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Case Study: Microsoft in China – Free Solution

Microsoft, the world’s biggest personal computer software company, developed MS-DOS and the windows, the operating system and graphical user interface that now reside on more than 90 percent of the world’s personal computers. In addition, Microsoft has a slew of best-selling applications software, including its word processing program (Microsoft Word) , spreadsheet program (Excel), and presentation program (Power Point). An integral part of Microsoft’s international strategy has been expansion into mainland China, which was projected to become the third largest PC market in the world in 2001. With a population of 1.273 billion, China represents a potentially huge market for Microsoft. Microsoft’s initial goal was to build up Chinese sales from nothing in 1994 to $100 million by 2000, a goal that it appears to have met. However, sales could have been very much higher were it not for a number of problems that Microsoft encountered in China.

The most obvious and serious obstacle to Microsoft’s success in China has been the rampant level of software piracy. Some 90 to 95 percent of the software used in China is pirated, according to figures from the Business Software Alliance. Microsoft is a prime target of this activity. Most Microsoft products used in China are illegal copies. China’s government is believed to be one of the worst offenders. Microsoft’s lawyers complain that Beijing doesn’t budget for software purchases, forcing its cash-strapped bureaucracy to find cheap software solutions. Thus, Microsoft claims, much of the government ends up using pirated software. To make matters worse, China is an exporter of counterfeit software. Microsoft executives don’t have to go far to see the problem. Just a few blocks from the company’s Hong Kong office is a tiny shop that offers CD-ROMs, each crammed with dozens of computer programs that collectively are worth about $20,000. The asking price is about 500 Hong Kong dollars or $52!

Microsoft officials are quick to point out that the problem arises because Chinese judicial authorities do not enforce their own laws. Microsoft found this out when it first tried to use China’s judicial system to sue software pirates. Microsoft pressed officials in China’s southern province of Guangdong to raid a manufacturer that was producing counterfeit holograms that Microsoft used to authenticate its software manuals. The Chinese authorities prosecuted the manufacture, acknowledged that a copyright violation had occurred, but awarded Microsoft only $2,600 and fined the pirate company $3000! Undeterred by this limited victory, Microsoft continued its attempts to use the legal system in China to limit copyright violations.

However, in late 1999 the tactic backfired when Microsoft sued a small Chinese firm, the Yadu Group, for $200,000, claiming it was using pirated Microsoft products. The Chinese press portrayed Microsoft as an American bully going after struggling Chinese start-ups. When the case came to court, the judge threw it out, claiming the engineers who actually admitted to using pirated software were not employed by Yadu Group, but by an affiliate firm. According to the judge, Microsoft was suing the wrong firm.

Another Microsoft response to the piracy problem has been to reduce the price on its software to compete with pirated versions. In October 1994, Microsoft reduced the price on its Chinese software by as much as 200 percent and it has kept prices low since. However, this action may have little impact, for the programs are still priced at $100 to $200, compared to $5 to $20 for an illegal copy of the same software. Even at lower prices, the cost of Microsoft’s software can amount to several months’ salary for the white-collar worker.

Yet another tactic adopted by the company has been to lobby the US government to pressure Chinese authorities to start enforcing their own laws. As part of its lobbying effort, Microsoft has engaged in its won version of “guerrilla warfare” digging through trash bins, paying locals to spy, even posing as money-grubbing businessmen to collect evidence of piracy, which they have then passed on to US trade officials. Initially, it looked as if the tactic might work, because the US government had some leverage over China. China wished to join the World Trade Organization and viewed US support as crucial. The United States said it would not support Chinese membership unless China started enforcing its intellectual property laws. This demand was backed up by a threat to impose tariffs of $1.08 billion on Chinese exports unless China agreed to stricter enforcement. After a tense period, the Chinese backed down and acquiesced to US demands in February 1995. The Chinese government agreed to start enforcing its intellectual property rights laws, to crack down on factories that the United States identified as pirating US goods, to respect US trademarks including Microsoft’s, and to instruct Chinese government ministries to stop using pirated software. However, by 2000 the level of software piracy in China was still running at 95 percent, suggesting that little progress had been made. The United States signed off on China’s entry into the World Trade Organization in September 2000, thereby losing leverage over China on this issue. Although WTO rules prohibit the piracy of intellectual property, such as software, few observers expect the WTO to be able to solve this problem. It seems to be endemic worldwide.

