The destruction of Nortel
Why protecting IP matters for Western economies
Dear all
I’m glad so many of you enjoyed my post about Chinese wine on Saturday – it had the biggest audience yet. Alcohol obviously hasn’t lost any of its attractiveness during this difficult time.
Today I return to a subject I have been looking at over the last few weeks, Intellectual Property (IP). It may seem a little dry for some, but IP is central to the relationship between China and the West. To summarise, China wants to be a/the major power by 2049. To do this it has to have made its economy number one, and to do that it needs massive amounts of IP. What many in the West claim is that much of this IP isn’t homegrown, but taken instead from American, British, etc companies.
There is of course some argument about this, but let’s say for a moment that it is the case that Chinese activities are taking IP from Western firms. The next question to ask is, does this even matter? “Intellectual property is theft” as many radicals would put it. Maybe. But IP is also the basis of financial survival for many large employers. Undermine the IP and you might destroy the company – as we will look at with perhaps the most famous case of all when it comes to reputed Chinese activities, Nortel.
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When Chinese businesswoman Meng Wangzhou was arrested upon arrival at Vancouver Airport in December 2018 it caused a global commotion. For a start, Meng was the Chief Financial Officer of Huawei, the firm then at the centre of President Trump’s efforts to push back on China’s technological influence. Then there was the fact that Meng – or Sabrina Meng, as she also calls herself – is the daughter of Huawei’s founder, Ren Zhengfei.
China naturally claimed foul. "We have said from the beginning that this is a serious political incident orchestrated by the United States to suppress Huawei and other Chinese high-tech companies”, said China’s Ambassador to Canada, Cong Peiwu. Others questioned why Canada, a country with a seemingly gold-standard record of international niceness, would involve itself in such an American move.
Dig a little deeper, however, and it becomes clear why there would have been the will in Ottawa to put a neck out and arrest Meng. It was Huawei, after all, which had a hand in destroying one of Canada’s prized corporate assets.
Nortel was, at its height, Canada’s leading technology company, with a long and proud history. Founded in 1895 as a subsidiary of the Bell Company, by 1991 it had become a public company with revenues of $8 billion and a strong expertise in wireless and optical networking. By the end of that decade Nortel dominated the market for fibre-optic transmission systems and had used its revenues to heavily invest in a new generation of technology, such as a touchscreen wireless device a decade before the iPhone.
At its peak in 2000 the company employed 90,000 people, had a market capitalisation of $250 billion, and represented 35% of the value of Canada’s main stock exchange. It was also at the centre of a sprawling tech ecosystem which attracted some of the best and brightest talents from across the world.
Their success didn’t go unnoticed. Starting in the late 1990s, as chronicled in a piece for Bloomberg by the journalist Natalie Obiko Pearson, the Canadian Security Intelligence Service began to notice unusual traffic that suggested hackers in China were stealing documents from the company. They warned Nortel, but its management did nothing.
The company was an excellent target because of its lax security. In a little-known event reported in the book China’s Quest for Foreign Technologies, it was even penetrated by Julian Assange and a group of Australian hackers. The future Wikileaks founder and his colleagues proceeded to roam around Nortel’s systems, and used this access to install password-cracking software on 5,000 computers in Canada.
This was small beer compared to what else was happening to the company. By 2004 the hacking of Nortel had shifted up a gear, taking what one expert called a “vacuum approach” – sucking up whole folders of information. Someone even managed to hack into the CEO’s email and use it to send 800 documents to an email address outside of the company, no doubt a compendium of proprietary information. And here’s the kicker: the address the files were sent to was in Shanghai.
Whilst there is no direct evidence that Huawei received any of the stolen IP from Nortel, there are widely held suspicions. “What was weird is that when we started receiving the Huawei telecoms parts, we realised that they worked almost perfectly with the Nortel equipment we already had,” said Tom, a UK-based friend of mine from the telecom sector, about his experiences from the early 2000s. Even the instruction manuals were the same.
Whoever was doing the stealing, Nortel’s failure to adequately deal with the thefts laid the path to its failure. “Perhaps because of the hubris that came from being a market leader, or because it was distracted by a series of business failures, Nortel never tried to determine how the credentials were stolen,” writes Pearson. It seems that the only measures taken were to change the passwords; that wasn’t nearly enough, and the hacking continued. By 2009 the company was dead.
There is an argument to be had that Nortel wouldn’t have been able to thrive in the longterm anyway, because it was also being outcompeted commercially, and in particular by Huawei. The Chinese firm was able to do so thanks to the advantages it enjoyed as a firm subsidised by the State.
Huawei poached Nortel’s biggest customers by offering terms that could not be matched: for example, lending the Nigerian government $200 million at an interest rate of just 1% so that they could buy Huawei equipment with it. This international expansion was seeded by over $10 billion of credit by the China Development Bank, and over the next decade this credit line would reach $100 billion. No company in the sector could match the terms provided by the Chinese giant, and not even in Canada. In 2008 Huawei beat Nortel on its home turf by winning part of a $1 billion wireless contract.
This is not to say that Huawei’s success is based on nothing but cheap credit (and allegedly stolen IP). The founder and former PLA engineer Ren Zhengfei has invested huge amounts of money into R&D, including $4 billion alone on 5G, more than all its Western rivals combined. This research is helping to cement Huawei as one of the world’s most important tech companies, winning billions of dollars of contracts across 170 countries, and garnering awards for its products.
The current legitimate success of Huawei cannot, however, take away from the accusations of how it was able to amass its technology and financial strength in the first place. We also can’t overlook what this meant for one of its major early competitors. It is clear that by fair means or foul, China helped one of its national champions to destroy a leading Western firm.
This caused the loss not only of tens of thousands of jobs, but also tax revenue for the Canadian government, and pension contributions for its people. It has also left Huawei in control over much of the world’s plumbing of the modern digital age, which America and its allies are now working very hard to roll back.
The lesson is simple: intellectual property is worth defending. Much like toothpaste, once it’s out it is impossible to put back in, and all you’re left with is an empty, worthless tube. This should be a salutary warning for managers and shareholders - not to mention any government that wants to foster and preserve its own corporate champions.
Corporate espionage and creative destruction have been part and parcel of capitalism from the start. What is different here is that China has now developed the centralised capability to destroy foreign companies. Some even argue that this is not a latent capability, but one that has actively been designed and executed to simultaneously boost its own innovation and diminish that of its rivals, in a process that is called Innovation Mercantilism.
Next week we’ll be looking at whether there’s any truth to this.
POSTSCRIPT: Sabrina Meng continues to live under house arrest in an upscale part of Vancouver as the court cases over her extradition to the US rage. By day she is allowed to leave her home, but must be escorted by a security detail at all times. This is in stark contrast to the fate of two Canadians, Michael Kovrig and Michael Spavor, who were apprehended in China shortly after Meng was taken into custody, some say as revenge for her arrest. Unlike the Huawei executive, the two men – a former diplomat and a businessman – remain behind bars and have reportedly been subjected to between six to eight hours of interrogation a day. Charles Parton, a British former diplomat, is leading a campaign to free them.