By Mark Schaub and Ray Black King & Wood Mallesons’ FDI Group
More than any other country,China has greatly benefitted from globalization. In the last 25 years China has risen to become the world’s workshop and a manufacturing giant.
However, there has been a small country that has undergone its own transformation in recent decades. Israel, a country in a “challenging” neighbourhood with a very limited domestic market, has become a technology innovation powerhouse. Indeed Google Chairman Eric Schmidt considers that “Israel has the most important high-tech centre in the world after the US.”
These two very different yet very complimentary countries are likely to find great scope for collaboration in the coming decades. They are certainly now looking for it.
Innovation: China Needs It – Israel’s Got It
China’s leadership has realized that future sustainable growth will require the development of an innovation based economy. China’s current Five Year Plan (2011-2015) and resolutions of the 18th Central Committee of the Communist Party of China recognize that innovation is a key Chinese strategic priority.
China has not been sitting on its hands in respect of technology. It is estimated that China currently spends approximately US $200 billion per year on research and development and that its annual expenditure has increased by at least 12% for the past 20 years. As China manages the transition from low-cost manufacturing base to an innovation driven economy it is likely to face similar bottlenecks that would have constrained its manufacturing growth during the 1990s manufacturing boom. However, this time China will not look abroad to secure supplies of iron or coal but rather to acquire innovative technology.
Chinese companies have become world beaters in delivering quality manufactured products at a low cost. In many cases these products have rested upon proven technology developed elsewhere. To a large degree, foreign commentators have not recognized the production know-how and innovative strides Chinese manufacturers have made to reduce cost and mass produce product. But being the best at manufacturing a certain level of product at acceptable quality for the cheapest price is a policy that will not enable Chinese companies to meet the challenges of the next stage of global competition – in order to grow in the next phase, China will need to be a world class innovator as well as manufacturer.
Innovation is occurring in China but in many ways it is the innovation of the large. Major Chinese companies such as Huawei (the second largest global telecommunications equipment maker after Ericsson) are innovating whilst major multi-nationals such as Nokia, Proctor & Gamble, General Electric and many others have established R&D facilities in China. But these activities do not address the truly creative, innovative technology that Chinese companies crave. For a variety of reasons the craving for this type of technology is unlikely to be quenched in the short to mid term purely by domestic supply.
Enter Israel: Production Pygmy but Innovation Giant
Israel’s credentials for high-quality innovation are clear. It is global number one per capita in:
• Patent registrations
• R&D spending
• Number of start-ups
However, with a population of only 8 million and a … challenging … neighborhood, Israel is constrained from becoming a major manufacturing center. Traditionally, Israeli start-ups have looked to the US and to a lesser degree Europe as a source of funding or as a potential acquirer.
Start Up Nation Meet Buy Up Nation
- “Follow the Money”
In recent years Chinese outbound investment has accelerated exponentially. China is rapidly becoming the ‘buy-up nation’. China’s provincial level SOEs and private enterprises are increasingly interested in acquiring overseas technology – Israel has the technology China needs.
- “China is Enough”
Interestingly, many Chinese enterprises are willing to buy or license technology exclusively for China rather than requiring global rights. With a population of 1.35 billion, the world’s second largest economy and a long “to do list”, China as a market is large enough for the most ambitious of companies.
- Political Support
The complimentary nature of China and Israel’s economies has not gone unnoticed by either side. Israel’s Chief Scientist has stated that Israel is ‘good at innovation and technology transfer’ and China ‘can scale up manufacturing and beyond.’ The Third Plenum was a hot topic at Israel’s Business Conference on 8 December 2013.
Israel and China’s political relationship has had its up and downs over the years. Israel recognized the People’s Republic of China all the way back on 9 January 1950, but China only formally established diplomatic relations in 1992. For many years (until the late 1980s) Israeli passport holders could not even visit China. Despite this issue, there was co-operation on a variety of fronts (including military) in the background.
