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Patents and Profits

14th 05 2018

(This article was written by Charles Arthur, first published 12/05/2018 on The Guardian, and can be found here: https://www.theguardian.com/technology/2018/may/12/lenovo-chinese-giant-plays-rules-loses-patents)

The war of words between the US and China over trade has many subtexts, but treatment of intellectual property (IP) is a major factor. Donald Trump believes that the world’s second-largest economy gains an unfair advantage over its main rival due to an overly aggressive and sometimes underhand approach to IP – the patents and copyrights that underpin big tech, manufacturing and creative breakthroughs.

So what happens when China plays the game fairly and buys American IP to gain a foothold in the world’s biggest economy? In the case of Lenovo, one of China’s biggest tech firms, doing so has been no guarantee of success. The Beijing-based company has bought three respected US tech businesses since 2005: IBM’s PC arm and low-cost server unit, and Motorola smartphones. None of them has worked out. Far from enabling Lenovo to trample rivals, the phone and server businesses, both acquired in October 2014, for $2.9bn and $2.3bn respectively, have turned into anchors that threaten to pull it down to a loss when it announces full-year results this month.

IBM’s sale of its PC division to a then barely known Chinese company in 2005 raised eyebrows, but it made sense at the time. By 2005 IBM couldn’t make a profit in personal computers, as it was beset by far cheaper rivals. Lenovo could, though, and quickly became a contender for the world’s biggest PC maker, vying with Hewlett-Packard. It looked like the harbinger of a Chinese invasion. While the IBM PC business complemented Lenovo’s existing offerings, Motorola seemed to be the big prize. It sold the world’s first mobile phones in 1983 and in the 2000s the “Hello, Moto” slogan achieved global recognition. Google snapped it up in 2011 for $12.5bn, thwarting Yang Yuanqing, Lenovo’s chief executive. But Motorola didn’t make a profit under Google, which offered it to Yang three years later.That sale of an American icon attracted little regulatory attention. But one American technology executive expressed private outrage at Google’s decision: “it’s an American brand! It’s shameful to sell it like this,” he said.Yang was confident that adding it to Lenovo’s China-based smartphone business would create a global behemoth: the combined company was then behind only Apple and Samsung in the smartphone market. Lenovo’s presentations sounded like a company preparing for war, with phrases such as “protect PC leadership” and “attack mobile internet”.

But Lenovo’s accounts show the smartphone business has lost money every quarter since the takeover – in total, nearly $2bn. Early in March, half of Motorola’s 380 engineering staff at its Chicago offices were let go. China’s Huawei, another big tech player, has raced past Lenovo to become No 3 in smartphones globally; Lenovo is almost out of the top 10, selling 17% fewer phones than in 2014 while the market has grown 15%.

The problem has been a long internal struggle over which brand – Lenovo or Motorola – should drive the business, says Neil Shah at Counterpoint Research. Choosing one brand in territories where they overlapped – China, south-east Asia and India – lost business for the other, but running both meant duplication. He expects the Lenovo brand to be retired in favour of the Motorola one. Asked why the business is not profitable, Lenovo responds that “component costs continue to present challenges” but that it will try to strengthen its position in Latin America and “drive breakthrough in mature markets” along with “controlled investment in emerging markets”. Nor has the server business been a shortcut to success. Since the 2014 takeover it has lost more than $700m. Adrian O’Connell at analysis firm Gartner says the growth of cloud services from Google, Amazon and Microsoft – which allow consumers and companies to store data without the need for their own hardware – threatens all server vendors, because those big providers bypass the profitable support contracts that server companies rely on (often by manufacturing their own equipment).

Security is also an issue. “In certain sectors there will also be the potential perception issue of working with a China-based supplier at the heart of their data centre, which is an unavoidable challenge for [Lenovo] now,” O’Connell adds. Even the profit engine of the PC business is struggling. Lenovo slipped from first to second place in 2017 as Hewlett-Packard regained its crown, and the PC industry is in a years-long decline, with no clear end in sight. Yang might yet have to swallow a paper loss on those 2014 acquisitions. Of the just over $5bn spent on the Motorola and IBM server businesses in 2014, $2.7bn was allocated to “goodwill” – the part of a company’s value that applies to intangible factors like brand names, customer relationships and patents. In January, a Bloomberg analysis said that Lenovo’s struggles indicated that a goodwill writedown, and potentially a full-year loss, was coming.

For Lenovo, the past four years provide a salutary lesson for those seeking a trade war over IP: that even buying patents and copyrights fair and square will not give you a lead in the cut-throat global tech market.

(This article was written by Charles Arthur, first published 12/05/2018 on The Guardian, and can be found here: https://www.theguardian.com/technology/2018/may/12/lenovo-chinese-giant-plays-rules-loses-patents)