As if privacy was not giving Microsoft enough headaches in China, in early 2000 another potentially serious problems appeared on the horizon, The Chinese government declared it was concerned about security issues related to Microsoft software. Government spokesmen started to liken China’s dependence on Microsoft software to leaving the keys to the country’s increasingly computerized economy in the hands of pa potential enemy. Some warned that holes in Microsoft’s computer code might allow the United States access to Chinese networks or even disable it, in times of war, to shut those networks down. “Without information security, there is no national security in politics, economics and military affairs,” declared an editorial in the People’s Liberation Army Daily in early 2000.

With these fears in mind, in 2000 the Chinese government started to promote a Chinese language version of the Linux operating system as an alternative to the Chinese language version of Windows 2000. A Finnish university student created Linux in 1991. The source code underlying Linux is now distributed free to anyone who wishes to use it with the stipulation that anybody who wishes to use it with the stipulation that anybody can improve upon it so long as any modifications are shared with the rest of the world. In the Chinese view, the fact that the Linux code is not privately held assures any security it wants to build into its computer systems will not have undetectable vulnerabilities.

Using examples from the case, identify the economic risks faced by Microsoft in China?

Economic risks faced by Microsoft in China, as highlighted in the case study, include:

1. Software Piracy: The rampant level of software piracy in China poses a significant economic risk to Microsoft. According to estimates, 90 to 95 percent of the software used in China is pirated, and Microsoft products are a prime target. This widespread piracy significantly hampers Microsoft’s ability to generate legitimate software sales and revenue in the Chinese market.
2. Ineffective Enforcement of Intellectual Property Laws: Chinese judicial authorities’ failure to enforce their own intellectual property laws compounds the risk of software piracy. Microsoft’s attempts to use the legal system to combat copyright violations have often resulted in limited success. In some cases, lawsuits against infringing firms were thrown out, leading to negative publicity for Microsoft and discouragement in pursuing legal actions.
3. Government’s Reluctance to Purchase Legitimate Software: Microsoft faces challenges in selling its software to the Chinese government. The government’s limited budget for software purchases and preference for cheap solutions have led to widespread usage of pirated software within government agencies. This undermines Microsoft’s efforts to establish legitimate sales channels and build a strong customer base within the government sector.
4. Counterfeit Software Export: China’s reputation as an exporter of counterfeit software further exacerbates the economic risks for Microsoft. The proximity of shops selling counterfeit CDs near Microsoft’s Hong Kong office exemplifies the ease with which counterfeit software can be obtained and distributed. This not only affects Microsoft’s sales in the Chinese market but also damages its global brand image.
5. Price Competition with Pirated Versions: Microsoft’s strategy of reducing software prices in China to compete with pirated versions faces limitations. Despite lowering prices by up to 200 percent, the legitimate software prices are still considerably higher than the cost of illegal copies. This price differential makes it challenging for Microsoft to effectively compete with pirated software, especially among cost-conscious consumers.
6. Security Concerns and Government Promotion of Alternatives: The Chinese government’s security concerns regarding Microsoft software pose an economic risk. The government’s perception of potential vulnerabilities and risks associated with foreign-owned software led to the promotion of alternatives like the Chinese-language version of the Linux operating system. This presents a potential threat to Microsoft’s market share and revenue streams in China.

Overall, these economic risks hinder Microsoft’s ability to fully capitalize on the immense market potential in China. The prevalence of software piracy, ineffective enforcement of intellectual property laws, government reluctance to purchase legitimate software, counterfeit software export, price competition, and security concerns all contribute to the complex challenges faced by Microsoft in the Chinese market.

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