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Heart of the Matter. The Recorder. October 6, 2008.

October 06, 2008

By Ned Isokawa, Qin Shi

_The Recorder_Heart of the Matter

By Ned Isokawa and Qin ShiOctober 6, 2008

Impressing the world as the host of this year's Olympics, China put on a graceful and sophisticated show filled with history, culture, art and technology.

Beyond the glitz and pyrotechnics of the Olympics' opening and closing ceremonies, the world also continues to marvel at China's rise over the past two decades. Indeed, a foreshadowing moment in China's emerging modernization occurred in the early 1980s, when Deng Xiaoping declared, "black or white, a good cat is one who catches mice," and led the country onto a realist's path towards social stability and China's version of middle-class wealth.

That profound realism transcended ideology and allowed China to develop a vibrant market economy while preserving a regulatory framework under the familiar state control the so-called market economy with Chinese characteristics.

Underlying this massive revitalization effort is a creative spirit that China has been vying to reclaim for itself a hallmark and legacy of the civil society that existed 1,000 years ago under the reign of such prosperous dynasties as the Tang. To be sure, Chairman Mao's old adage, "let a thousand flowers blossom," best describes the first wave of China's economic growth, evident in its southern coastal area near Hong Kong.

Generally known as the Pearl River Delta, this area was carved out as a special economic zone. Building on its close ties with overseas Chinese in Hong Kong, Taiwan, Southeast Asia and Japan, the area ushered in a new era of private enterprises in China in the 1980s and 1990s. Manufacturing and trading mushroomed across a wide variety of industries, including textile, domestic appliances, jewelry, chemicals, construction and electronics. The newly awakened entrepreneurial drive resonated throughout this southern new frontier of growth and opportunity in China.

Fueled with overseas capital, enabled by Western-style management know-how and boosted by favorable policies from China's central and local governments, the delta's economy achieved sizable growth and elevated the local standard of living to new heights. Undoubtedly, the delta's development was a powerful demonstration for the new achievements possible under Deng's design sustained productivity and a comfortable living.

If this initial wave of development was China's opening statement for its case of returning to the world stage as an economic force to be reckoned with, the country's closing statement is unfolding before our eyes as it extends its growth and opportunities to its vast heartland outside of its major cosmopolitan cities.

This, to China observers, signifies the third wave of development one that succeeds the second wave of development in the cities and promises to ease disparities between urban and rural China. (Little needs to be said about China's second wave of development for it is self-evident and still going strong in China's major cities. For example, few would quarrel that Shanghai now rivals Hong Kong, London, New York and Tokyo as an international financial powerhouse and an epicenter of the global economy.)

It is what is happening outside of cities like Shanghai that will decide for China whether it remains a giant with pockets of economic wealth in its cities and a subsistence existence in its heartland villages. By taking the new wave of development to its heartland, China is attempting to even the pace of its growth across the entire country and to finally and resolutely bring its economy up to par with that of the world's developed countries.

Just as the Wild West once brought golden opportunities in America, heartland China now brings great opportunities to venturous Chinese businesses as well as foreign companies and investors. This is particularly true for those who shun the major cities such as Shanghai in the face of rising costs and shrinking space.

It is important to recognize that heartland China may have a different business and regulatory climate than that of coastal China. Issues of critical import to technology enterprises such as intellectual property protection may be thought of and dealt with differently. Thus, while the exploitation of the new heartland frontier offers exciting opportunities, it also presents unique challenges.

To appreciate these opportunities and challenges, it is instructive to survey some of the new drivers that bring impetus to the developing heartland. In particular, the emergence of platform-oriented industry parks deserves special attention. These industry parks first appeared in major cities. They then spread into satellite or second-tier cities near the major cities. Now, they are spreading further into discrete, newly developed zones found in the open rural spaces all over China.

These industry parks are distinct from traditional incubators for early-stage businesses. Instead, they are designed to sustain the full-growth trajectories of the businesses they house. They are home for fledgling startups as well as mature, publicly-traded companies with multimillion-dollar market capitalization.

