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Cablegate: China/Ipr: Apple Takes a Bite Out Of

VZCZCXRO1957
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3732/01 2700120
ZNR UUUUU ZZH
P 260120Z SEP 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 0136
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEHIN/AIT TAIPEI 7073
RUEHKO/AMEMBASSY TOKYO 2238
RUEHUL/AMEMBASSY SEOUL 0954
RUEHMO/AMEMBASSY MOSCOW 9123
RUEHGV/USMISSION GENEVA 2295
RUEAHLC/DHS WASHDC
RUCPDOC/USDOC WASHDC
RUEAWJA/DEPT OF JUSTICE WASHDC
RHMCSUU/FBI WASHINGTON DC

UNCLAS SECTION 01 OF 05 BEIJING 003732

SENSITIVE
SIPDIS

State for EAP/CM - PPark and EB/IPE - DBubman
State for EB/TPP - EMagdanz and INL - JVigil
State for EB/CIP - WWitteman and RDaley
USTR for China Office - AWinter; IPR Office - RBae;
and OCG - SMcCoy; and JRagland
Commerce for National Coordinator for IPR
Enforcement
Commerce for WPaugh, NWinetke
Commerce for MAC 3204/ESzymanski
Commerce for MAC 3042/SWilson, JYoung
LOC/Copyright Office - STepp
USPTO for Int'l Affairs - LBoland, EWu, STong
DOJ for CCIPS - MDubose and SChembtob
FTC for Blumenthal
FBI for LBryant
DHS/ICE for IPR Center - DFaulconer, TRandazzo
DHS/CBP for IPR Rights Branch - GMacray, PPizzeck
ITC for LLevine, LSchlitt
State for White House OTP Ambassador Richard Russell

E.O. 12958: N/A
TAGS: ETRD EIND KIPR ECON CH
SUBJECT: CHINA/IPR: APPLE TAKES A BITE OUT OF
CHINESE FAKES

This cable is sensitive but unclassified and is not
for Internet distribution.

Summary
-------

1. (SBU) As amazing as it seems, computer maker
Apple Inc. had no global security team - including
inside China - until March 2008, when they hired
away the team from Pfizer that formed and led a
multi-year crackdown on counterfeit Viagra
production in Asia. Now with Apple, Don Shruhan,
based in Hong Kong, has taken the first basic step
of registering the company's trademarks in China and
Hong Kong and is targeting retailers, manufacturers,
distributors, and online vendors to take a bite out
of China's counterfeit iPod and iPhone production.
Early evidence suggests nearly 100 percent of Apple
products in unauthorized mainland markets are knock-
offs, while factories in Guangdong province are
exporting enough counterfeits to single-handedly
supply the world with fake Apple products. End
Summary.

From Viagra to iPods
--------------------

2. (SBU) Apple Inc., the Cupertino, California-based
designer of Mac desktop and laptop computers, was
not especially well known in mainland China before
the introduction in 2001 of its now-ubiquitous iPod
music player and, more recently, the iPhone. Now
those products are so popular worldwide that China's
notorious counterfeit markets are filled with knock-
off versions. After finally recognizing the threat,
Apple hired Don Shruhan from Pfizer in March as
Senior Director of Security for Asia Pacific to
design and launch the company's security strategy,
including anti-counterfeiting efforts, in the
region. His focus is on China, where he is "afraid"
of the volume of fake Apple products being produced,
though he is so far unable to quantify the scope.
Shruhan's boss at Pfizer, John Theriault, was also
hired by Apple, and is now VP of Global Security,
based in California.

3. (SBU) Shruhan, who over the past five years
developed and implemented a security and anti-
counterfeiting strategy for Pfizer aimed largely at
tackling fake Viagra production in China, said that
he is starting more or less from scratch at Apple -
the company had not so much as registered its
trademarks in China or Hong Kong until he joined the
company early this year.

