By David Hechler
IP Law & Business/June 2007

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As the leading seller of soccer shoes, Adidas AG has long been an official sponsor of the World Cup. And every four years, when the tournament rolls around, its shoe sales rise. But typically, counterfeitersÑprimarily in ChinaÑalso spring into production. That's what Adidas found in 1998 and 2002, according to customs seizures, market surveys, and reports from outside investigators.

However, during last year's World Cup, while demand for its shoes jumped, there was no corresponding rise in fake Adidas footwear in China, according to those same indicators. "Zero," says Ray Tai, head of Adidas's intellectual property rights enforcement in Asia. In fact, in 2006 the number of counterfeit shoes seized in China plunged 20 percent, from 480,000 pairs in 2005 to 385,000, despite the same level of enforcement efforts.

That's one reason that Tai, sitting in a Beijing restaurant in March, flatly states that his company no longer has a counterfeiting problem. Which is not to say that after an intense three-year campaign he's eliminated all fakes. But unlike some of his competitors, he believes he's finally managed to cap them at an acceptable level. Tai says that's as much as any company can do.

Adidas, based in Herzogenaurach, Germany, says a few key factors led to its success. While its competitors continue to focus on raiding factories, Adidas has increasingly targeted retailers and wholesalers. (Raids on these groups take a bigger bite out of their bottom lines.) Adidas's China-based in-house lawyers work with the business side to make shoes harder to copy (by using a state-of-the-art label), and with outside investigators to build cases and prod government enforcement. It's all done on an annual budget of less than $1 million, Tai says.

While the IP attorney is the mastermind behind these efforts, he shares the credit with his colleagues. Adidas is the only one of the big three athletic shoe makers with IP lawyers working full-time in China. Tai has three lawyers working for him. The other two companies, Nike, Inc., and New Balance Athletic Shoe, Inc., don't have a single in-house attorney in China solely dedicated to IP rights enforcement, or IPR. (Adidas acquired Reebok in 2006.)

Counterfeiting in China has simmered on the international back burner since 2001, when the country joined the World Trade Organization after promising to enforce its new IP laws. (The pot boiled over in April, when U.S. trade representative Susan Schwab filed two cases with the WTO challenging China's failure to follow through.) Now, as China prepares for the Beijing Olympics next summer (Adidas is an official sponsor), IP protection is once again a hot political issue.

The Congressional Research Service, the research arm of the U.S. Congress, reported last year that the Chinese government estimates that "counterfeits constitute between 15 to 20 percent of all products made in China." Statistics compiled by U.S. Customs and Border Protection suggest the impact on the U.S. market: 81 percent of all fake goods seized in the United States last year originated in mainland China, with another 6 percent from Hong Kong.

The product hit hardest? Footwear. Shoes represented 41 percent of the seizures in 2006 and were valued at $63 million of the $155 million total. Far back in second place was apparel, with a price tag of $24 million (16 percent).

And that was just in the U.S. Last November, German customs officers in Hamburg announced that they'd netted a gigantic haul of counterfeit footwear from ChinaÑone of the largest ever. About 150,000 counterfeit pair of Adidas sneakers were confiscated. But a whopping 1.5 million pairs of Nike shoes (which has comparable sales to Adidas in Europe) were seized, according to Kevin Brown. He oversees global brand protection at the Beaverton, OregonÐbased company. Nike has a strong and comprehensive approach to IPR enforcement, Brown says. "But then Hamburg happens, and it makes you wonder how well things are going."

For Tai, figures like these bolster his confidence that Adidas is taking the right approach. He's been grappling with these issues for a decade, and he's certainly made his share of mistakes, he's quick to add. He was born 44 years ago in the same city where he lives now, Hong Kong. But when Tai was 8, his parents moved to New Jersey and went to work in a Chinese restaurant. He earned an engineering degree from Rutgers University before an interest in IP law led him to the Franklin Pierce Law Center at the University of New Hampshire. After law school, Tai moved to San Francisco in 1991 to work at an IP litigation firm. On the side he worked pro bono helping Chinese immigrants resolve labor disputes. He found the latter rewarding enough to consider doing it full-time. Only he'd grown up speaking English and was frustrated by his limited ability to communicate with his clients. Wanting to learn Mandarin and Cantonese, he moved to Hong Kong in 1995. He's now fluent in both dialects.

