. will not be able to accommodate expected future demand based on current growth expectations. Accordingly, it plans to open a $490 million factory in Chongqing in 2012, producing up to 150,000 vehicles per year and increasing total capacity to 600,000.  [viii]   B Detailed Assessment of the Political and Legal Issues Relating to the Counterfeit Auto Industry I Overview of the Political Landscape in China Although China has moved from a centrally planned economy to a market-oriented one, the Communist Party of China (CPC) still maintains political power. Having a one-party system makes the CPC susceptible to civil unrest that could threaten its power and, as a result, the CPC has been hesitant to take action that threatens local economies for fear of unrest. But as an emerging country with the worlds third largest economy on the frontier, China is struggling to balance the need to support local economies with a growing need to protect IP rights for both multinationals and domestic firms. Yet despite a reputation for considerable corruption, demonstrated by its 2009 corruption perception index score of 3.6, and a ruling CPC that often ignores counterfeiting since it supports many local economies, China still manages to attract multinationals such as Ford due to its potential for new customers and windfall profits.  [ix]   China and the World Trade Organization (WTO) Admitted to the WTO in 2001, China agreed to implement various measures that would liberalize its trade regime. Among these measures was the WTOs Agreement on Trade-Related Aspects of Intellectual Property Rights (the TRIPS Agreement). This agreement guards against counterfeit products by addressing minimum standards of IPRs protection, domestic procedures and remedies for enforcement of these rights, and dispute settlement procedures among WTO members.  [x]  However, despite these IPR protections, counterfeiting still represents about 8% of Chinas $10 trillion economy.  [xi]   To address this growing problem, in 2007 the U.S. asked the WTO to intervene, claiming that Chinas enforcement of IPR laws was so weak that it failed to limit the production of counterfeit products. Specifically, the U.S. argued that weak penalties for infringers and Chinas practice of allowing counterfeiters to sell goods seized by Chinese customs officials, provided that the fake labels were removed, provided little financial incentive for counterfeiters to cease production.  [xii]  In 2009 the WTO ruled that China breached trade rules by ignoring piracy and counterfeiting, yet it upheld Chinas criminal law on IPR; without strengthening Chinas criminal law and enforcement of IPR, it is likely that counterfeiting will continue to be problematic.  [xiii]   Conflicting Incentives for the Chinese Government Despite Chinas laws that aim to protect IPR, the Chinese government faces opposing incentives in cracking down on counterfeiters. Specifically, China must balance the economic benefits local economies enjoy from counterfeit products with the growing need to protect the IPR of foreign and domestic companies.  [xiv]  Because counterfeiting supports many local economies and millions of people, any crackdown on counterfeiting could result in serious economic losses. As this action would not be well-received, Chinese politicians are even less apt to prosecute counterfeiters or focus on strengthening enforcement of IPR laws. On the other hand, China must strengthen these laws and enforcement mechanisms if it hopes to continue attracting multinationals.  [xv]  However, many multinationals are so intent on entering the Chinese market, given its sheer size and potential profitability, that they are willing to operate in an environment with little IPR protection. As a result, the Chine se government has very little incentive to crack down on counterfeiters or greatly strengthen enforcement of IPR laws. Fords Risks in China and its Current Strategies Given this political landscape, Ford faces considerable risk in China. With three assembly plants in China, Ford has already encountered problems with counterfeit parts, claiming that counterfeiting costs the company $2 billion a year in sales.  [xvi]  Exhibit 2 Despite some multinationals willingness to live with Chinas lax IP protection, Ford has taken steps to protect against the growing problem of counterfeit auto parts and vehicles. Specifically, Ford has been using undercover intelligence to identify counterfeit producers and raid Chinese factories.  [xvii]  While these raids have prevented thousands of counterfeit products from entering the market, penalties still remain weak; the few offenders sentenced to prison can reduce their terms for $30 a day.  [xviii]  Despite Fords efforts and commitment to protecting its brand, this weak enforcement discourages any meaningful lawsuits and provides little deterrence to counterfeiters. Ford must develop strategies to work with the U.S. and Chinese governments to better protect against counterfeit products. II Overview of Intellectual Property Rights in China Chinas Current IP Environment Since joining the WTO, the Chinese government has been placing increasing emphasis on IPR to help encourage foreign investment in the country. Most recently, the Chinese State Council established a task force known as the Intellectual Property Executive Conference to look into IP-related issues. Chinas new auto policy released this year stresses the need to protect the intellectual rights of auto companies and bans the sale of auto products that violate these protections. China is also a party to many international agreements to protect IP (including the World Intellectual Property Organization and Paris Convention, among others). For example, China joined the Madrid Protocol in 1995, which requires reciprocal trademark registration for member countries, which now include the United States.  [xix]   The Chinese government has also established special IP courts to handle cases of IPR infringement more efficiently. In addition to having these specialized courts in some cities and provinces, Beijing, Shanghai and Tianjin have also established IP courts within the Intermediate Peoples Court. In 1992, the Supreme Peoples Court established an IP division as well. This increase in the legal systems capacity to handle alleged IP theft has been used to facilitate highly publicized campaigns, including activities such as raids and educational programs. Enforceability of IP Laws China has made significant progress on the legal and regulatory front, but despite stronger statutory protections, IP theft remains a major problem, as evidenced by the widespread existence of counterfeit products.  [xx]  In reality, IP laws are rarely enforced, and it is even rarer that those who are caught stealing, cheating, counterfeiting and pirating go to jail. Because China is a large country with some political decentralization, enforcing IP laws and regulations in China is a major challenge.  [xxi]   Several institutional factors undermine the enforcement of IP laws, including Chinas reliance on administrative instead of criminal measures to combat IPR violations, corruption, local protectionism, limited resources and training available to enforcement officials, and lack of public education regarding the economic and social impact of counterfeiting and piracy. At the most basic level, without adequate education with regard to IPR, there is little awareness that infringement is a crime. Furthermore, the fragmented nature of political authority in China and, more specifically, decentralized corruption exacerbates the lack of enforcement. For example, when counterfeiters have connections with local government or law enforcement officials, this may provide an easy cover for their counterfeiting activity. Local officials may create obstacles during investigations and assist local counterfeiters by letting them hide their production lines in safe places. Chinas fragmented legal system contributes to the problem as well. Protection of IP in China follows a two-track system. The first and most prevalent is the administrative track, whereby an IPR holder files a complaint at the local administrative office. The second is the judicial track, whereby complaints are filed through the court system. However, determining which IP agency has jurisdiction over an act of infringement can be confusing. Jurisdiction of IP protection is diffused throughout a number of government agencies and offices, with each typically responsible for the protection afforded by one statute or one specific area of IP-related law. There may be geographical limits or conflicts posed by one administrative agency taking a case, involving piracy or counterfeiting that also occurs in another region. Chinas courts also have rules regarding the scope of potential orders. In most cases, administrative agencies cannot award compensation to a rights holder. They can, however, fine the infringer, seize goods or equipment used in manufacturing products, and/or obtain information about the source of goods being distributed. China was also required to provide IP remedies through criminal enforcement for commercial scale piracy and counterfeiting, under the enforcement provisions of TRIPs. Chinas laws and regulations stipulate that IP administrative authorities and Customs may transfer egregious IP infringement cases to police and prosecutors for initiating criminal investigation. However, despite these criminal provisions, most IP cases continued to be handled through the administrative system. Foreign rights holders have considerably less success in encouraging criminal prosecution of IPR violations. When jail sentences are handed down, Ford officials in Taiwan say that those few offenders sentenced to prison can reduce their terms for $30 per day. Lawsuits are also often a waste of time, due to local protectionism. In 2003, Toyota lost a closely watched case in China against the countrys biggest private carmaker whose brand logo was nearly identical to Toyotas.  [xxii]  In the end, although interna tional pressure may have succeeded in getting Beijing to establish IPR laws and regulations, the enforcement of IP, as with most policy in China, falls within the domain of Chinas complex bureaucracies and local government officials. Outsourcing vs. Ford manufacturing To operate in China, Ford had to form a joint venture with a quasi-governmental partner: Changan Ford Mazda Automobile Co. in China.  [xxiii]  Fords other partner in China, Jiangling Motors Corp., makes commercial vehicles, including the popular Ford Transit van.  [xxiv]  These joint ventures are one of the biggest risks automakers face as they expand in China due to the danger of IPRs violations. The Chinese made no secret that part of their strategy in forming joint ventures was to begin to learn about the auto industry and how they can produce cars. Ford produces all of their vehicles in their own three plants in the country. However, they now source many of their component parts, which increases the risk of counterfeiting since the company has transferred production of certain parts from their own plants to third-party operations in China and India.  [xxv]  There are other issues that come with operating in a rapidly developing country. In China, factories are at risk of unscheduled shutdowns because of power shortages. Ford also faces political risk. Although the danger of nationalization or outright confiscation of Fords assets may not be high, China may not always have the best interests of foreign multinationals at heart. Despite these concerns, Ford is not shying away from the fast-growing Chinese auto market. Ford currently operates two plants in China, and it broke ground for a $490 million plant in September of 2009. The factory will make the next-generation Focus compact car, which Ford plans to sell globally. Its current plant in Chongqing makes the Ford Focus, Ford Mondeo and Ford S-MAX. Its plant in Nanjing, in eastern China, makes the Ford Fiesta.  [xxvi]   In order to set up operations in China, Ford was also required to establish research and development facilities alongside its manufacturing operations to help build the countrys technical know-how. Ford has taken steps to boost their Chinese design capabilities, which also benefits domestic Chinese companies. For example, Fords China design team is putting its own spin on the upcoming Ford Fiesta (tailored for the Chinese market). Fords Current Strategies Fighting counterfeiters is a key priority at Ford, and it has stepped up countermeasures worldwide. Ford, GM, and DaimlerChrysler formed a global industry network in 2001 to work with law enforcement agencies and governments to strengthen patent and trademark protection laws and impose criminal penalties to prevent counterfeiting.  [xxvii]  The problem is especially acute in the Middle East, where many counterfeit Ford parts made in China are shipped and sold alongside genuine parts.  [xxviii]   Ford admits it was late in its efforts to protect its IPR abroad. However, the company is now very active and has even established its own brand protection team. The unit has led a number of raids, which have led to prosecutions. Ford recently raided a Chinese factory and turned up 7,000 sets of counterfeit brake pads destined for Egypt, each stamped with a replica of Fords blue oval. A legitimate set of pads would cost the equivalent of $47 in Egypt; the phony ones might cost $30.  [xxix]   Furthermore, as a brand Ford is trying to make everything as sophisticated as possible. It has security features in the parts packaging itself and spends time on brand awareness and training exercises so people can better identify fakes. The company says this is critical to long term public awareness and stopping sales of counterfeit products.  [xxx]   III Overview of Product Liability Product Liability All auto manufacturers, including Ford, are exposed to product liability lawsuits related to the sale of autos or parts to the public, especially in litigious countries. Ford has the most exposure in the U.S. given the extremely litigious environment and its large sales. According to the Restatement (Third) of Torts: Products Liability a user or bystander in the U.S. can sue for injuries related to a defect or malfunction of the product, and, in some instances, a defective design or a failure to warn. Even though Ford does not manufacture and sell the counterfeit Ford parts it increases its exposure if the parts are believed to be manufactured by Ford and then cause accidents and injuries. Ford could be sued and incur substantial attorneys fees and possibly even settlement costs. Ford would then have to prove that the product was not manufactured or sold by them, and even if Ford is successful it will still face attorneys fees, damage to its brand, and wasted corporate resources. Product Liability History and Severity Product liability lawsuits can take years to defend, result in millions of dollars of fees and settlements, and severely damage a brand. Ford has faced product liability lawsuits in the past such as the Ford Pinto case in the 1970s that cost it millions and the Ford Explorer rollover related lawsuits in the 2000s. Ford manufactured the Pinto throughout the 70s and due to a faulty gas tank the cars often caught fire during rear-end collisions. The most notable Ford Pinto case (versus Grimshaw) cost Ford $6.5 million in 1981.  [xxxi]  Ford has faced many other product liability lawsuits throughout its history. Fords Current Strategies Ford recognizes its exposure to insurable risks including product liability related to the manufacture and sale of autos and parts. Given the critical nature of risk management Ford maintains a Global Risk Management Committee (GRMC) that makes risk related decisions and is headed by the Chief Financial Officer. Ford chooses to manage and protect against product liability risks through a combination of self-insurance and product liability insurance.  [xxxii]  The self-insurance is typically in the form of a calculated monetary fund setup to may attorneys and claims. The product liability insurance would provide Ford with attorney support and claims/settlement payments in the event of an insurable claim. Ford also has a Sustainability, Environment Safety Engineering (SESE) Team that works to prevent faulty products from being sold and to ensure Ford complies with safety and environmental regulations. They also provide technical analysis to corporate counsel on product liability lawsuits when needed.  [xxxiii]   Finally, Ford has created a Global Brand Protection group to protect consumers from counterfeit products threatening user safety. This group is tasked with: preventing the distribution of and removing counterfeit parts from the marketplace, ensuring that the companys trademarks are used appropriately, and maintaining the integrity of the sale and distribution of original equipment parts.  [xxxiv]   4 Recommendations China has quickly become the worlds largest auto maker, surpassing the US in 2009  [xxxv]  . Due to its immense scale and rapid growth rates, China is an important strategic market for Ford from a production and sales perspective. Despite the political and legal issues and risks Ford faces in China, the company cannot simply withdraw its operations from China. Ford must engage in market and non-market strategies to help manage the counterfeit problem in this market. Recommendation 1: Refine Internal Firm Strategies As mentioned previously Ford has started to invest in internal strategies, such as raids and setting up the Brand Protection Group, to help address counterfeiting. We recommend that Ford continue to refine these strategies as well as incorporate additional internal firm tactics. From a product perspective, Ford has noted that there are security features in the packaging of the auto parts and that consumers should use reputable dealers and repairers, inspect parts and packaging closely in case they spot something and if they are concerned to ask that only original parts are used or call the auto maker.  [xxxvi]  We recommend that Ford continue to invest in its packaging to help dealers, repair shops, and consumers detect fake products. The company could consider implementing a certification program where only legitimate Ford plants and OEMs are able to put a Pre-Approved by Ford label on its products. Additionally Ford needs to employ efforts to minimize spare factory capacity in these production facilities and to increase monitoring from U.S. Ford managers. In conjunction with product-related tactics, Ford needs to educate its customers (e.g. dealers, auto-body shops) and end-consumers and bring this issue to light. Because counterfeiting auto and auto parts drastically affects consumer safety, Fords customers and consumers should have a strong commitment to help prevent counterfeiting once they are aware of the issue. These educational efforts can be spearheaded by the Global Branding Team and be implemented in various public relations and marketing efforts. Most consumers may not be aware that counterfeit autos and auto parts exist and are responsible for associated safety risks. One campaign can highlight how counterfeit auto parts can lead to injuries and fatalities. The campaign can then empower consumers to ask for Ford parts only when having their autos repaired. This will encourage customers to seek out Fords legitimate replacement parts and be wary of counterfeit products. Ford also should implement tactics to educate and incent their employees, critical stakeholders. In conjunction with educating consumers, the Global Branding Team can utilize the same resources to educate its employees. This knowledge can help increase employees commitment to prevent counterfeiting and can also create a culture of pride related to high quality production and safety. Ford ca