China: Source of Fake (and Real) Apples
---------------------------------------

4. (SBU) Effectively all of Apple's iPod and iPhone
production is performed by sole-sourced third party
vendors in China, largely in Guangdong province --

BEIJING 00003732 002 OF 005


China's manufacturing heartland and counterfeit
capital. (Note: MacBook laptop computers are also
produced in China, but are less popular than the
company's other products and not subject to
counterfeiting. Shruhan has not yet spotted any
fake Apple computers. End Note.) Media reports
indicate that a single plant operated by electronics
subcontractor Foxconn employs 200,000 workers making
iPods in Longhua, Guangdong province. While cities
in that province, which also include Shenzhen and
Guangzhou, are far and away the biggest source for
fake Apple products, Shruhan says that internal
controls at subcontracted facilities, combined with
independent audits, are good enough that he does not
believe authorized plants are producing unlicensed
products in a so-called "third shift" scenario. He
explained that Apple's system for tracking each
product's unique serial number appears very
effective, and more sophisticated than Pfizer's.
Instead, he attributes the usually poor-quality
fakes to independent operators without links to the
licensees, though he acknowledges the manufacturing
molds for iPods or iPhones could be removed from
licensed factories and used in illegal production.
This can result in fakes that appear flawless on the
surface, but whose internal hardware is substandard.
Shruhan has discovered, for instance, what appear to
be real iPods with 80GB of storage, but that in fact
have only a very inexpensive 1GB hard drive inside.

Exports Shipped through Hong Kong
---------------------------------

5. (SBU) Whatever means counterfeiters are able to
exploit, the numbers are compelling: Shruhan notes
that customs seizure data definitively show that
there is enough counterfeit production of Apple
products in Guangdong to effectively make China the
single source for the world's fake iPods and
iPhones, many of which are transshipped via Hong
Kong to points onward. Even with the introduction
of genuine iPod and iPhone retail sales in China
(through authorized dealers and, more recently, an
actual Apple Store), Apple's marketing strategy here
is still in its infancy. The popularity of its
products is stronger outside of China. In three
recent raids in India, all fake Apple products were
found to have been transshipped through Hong Kong
(from China). Also, goods bound by air for
Mauritius were recently seized in Hong Kong.
Shruhan explained that Hong Kong's port has
historically received less scrutiny than others for
outgoing goods. In his experience with Pfizer, he
found Hong Kong customs authorities reluctant to
launch investigations that they fear could slow port
traffic - especially in comparison to more willing
mainland customs officials - but could be convinced
to cooperate if negative publicity can be minimized.

6. (SBU) Hong Kong is not only the exit port for
outbound fakes, Shruhan said, but is also the point

BEIJING 00003732 003 OF 005


of entry for legitimate Apple products entering
China's gray market. By buying iPods and iPhones in
Hong Kong, outside of mainland China's customs zone,
entrepreneurs willing to transport products across
the border can resell them at an instant profit of
approximately 25 percent to mainland Chinese
accustomed to paying import duties and value-added
taxes.

Retail Outlets
--------------

7. (SBU) Genuine Apple products in China until
recently were sold only through authorized
resellers. In July, the company opened its first
official Apple Store in Beijing and plans to open
another - the world's largest - in the Chinese
capital in early 2009. Outside of these legitimate
channels, vendors misrepresenting themselves as
"authorized" may sell the occasional real iPod or
iPhone, but predominantly offer fakes. Shruhan
recently completed an informal (and statistically
insignificant) survey of markets in Beijing,
including the notorious Silk Street Market, where
his team found that, while many Apple products "look
good," nearly 100 percent were fake.

The Approach to Fighting Fakes
------------------------------

8. (SBU) In many ways, Shruhan intends to model
Apple's security plan in China on his successful
experience at Pfizer, so he can quickly unroll a
strategy. In broad terms, the company will target
retailers first to raise their costs and get
counterfeit products off the street. Next, Shruhan
will work with the authorities to crack down on
major manufacturers and distributors of fakes to
undermine the supply of fake products. Finally, he
will seek out vendors who sell knock-offs online.
To accomplish this will require not only a team of
investigators, which Shruhan has subcontracted, but
also tools like a laboratory to begin accurately
tracing the source of counterfeit goods. A lab that
can perform forensic analysis on individual parts
like batteries, for example, can help to locate
high-volume manufacturers of such component parts.

