Shan Zhai: How copycat businesses in China pose a real threat to large foreign companies

By Nitya Pandit 

Over the last few years, Shan Zhai has become a huge phenomenon in China. “Shan Zhai” is any business that produces and sells fake products. Some of these businesses have even become market disrupters, and in few cases, market leaders. The enormous potential that lies in the Chinese market has provided a platform for Shan Zhai companies to grow. These risk-taking and flexible companies move fast in the value chain to develop core competencies, that set them apart from their competitors. The Shan Zhai phenomenon has evolved from being just producers of low-cost copied products to gaining success by skipping the usual route of conventional operations.

A booming economy

Shan Zhai has managed to capture a major proportion of the Chinese consumer’s daily life. There’s a Shan Zhai business for everything, from smartphones to movies to medicines. This phenomenon did not arise over-night. It was the combination of soft and hard factors, which include Chinese culture, history, policy making, and market supply and demand, respectively. Shan Zhai businesses have superior production speed and ability to adapt to the local Chinese market. Hence, foreign companies need to be aware of Shan Zhai business moves at all times.

An example of how a Shan Zhai business started small and has now gained huge market power is BYD, a local battery and automotive manufacturer. After initially producing half-price versions of Toyotas, it has now become one of China’s most successful automotive manufacturers as well as a leader in car battery technology and dual-mode drive-train system. A cheap imitation of Coca-Cola, Future Cola, now ranks as the third largest company in the local carbonated soft drinks market—placing itself right after Pepsi. Even in the virtual world, Shan Zhai businesses don’t take a back seat. QQ, which is a copycat version of ICQ, has become China’s largest online instant-messaging platform. It boasts an eighty-percent market share, with about 380 million active users. All such companies come together to form the Shan Zhai economy.

Most of these companies start-off by focusing solely on the domestic economy, and usually target mass consumers. Their aim is to have a very short cycle time of product launch, and are determined to get low costs, which may result in lower quality at times. The products feature and functions are developed in such a way that they meet all the local requirements. As and when these companies become successful, they transform into businesses with their own intellectual property (IP) and portfolios, despite having started-off as counterfeiters.

The many dangers of Shan Zhai

Advocates of Shan Zhai businesses believe in the social and economic benefits that the businesses bring in. They also encourage such businesses, as they offer a wide range of products, hence providing consumers with a variety of items at low prices. This is an advantage for the current economic landscape in China. Additionally, the supporters also believe that Shan Zhai companies can compete, as well as break, monopolies which sell expensive products, along with boosting innovation in the home ground. The ones in opposition believe that Shan Zhai products are not only substandard but also publically defy the IP rights of other businesses. Opponents also blame Shan Zhai culture for being a breeding ground for laziness and lack of innovation and creativity.

In the past, products like the Shan Zhai ones were sold in alleys, underground markets and in poorly regulated countries. With the boom of e-commerce, however, not only can these counterfeiters penetrate through markets, but can also compete with the largest players. You may even find Shan Zhai products placed right next to the original products online. Hosting 62 percent of Chinese online vendors and 91 percent of those selling to the US, Amazon claims the position of the largest cross-e-commerce marketplace for Chinese sellers. These Chinese sellers now contribute to about 25 percent of Amazon’s global marketplace. While Amazon may have opened its platform to the Chinese manufacturers, it doesn’t know how to close or reduce their entry.

One of the biggest loopholes in the current situation is cross-border shipping and selling. Globally, the products see no borders, and hence, when selling internationally, IP laws, health and safety standards, and government regulations have become debatable. Chinese sellers on Amazon and eBay take cover under their wall of national regulations, hence shielding themselves from legal prosecution. This allows them to sell illegal and possibly dangerous items as well. For instance, a lady’s eyes were glued together, when she bought a supposed designer eyeshadow from eBay. Also, a Tennessee-based family’s house burned down when a copycat version (bought on Amazon) of a hoverboard exploded.

American companies cannot follow the Shan Zhai strategy because the likelihood of them getting sued by other American companies is very high—as has been seen in the past, with brands like Apple and Chanel. The American innovators are helpless because not only does their IP get stolen, but they are also kicked out of their own market. For example, Tianyu, a phone maker, that has copied and produced trended yet economical handsets, overtook Lenovo, the domestic leader. Additionally, it also aggressively competed with huge foreign brands like Samsung and Nokia.

Shan Zhai companies have posed a threat to foreign companies, but the threat goes above and beyond just them. This phenomenon has led to the evolution of an educational culture which demoralises creativity and innovation. Hence, such production results in merely mirror image of Western ideas. Additionally, since Shan Zhai companies work on the borderline of intellectual property laws, it results in foreign companies wanting to leave China. These companies also reduce their foreign investment in the country but also ensure that they don’t bring in their IP-sensitive products. Unable to move from being just a producer to an innovative disruptor, China is not able to create the best because of its dependency on borrowed concepts.

What can the foreign companies do?

Foreign companies, usually uncertain about their response to the Shan Zhai phenomenon, need to be prepared for it. These foreign giants should not underestimate the Shan Zhai companies just because they produce low-cost products and need to become game changers to really compete with them. Taking the legal route, companies can reduce the possibility of being copied. The foreign company should begin with applying for utility and design patents for an item that is valid everywhere it hopes to sell, including the US and, China, among others. These companies should also combine forces with its Chinese partners by signing NNN agreements before sharing any IP. This contract bars the Chinese companies from using and sharing the IP or inking a partnership elsewhere and then selling their own units. Creating limitations through the manufacturing route, companies should make products that are difficult to copy, play around with a specific feature, or simply create a strong brand loyalty. Foreign companies can follow Apple’s footsteps, and use a software which goes hand in hand with the physical hardware, hence protecting it from any imitation.

Even after implementing these changes and having the American government run after the Chinese government, companies can’t be completely assured that their product won’t get copied. So while foreign firms might want to get these Chinese factories shut down (which can be expensive and time-consuming), they must take the time to learn from these Shan Zhai firms. There is much too learn from the latter, such as being fearless with experimentation.

Photo by Flickr under CC BY-SA 2.0