It didn't take long for his legal background to come in handy. Tai got his first taste of IP combat in 1996, when he landed a job working on IP enforcement for a Nintendo Co., Ltd., distributor. It was a little like skipping boot camp and parachuting straight into the front lines. Software piracy was rampant and almost impossible to stop.

Two years later, he was hired by Adidas, the second-largest athletic shoe manufacturer, behind Nike. Tai's job was to manage the European consultants who oversaw the company's IP protection in Asia. He says he quickly recognized that he could do the job himself for 20 percent of the consultants' budget. Tai declined to specify the amount or the firm (which he still uses), but offered an example of the savings. The consultants charged Adidas $38,000 to process a customs seizure. After Tai took over, the same work cost the company a $200 plane ticket to Fujian province, where he filled out forms identifying the shoes, negotiated a bond, and returned to Hong Kong. (Similarly, he says, he can pay the monthly salary of one of his in-house lawyers for what it costs other companies to hire a foreign lawyer for one day.)

It took three years before Tai was able to hire an assistant. Since then, he's slowly built a staff of three other attorneys. Vivian Yao, based in Beijing, manages brand protection throughout China, while Spring Tang is in charge of customs cases. The third lawyer, Zhang Ding, is based in Guangzhou, the southern manufacturing hub where nearly all the legitimate shoes are manufactured. Zhang works closely with the fourth employee, former cop Wang Yong. The duo travels widely, often accompanying investigators on raids.

The Adidas IPR operation stands in sharp contrast to those of its competitors. Nike has eight employees (none of them lawyers) working on IPR in China. Caterpillar Inc., which manufactures work shoes there, has one employee in China who spends a small portion of his time on IP protection. Shoemaker Puma AG, also based in Herzogenaurach, Germany, has one in-house lawyer in China devoted to this area. New Balance doesn't have any. At press time it had just hired its first in-house attorney everÑa trademark attorney in Boston. IP enforcement in China will continue to be directed by outside counsel in New York.

Tai and his team also stand out from the competition in shifting the focus of enforcement away from factories. The Adidas lawyer recounts the day several years ago when investigators led him to an illegal shoe factory they'd uncovered in Fujian province. Only this factory turned out to be a converted barn occupied by an extended family no longer able to eke out a living as farmers. Mom and dad toiled at sewing machines in front, grandma cooked in back, and small children scampered across the dirt floor. One look at the shoes they were producing told Tai that the raid was pointless. Companies fear replicas that fool consumers into thinking they are buying the genuine article. But these were crude imitations that were not going to be mistaken for the German sportswear maker's distinctive high-end sneakers.

"I hit the roof when I did that raid," says Tai. The investigators chose it "just so they could bill us," he says. He ordered them not to take him to "soft" targets again.

At big factories that produce quality knockoffs, Tai says, shoes may be worth $3 a pair. So for counterfeiters who can net $1 million a year, a seizure of 10,000 pairs and a fine of a few thousand dollars is merely a cost of doing business.

The equation turns less favorable for counterfeiters downstream. In the warehouse, the same shoes may be worth $10 a pair, and the wholesaler, whose staff is far smaller than a large factory's, isn't likely to have the same political clout. Nor is a loss of $100,000 as easy to shrug off. The same shoes in shipping containers in Hamburg cost perhaps $30, which means that a seizure even farther down the distribution chainÑlike a storeÑhits counterfeiters even harder. That's why in China last year 67 percent of the Adidas raids involving shoes targeted retail outlets, compared to 23 percent in warehouses, and 9 percent in factories, according to Adidas's Yao.

The company's strategy to reduce factory raids began three years ago. Before then, in 2003, 90 percent of the sites raided were factories; in 2004 factory raids constituted 26 percent of Adidas's total, and the figure dropped to 18 percent the next year. Warehouse raids rose from 17 percent in 2004 to 29 percent in 2005.

