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Monday, September 12, 2005 - Page updated at 12:00 AM

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Microsoft still trying to find its footing in China

Seattle Times business reporter

Last week, Microsoft lost an opportunity to improve its relations with the Chinese government after Chinese President Hu Jintao's trip to the U.S. was postponed. Instead, the company found itself in court, hearing an executive who defected to its biggest rival disparage Microsoft's record in China.

Not an ideal outcome for a company that already has seen its share of challenges doing business in China.

Its chairman, Bill Gates, has a reputation as the leading hero among Chinese youth. But his company has another distinction — as the leading victim of piracy.

The world's biggest software company has also fought to counter the rapid growth of open-source software in China and a poor image as an overpriced bully.

Before Hu postponed his trip because of Hurricane Katrina, Gates had planned to accompany him on a tour of Microsoft and then host a dinner for the visiting Chinese delegation at his Medina mansion. He and other Microsoft executives had planned to use the opportunity to broaden and deepen discussions with the Chinese government.

Gates has called China's economic transformation "the greatest unpredicted miracle in history."

He has lauded Microsoft's experience in China, particularly its Beijing research lab, which he said attracts top talent from Chinese universities and now contributes to Microsoft products worldwide.

Meanwhile, former Microsoft Vice President Kai-Fu Lee testified in King County Superior Court last week that the company has bungled much of its Chinese operations in recent years. In a 2003 e-mail to Gates and Chief Executive Steve Ballmer, the man who had been a linchpin in establishing Microsoft's Chinese presence said he was "deeply disappointed at our incompetence in China."

Lee's testimony came at a hearing in which Microsoft sought an injunction to keep him from taking a job at Google to open a China research center. Microsoft, citing a noncompete agreement Lee had signed in 2000, sued the executive and Google. Judge Steven Gonzalez is expected to rule tomorrow on whether to grant the injunction until a trial begins in January.

The dispute has generated some heated discussion on Chinese Internet sites such as Sina.com.

"Microsoft is just like the United States, too tyrannical," one observer wrote.

Another called Lee capricious. "There's no need for Dr. Lee to call Microsoft a devil today, just as there was no reason to call Microsoft an angel yesterday," the reader said. "It just goes to show you, education does not equal ethics."

Eye on potential market

No matter what happens in the Lee case, it's clear much of Microsoft's attention these days is directed toward China, not only as a market for the company's flagship software, but for the potential China's 1.3 billion consumers hold for future mobile and Internet services.

The company has 1,200 employees throughout the country, and its operations there span all facets of its business, including basic research, product development, technical support, sales, marketing and manufacturing.

"We have a very strong focus on this market," said Pamela Passman, Microsoft vice president of global corporate affairs. "We've been investing and building a talented group of people there."

Microsoft's efforts have hit a countervailing trend in China to promote greater self-reliance and less dependence on imported software. In addition to demanding lower prices to make products more affordable in China, the Chinese government wants Microsoft to help domestic software companies compete with India for lucrative outsourcing contracts.

Yet the problem of piracy has become entrenched, and China's promises to crack down on enforcement have failed to make a dent. Technology leaders were hoping to hear how China's president might address the problem in a policy speech Hu was to give as part of his Seattle visit.

"If as many people paid for software as they do here, we'd have well more than 10 times the business we do today," Gates said, addressing a group of business journalists in Seattle in May.

Microsoft is trying to persuade more Chinese customers to pay for licenses, and it has seen signs of improvement over the last year among corporate and government customers, Passman said.

"There has been a change in terms of the Chinese government really recognizing the impact that piracy is having on local industries and the [problem's] importance to China and its future development," she said.

But Microsoft faces something of a conundrum.

By allowing the free use of Windows and Office, it ensures that Chinese computer users remain committed to Microsoft and not flock to open-source Linux or other alternatives. Open source is a system of software that can be freely developed and modified by anyone.

As long as Microsoft gets them to convert to legitimate versions of its software in the future, some argue, it suits the company's long-term interests better than removing fake copies from stores altogether.

Bellwether company

Counterfeit copies of Windows may not be as flagrant or damaging as the wholesale rip-off of new technology ideas, which is also common in China, but Microsoft remains a bellwether.

The Business Software Alliance estimates that more than 90 percent of software used in China is illegal.

"Microsoft is the perfect canary because they are 100 percent vulnerable to IP [intellectual property] theft, and IP theft has turned out to be the key question in China's ability to go forward," said tech pundit Mark Anderson, president of Strategic News Service, a newsletter that provides market research and advice.

Countries like Singapore and India are starting to use better IP protection as an edge over China in attracting investments by pharmaceutical and software companies, he said.

"It may be a small number today, but it will be a big number tomorrow," Anderson said.

Challenge from Linux

Microsoft's other challenge in China is the growth of Linux. A government-sponsored alliance of open-source companies known as Red Flag Linux has lured some customers away. Red Flag Linux has also won support from global tech giants, including Hewlett-Packard, Oracle and IBM.

Microsoft has attempted to alleviate concerns about security by allowing Chinese government officials access to its secret sauce — the underlying source code to Windows.

Microsoft's corporate image in China has not enjoyed the same status its founder has among the masses.

Gates visited China a few years ago to promote Microsoft and IP protection. But soon after his departure, the Chinese government announced it was endorsing Linux for government and military contracts, Anderson said.

"That was a real slap in the face," Anderson said. "I think they perceive Microsoft as part of Western hegemony somehow."

As a figure young people admire, "Bill Gates is right up there with Yao Ming, the basketball star," said Sidney Rittenberg, a business consultant who advised Microsoft on its China strategy several years ago. But "people on the street tended to view Microsoft as a company that peddles high-priced software and tries to kill the Chinese' own software industry," he said.

Microsoft has started to form partnerships with local Chinese software companies and provide training in rural areas, which has helped strengthen its reputation in China, said Tim Chen, chief executive of Microsoft China.

Admired company

The company also points to a survey in the Chinese version of Fortune magazine a year ago that ranked the company as the third-most admired in China — with IBM topping the list. Still, the company has not stopped the revolving door of executives leaving Microsoft for other opportunities.

In addition to Lee, who left for Google, Microsoft recently lost Chief Marketing Officer Wu Shixiong to eBay. Before them, other departing China executives included Juliet Wu, Jack Gao and Jun Tang.

Gao, who was president and general manager of Microsoft China, later published a book about his experience at Microsoft, a work that Lee quotes in court documents to make his point about the company's missteps.

"Microsoft is indeed too stubborn and too bullying," Gao wrote. "Microsoft China inappropriately moved their manners in the U.S. and other countries to China."

Meanwhile, Anderson does not think the piracy problem will be solved in China for at least another decade, the time it will take the country to fully develop its judicial institutions. But Microsoft is known for its perseverance.

"Microsoft has a tremendous amount of patience, which can be inspiring or distressing, depending on your point of view," Anderson said. It's possible that "they will have waited so long for so little and have been willing to spend a long, long time in the red."

Kristi Heim: 206-464-2718 or kheim@seattletimes.com. Seattle Times technology reporter Brier Dudley contributed to this report.

Copyright © 2005 The Seattle Times Company

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