Microsoft's Long March

Its Chinese ploy may win big-or cost the software giant dearly

You'll forgive managers at Microsoft Corp.'s Beijing headquarters if they sometimes feel like they're behind enemy lines. China is the Barbary Coast of old when it comes to software piracy, harboring huge plants that churn out some 54 million illegal software packages each year. In a market located just blocks away from Microsoft's office, bogus copies of the latest Chinese versions of Windows sell for just $5 before they are even officially released.

But the treacherous environment isn't stopping the U.S. software giant from pressing ahead with one of its most extensive technology-sharing programs in the developing world. While Microsoft spends considerable energy trying to shut down China's counterfeiters, it also is spending $2 million a year to train Chinese technicians and programmers. And it's plowing millions more into some two dozen strategic tie-ups with government ministries, local computer makers, and universities to help bring China's software industry into the 21st century. In the process, Microsoft says it is sharing some of its proprietary code, the basic building blocks of its programs, with government research institutes to co-develop Chinese versions of its operating systems.

Why would Microsoft be generous with its technology in a country where it is so difficult to protect intellectual property? The answer is that the company is playing the market two ways. Officially, Chairman William H. Gates III has taken a hard stance in the U.S.'s dispute over intellectual property rights enforcement. Gates and gther U.S. software executives argue that Washington should hit China with sanctions if it fails to shut down rogue CD plants by a June 17 deadline.

But most experts are expecting some sort of compromise. And in reality, the Redmond (Calif.) giant would not want the U.S. to push relations with Beijing over a cliff. The reason is that China is the world's biggest emerging software market. Over the next five years, China plans to invest billions to computerize its immense, paperbound financial sector, government bureaucracy, and state industries. As the Chinese also rush to buy personal computers for their homes and small businesses, PC sales are expected to explode from 1 million units in 1995 to 5 million in 2000, according to International Data Corp. Microsoft is clearly positioning itself to be king of China's software industry.

PIRATE POWER. Paradoxically, the proliferation of cheap, pirated editions of software may end up bolstering Microsoft's position in the long run. An estimated 80% of computers in China already run on Microsoft's Windows 95, Windows NT, and DOS operating systems--even though much of the software is bootlegged. Apple Computer's share of the market is only about 3%. "The pirates are actually helping Microsoft greatly," says software analyst Darwin P. Singson of Dataquest Inc. in Hong Kong. "They are creating a huge installed base of customers." Microsoft anticipates that this eventually will lead to billions of dollars in sales of applications, upgrades, and service contracts.

And while Microsoft's annual sales in China now are only around $20 million, they're rising fast thanks to government purchases. "We're looking at 100% growth every year as far as we can see," says Bryan Nelson, Microsoft's Hong Kong-based director for Greater China.

Microsoft is learning that developing this market demands a massive on-the-ground presence. To alleviate the dearth of Windows applications in Chinese characters, Microsoft must help programmers who are strong on academic theory but weak at turning out commercially viable products. It also must train thousands of technicians at Chinese banks, state-owned industries, and government bureaucracies to work on Windows. "Microsoft recognized that Chinese customers need more than products," says Vice-President Yang Jun of China National Computer Software & Technology Service Corp. (CS&S), which is working with Microsoft on huge government contracts to install data networks. "We need good consulting, good systems integration, and good service."

Microsoft stumbled in its early approaches to the Chinese market. When it opened its Beijing office in 1992, Microsoft planned to use its Taiwan operations to supply a Mandarin-language version of Windows designed especially for the mainland's simplified characters. But the Electronics Industry Ministry resented the fact that Microsoft was relying on the mainland's rival, Taiwan, for such sophisticated work. The government not only wanted such operating systems to be designed in China but also insisted on defining the coding and standards for Chinese character fonts--something Microsoft had done independently everywhere else in the world.

Gates got a frosty reception when he arrived in Beijing in March, 1994, to launch Chinese Windows, dubbed P-Win. In a flurry of meetings with officials, he argued that the marketplace, not governments, should set standards. But the Chinese electronics industry threatened to ban Chinese Windows, and President Jiang Zemin personally admonished Gates to spend more time in China and "learn something from 5,000 years of Chinese history."

Gates sacked his old China management team and promised to cooperate with Beijing. He also took Jiang's advice. The next fall, Gates, a notorious workaholic, took an extended vacation in China with his then-pregnant wife and with fellow billionaire Warren E. Buffett. He rode a bicycle in Beijing, flew a kite at the Great Wall, explored caves containing Buddhist shrines along the old Silk Road, and took a boat on the Yangtze River.