Tai says his approach is paying off in other ways. In China, economic crimes can't be prosecuted unless it can be proved that the infringing goods are worth at least $6,000. As a result, many foreign companies are wary about taking the time and effort to build a case against counterfeiters, who don't tend to keep business records that show the value of fake goods. But last year, 24 counterfeiters of Adidas shoes or apparel were convicted of criminal chargesÑthanks in part to the efforts of Tai's team and their outside investigators, who prodded the police to make the arrests. In a country where this sort of prosecution is rare, that's impressive, according to the main outside lawyers who represent New Balance and Caterpillar. "When a guy is arrested and put in prison," adds Michael Feng, Puma's IPR lawyer in China, "everyone hears about it. So it's a great threat." The 28-year-old attorney, who has been working for Puma for three years, says conversations with the Adidas team inspired him to follow their lead in pressing for arrests.

Adidas lawyers are also adept at working with outside investigators. It's not a natural alliance, and it's not easy to find lawyers who combine an understanding of IP law with investigative skills. It's particularly important, however, because the shoe companies depend on outside investigators to report sightings of fakes and help arrange raids. At the same time, these investigators, whom Adidas sometimes compensates according to the number of shoes seized, have also been known to inflate those numbers. Adidas must closely monitor them, Tai says, by checking their reports against law enforcement and court documents.

However, raids are just part of Adidas's in-house IPR approach. "If you're only thinking about raiding," Tai says, "you, as a lawyer, are not doing your job." Attorneys should be preventing problems as well as solving them, he observes. To start with, Adidas has its own employees working on-site in factories to monitor production. That cuts down on opportunities for fraud.

The company also needs to be able to ID fakes quicklyÑwhether on a factory floor or in a customs office thousands of miles awayÑwithout disrupting business. It's expensive and time-consuming to dispatch lawyers each time that suspect shoes turn up. But identifying fakes is one of the biggest hurdles the lawyers face, because the quality is so much better now than it was even a decade ago, Tai says. A few years ago, law enforcement raided a retailer after Tai mistakenly identified its shoes as counterfeit. "There was a large stink," he recalls ruefully, which took a lot of time and effort to resolve with the local authorities. Mistakes like this can seriously jeopardize relations with law enforcement because the authorities can be sued by targets of bad raids.

The solution, Tai decided, was to design a new method of identifying the shoes. Soon after he got the Adidas job he began lobbying the company to create a high-tech label. After many years and meetings, the company adopted one in 2004. (Other footwear brands have implemented similar strategies.) Tai explains that Adidas labels are printed on special material, contain patterns not easily replicated, and sport a unique, nonsequential, alphanumeric serial number. Tai can't always tell a fake by examining the construction of the shoe, he says, but he can make the confirmation when an investigator e-mails a digital photo of the label and he consults a secure database. That information is solid enough to present as evidence in court, he adds. The technology also helps prevent unauthorized factory overruns that end up in the "gray market"ÑAdidas only gives factories enough preprinted labels to cover the orders it has placed.

Helping devise this strategy was the quintessential behind-the-scenes role for an in-house lawyer. "You have to have a close relationship with your clients," Tai says. And the result "has to be a business solution," he emphasizes, not just something that meets the needs of lawyers.

Tai credits the labels Adidas has been using for three years now, along with a legal team that has grown more knowledgeable and skillful, with the progress that he saw during last year's World Cup. But he's also realistic about how much more Adidas has to do. Touring the Silk Street Market in Beijing (a notorious mall for knockoffs that companies are trying to shutter), he's disheartened to find shelves full of "Adidas" sneakers (and every other major brand) that are so well crafted he has to study the labels to be sure they are fakes.

But Tai can't afford to dwell too long on failureÑor success. He's already thinking ahead to the next big challenge: the Beijing Olympics next year, for which Adidas is a sponsor. Six months before the Opening Ceremony is when his company will probably start seeing an increase in fakes. He's hoping for the same results as Adidas had during last year's World Cup, but the Olympics "will be the ultimate test," he says. "We are shaking. Seriously."

This story originally appeared in Corporate Counsel, a sister publication of IP Law & Business.