In recent times the political and economic relationships have never been better. The Chinese Government is actively taking actions to improve and boost economic relations. In 2013 China and Israel signed both export enhancement and trade agreements.
Specific hot areas of China interest for Israeli technology includes:
• Environmental • Medical devices • 3D printing
• Agri-business • Pharma • Robotics
• Solar energy • Online media • Cleantech
• Security • 5G networks • Industrial tech
The Trend is Here … kind of
Although there is movement in the level of Chinese investment into Israel it does seem likely that the amount of media attention does exaggerate the actual deal flow. The major deals which have taken place to date seem to have been in relatively mature companies and technologies such as AfiMilk milking technology, Hans Laser Technologies acquisition of Nextec Technologies, Fosun’s acquisition of Alma Lasers, ChemChina’s acquisition of Makhteshim Agan, and the possible acquisition of Tnuva Food Industries by Bright Food Group. It is possible that there are many more technology deals occurring below the radar but the more likely explanation is that the trend has not yet taken wing.
American Dream … Israeli Dream … China Reality
The definition of the American Dream as stated by James Truslow Adams in 1931 is “life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement”. For many the Israeli Dream seems to be to work in a start up and be bought out by a US company. However, the Chinese reality in respect of buying a hi-tech start up is that after the cheque has cleared so have the employees. A major issue for Chinese investors in high-tech companies is to retain the overseas employees.
For this reason it is very likely that Chinese companies will either continue to buy mature Israeli companies or take strategic stakes or enter a joint venture in respect of immature technologies and/or strategic investments in venture capital funds. One example of Chinese companies strategically investing in immature technologies is the investment in WBP Venture Partners, a venture capital firm that is raising $50 million for investing in Israeli tech startups that are looking to break into China and particularly focusing on life sciences, medical devices, green technology, telecommunications, online media and industrial technologies.
Although many Israelis instinctively look to the US or Europe for their export markets, most Chinese companies are content (at least initially) to gaze inwards at the China market when considering Israeli technology. In many cases the Chinese company will be content with only exclusivity for China. Often China is the biggest market for a particular technology or its application.
IP Protection in China – Register Early, Pick the Right Partner
Invariably whenever the terms China and foreign technology come together, concerns as to IP protection are not far behind. Israeli hi-tech start ups have legitimate concerns as to protection of their intellectual property. Despite improvements in China, IP protection remains a major issue. Accordingly, Israeli companies are well advised to take steps to protect their technology in China (through patent registrations, protection of their business secrets and trade marks), and also to co-operate with the right Chinese partner. A long term Chinese partner is not just a partner in the technology transfer but also in the protection of such technology within China.
The Chinese leadership realizes that a transition from a low-cost manufacturing to an innovative high end product based economy will require China to clamp down on IP infringement. In this regard China has taken many steps, the most recent of which is the reform of the Trademark Law. However, the size, fragmentation of manufacturing and sheer volume of competition within China means that IP infringement will be an issue to deal with for some time going forward. Once China has its own IP to protect, though, the rate of progress should noticeably accelerate. Israel-China cooperation can also contribute to this development, as mutuality of interest will prevail.
Overall, a shidduch between a start-up nation with limited manufacturing resources and market opportunities and a buy-up manufacturing titan that lacks sufficient innovation makes sense.
Both Israel and China realize they are highly complementary and are placing emphasis on building a long term relationship. As Benjamin Netanyahu says, Israel and China are ‘two ancient peoples with a glorious past, a difficult in-between period, and then soaring into the future.’
However, Israeli companies need to realize that Chinese buyers do not want to be a freier (sucker). Chinese investors will need to understand what they are buying and know that the talent that they buy will still be there after the transaction closes. Israeli companies will need to understand this too, and understand the Chinese decision making process. Potentially, the combination of Israeli know-how with Chinese manufacturing muscle is unbeatable. However, ultimate success will require efforts on both sides.