TAXING PROBLEM. More than anything, executives say, the trip helped Gates realize the magnitude of China's computing challenge and why Microsoft needed to work with Beijing. Take China's State Administration of Taxation, which has the task of boosting the government's shaky finances by implementing new personal-income, corporate, and value-added taxes. Beijing wants to monitor tax assessment and collection nationwide through a central database. Within two years, the bureau plans to link all of its 3,200 offices with some 20,000 PCs, most of them running on Windows 95 and Windows NT and connected to Microsoft servers. Microsoft also is working with the People's Bank of China, the country's central bank, which wants to equip its 10,000 branches with Windows-based PCs and servers.

To boost the supply of technicians, Microsoft has set up training institutes at the Chinese Academy of Social Sciences, three universities, and more than 70 centers. It employs 32 full-time Chinese instructors, trained in the U.S., who teach computer architecture, networking, and client-server applications. In addition, Microsoft has tied up with Chinese researchers to develop technology in such areas as interactive television and Chinese handwriting and speech recognition--areas many experts consider crucial to the popularization of PCs because of the difficulty in entering Chinese characters onto a keyboard. IBM also is collaborating with the Chinese in developing software, setting up some joint universities to teach object-oriented software design.

GANGBUSTERS. Developing a legitimate Chinese software industry in close cooperation with top ministries and institutes helps Microsoft fight against the piracy of its products. Because of the way it has insinuated itself into China, Microsoft is often able to provide information to help investigators identify illicit retailers and manufacturers. In one case, authorities on Apr. 27 busted a plant in the southern city of Guilin that was turning out 20,000 bogus software CDs a day.

The problem isn't with China's big computer manufacturers. PCs made by Chinese companies such as Legend Computer and Great Wall now come bundled with legal Windows and DOS. Trouble is, a hefty percentage of the PCs sold in China are made by small manufacturers such as Beijing Three Creative Corp., which assembles 40 PCs per month from components available in the open market. Most individuals who purchase such PCs install illegal software, speculates company manager Wang Xudong.

The situation with more lucrative business applications is even more out of control. Pirates currently supply 98% of the Chinese market for programs such as Windows Office, Lotus 1-2-3, and AutoCAD, according to the Business Software Alliance. "As we move from a manufacturing- to an information-based society," Gates told reporters recently in Washington, "this is becoming a real issue."

Clearly, there are potential risks in Microsoft's technology collaboration in China. For one, sharing its design code with institutes connected to the Electronics Ministry, which also supervises state-owned software companies trying to develop competing operating systems, could boomerang. "The cons seem to outweigh the pros," says Joseph Lung, managing director of Hong Kong-based market research firm ATC Ltd. "Microsoft is giving away its family jewels for peanuts."

But to Microsoft, the collaboration with government institutes, although mandatory, has more advantages than disadvantages. One advantage is the strength it gives the company to overcome technical challenges. An example of the problems of serving China from Taiwan came from the P-Win version of Windows, which used the mainland's simplified characters. Many Chinese PC users found P-Win confusing to use because it was riddled with clumsy translations. And it didn't work with many programs.

Instead, people preferred mainland-developed programs that translate English versions of Windows into Mandarin. By working with government agencies to develop a new Chinese version of Windows 95 based on national standards, executives say, Microsoft has been able to solve most of the bugs faster than if it had worked on its own. Windows is now officially "endorsed" by the government, as are IBM and Apple operating systems.

BOGUS BETAS. Now that it is no longer working at cross-purposes with the government, Microsoft seems to be achieving its top objective--to establish Windows as the national platform. But the launch of Chinese Windows 95 shows how difficult it will be for Microsoft and other software companies to reap the benefits of their success. As part of its usual "beta test" to gauge customer response, Microsoft distributed advance copies to a handful of government agencies, computer makers, and state enterprises. Within no time, the pirates were at work. Months before the official March 14 product launch, bogus versions of Chinese Windows 95 were available all over Beijing. Quips Greater China Director Nelson: "Our beta test was wider than we expected."

Even if Washington and Beijing resolve their intellectual property differences in time to avoid sanctions and countersanctions, the war against counterfeiting will rage on as China's pirates move deeper underground. In that battle, Microsoft will be on the inside, strongly aligned with government ministries and institutes. The strength of those relationships is why the company is willing to take a gamble aimed at ultimately winning domination of the world's biggest market. If it works, any financial losses from the current rip-offs of its software will seem minuscule in comparison.

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