These parks are platform-oriented in that they are designed to enable horizontal and vertical integration in a given industry and its related areas. For example, a manufacturing and machining platform-oriented park may house tools manufacturers, clean room facilities, repair and service operations, component providers, material science testing facilities and logistics and warehouse operations. In addition, the park would provide basic infrastructures including power supply, communication fiber networks and, if desired, restaurant or cafeteria services. As is evident, businesses in the park would have the ability to partner or cooperate with one another, thereby enhancing productivity and efficiency.

Besides such hard integration, a platform-oriented park also promotes soft integration among the managers and engineers from different businesses. For example, regular C-level executive lunch meetings can be arranged for the top managers from all of the businesses. A fancy term, "co-promotion," is given to such activities. And a simple algorithm is put to work: meet and co-promote; repeat, until new ideas emerge; assess new productivity achieved from the new ideas; return.

Platform-oriented parks have succeeded already in both traditional industries and new technology areas, including materials, electronics, software, computer gaming, biotechnology, communications and energy. Regions in China that are benefiting from the trailblazing activities of these parks include the Yangtze River Delta near Shanghai and the northeastern provinces.

These parks are especially effective for targeted expansion of a given industry or translocation of a particular technology from a major city to a rural area where industrial and technological infrastructures is lacking. For example, a successful software park in a major city can spin off a new park in its satellite city, exporting its management protocols, infrastructure standards and logistic formulas. The new park, in turn, may expand further and establish yet another park in suitable rural inland areas away from the satellite city. At every level, each new park maintains the original model by replicating the same protocols and standards handed down from the older park. As a result, the expansion of relevant technologies and services is achieved in a way that is akin to a franchise with some unique Chinese characteristics such as a larger scale and perhaps greater complexities.

It is a relatively new phenomenon that the local government in an inland city or rural village would initiate such an expansion. That is, local governments interested in developing a particular industry or technology would invite an industry park with a recognized expertise and a successful record from a major city to set up a new local park. That new park would anchor the industry and enable its growth in the local area. Under this ideal scenario, the local government would then provide favorable terms for the use of land and other local resources, as well as favorable local tax allowances.

In essence, therefore, platform parks are a vehicle to jump-start specific industries outside of the primarily city-based production and technology infrastructure in China. Slowly but steadily, these parks are bridging the chasm between coastal and heartland China. Riding this new wave of development, operators of platform parks and businesses settling in them could most assuredly expect handsome returns.

Nevertheless, it should be remembered that local and central governments are key principals in this new phase of development. Before embarking on the process of setting up a platform park or deciding to settle in one, it is vital to consult with local government representatives and to secure support early and often. This local support comes in the form of long-term land use authorization, tax incentives and various local licenses and permits for infrastructure and supply and necessary business operations.

Of critical importance, and relevant also for all businesses operating in a park, is local support for intellectual property protection and enforcement. IP enforcement in heartland China is expected to rely heavily on nonjudicial, administrative proceedings. The enforcement arm of the local government plays a critical role in curtailing potential infringement activities. For this reason, it is essential to establish an effective, working relationship with the local government and to recruit local assistance whenever an IP violation is suspected.

Aside from an effective public-private partnership for IP enforcement, it is crucial for those going into China's heartland whether they are Chinese or foreign businesses to negotiate rigorously vetted contracts and commercial papers that clearly set forth all terms of the relevant business relationships and transactions. This is particularly essential in light of the well-worn cliché that the Chinese are not to be held to a piece of paper. If a new phase of growth in heartland China will help to retire that cliché, quality papers are a must.

If the world discovers heartland China as a new frontier of opportunity and challenge, the winners will be those who understand China's macroscopic growth patterns and who are best equipped to deal with local cultural, regulatory and business microcosms.

Ned Isokawa chairs the Asia litigation department at Paul, Hastings, Janofsky & Walker. Qin Shi is a litigator and senior associate in the firm's Palo Alto office, where she specializes in IP and China-related matters.

Reprinted with permission from the October 6, 2008 edition of The Recorder. © 2008 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited. For information, call 749.5410 or Paula.Ryplewski@incisivemedia.com. ALM is now Incisive Media, www.incisivemedia.com