Cooperation with the Chinese Government
---------------------------------------

9. (SBU) A key component in Shruhan's plan is close
cooperation with the Public Security Bureau (PSB).
Pfizer enjoyed very strong support from the PSB in
pursuing counterfeit pharmaceuticals, in large part
due to health and safety implications at a time when
China was particularly sensitive to such image
issues after the use of lead-based paint in toys and
unsafe Heparin. Shruhan is unsure how much the PSB
will focus on Apple's issues, but believes a safety
angle like shoddy devices causing fire hazards will

BEIJING 00003732 004 OF 005


strengthen his case. Short of this, his most
persuasive argument will be the economic impact of
counterfeiting: lost tax revenue and jobs. Apple is
studying what this costs the Chinese Government per
counterfeit device sold. Whatever degree of support
the PSB offers, Shruhan accepts that, as with
Pfizer, the reality of successful cooperation will
be that his team "does 95 percent of the
investigative work," turns case files over to the
PSB, and "gives the PSB 100 percent of the credit"
for successful enforcement actions. The payoff is
worth it. China has some of the strictest penalties
around for counterfeiters, he claimed - if the PSB
can successfully prosecute a case. Shruhan recalled
a pharmaceuticals case in which the counterfeiter
was sentenced to ten years and received a USD
250,000 fine.

10. (SBU) Apple's first raids will be carried out in
Shenzhen in Guangdong province, where Shruhan has
identified at least one major underground factory.
In such a raid, carried out by the PSB, the factory
will be shut down by authorities only if its output
exceeds the criminal threshold that under Chinese
law represents production on a commercial scale: RMB
150,000 (USD 22,000). In addition to working with
the PSB to shut down manufacturers, Shruhan is also
encouraging China's local Administrations of
Industry and Commerce (AICs) to raid retailers.
Such raids may not put vendors out of business, but
associated fines and penalties from civil suits will
raise their costs. Shruhan said that low profile
retail raids are a good option for Apple, a company
that wants to stay away from too much publicity
surrounding this issue. The evidence Apple gathers
doing market surveys, including the names of
infringing shops, the number of fakes found, and the
trademarks being violated, will be provided to the
AIC for support in upcoming raids in cities
including Shanghai, Beijing, Guangzhou, and
Shenzhen.

11. (SBU) Shruhan describes his relationship with
China Customs, developed over five years of joint
efforts to fight fake drugs, as very cooperative,
and he is already getting the support he needs,
including five export seizures in August. A key
element of his relationship with customs officials
in the past has been providing them with the
training they need to identify counterfeit goods in
the field. In addition to building strong
relationships with investigators and law enforcement
agencies, Shruhan knows that currying favor with the
Supreme People's Procuratorate and the courts are
essential in ensuring effective prosecution and
sentencing.

Selling the Plan in California
------------------------------

12. (SBU) While Shruhan has the benefit of his

BEIJING 00003732 005 OF 005


Pfizer experience in China, he laments that Apple
lawyers do not. Based in California, the company's
inexperience has slowed cooperative progress with
Chinese Authorities. Officials at Lowu Commercial
City, one of China's notorious counterfeit markets
near Hong Kong, asked Apple for training and
evidence of counterfeit sales in their shops.
However, reluctance by the company to accept
standard Chinese legal documents and other problems
in corporate communication have so far prevented
such cooperation. Shruhan has an ally at Apple's
Cupertino headquarters who will help him win the
support he needs to build an effective security
operation in China. John Theriault, former Vice
President of Global Security for Pfizer, was
Shruhan's boss for the last five years, and is the
one responsible for bringing Shruhan to Apple, where
Theriault is now Vice President of Global Security.
Theriault, said Shruhan, has already pitched the
China security strategy to Steve Jobs.

Comment
-------

13. (SBU) Shruhan and Theriault spent five years
building an effective security plan for Pfizer,
resulting in high-profile raids and seizures of
large quantities of counterfeit drugs like Viagra.
This was due in large part to the high priority the
Chinese Government placed on health and safety
issues. Now at Apple, they have an excellent
understanding of China's underground manufacturers
and global distribution channels that will serve
them well as they seek to stem fake iPod and iPhone
production. However, the key will be whether their
personal relationships with customs, law
enforcement, and judiciary officials will be enough
to focus the Chinese Government on Apple's non-
health-related problems as they seek to make life
uncomfortable for counterfeiters. End Comment.

© Scoop Media

 
 
 
 
 
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