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What happens when the world's largest software company enters one of the world's largest technology markets?

So far, not a whole lot.

Amid the recent buzz over China -- whether it's


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stratospheric IPO or



billion-dollar deal with




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has remained a bit player there, its name tossed out as just another company trying to get a toehold in the massive market.

Piracy has prevented the tech behemoth from generating substantial software sales in China, and the theft does not appear to be abating anytime soon. While Microsoft has enjoyed some modest success there on the Internet -- its Messenger service has nabbed a solid No. 2 position in the country, trailing only Chinese firm


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QQ brand -- it may take several years for the company to develop this into a thriving business.

Unlike in the U.S., where its flagship Windows and Office brands are cash cows, Microsoft initially may have a bigger opportunity on the Internet and in mobile phones in China than in software. A few statistics bear this out:

The Internet population in China is roughly 100 million and is on track to exceed the U.S. population in five to seven years, estimates senior analyst Safa Rashtchy, who covers Internet and China for Piper Jaffray.

The handset market in China sits at a whopping 350 million users, according to Beijing-based technology advisory and research firm Analysys International. That's about 40% more users than the U.S. market.

Meanwhile, the installed base of PC users in China is only 60 million and growing at less than 20% a year, according to Analysys. And about 90% of software on those PCs is pirated. (By comparison, the U.S. market is estimated to have a piracy rate of about 22%, according to a study by the Business Software Association of Australia.)

Off to a Slow Start

Microsoft has had a research lab in Beijing since 1998, but the company officially launched its MSN China Web site in May. At that time, MSN announced a joint venture with state-owned Shanghai Alliance Investment to launch MSN China and also entered an agreement with and acquired some assets of TSSX, a mobile software and services company, to deliver MSN mobile products to the Chinese market.

Creating such partnerships -- a similar approach of


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and Yahoo! -- makes sense, but comes a little late for Microsoft, Analysys Vice President Eagle Zhang said in an interview.

"Microsoft China is not a first mover," he said. "They are lagging behind other competitors."

Microsoft declined an interview request for this article, but via email a company representative said Microsoft is committed to "growing together with China's IT industry."

"China is an important and strategic market for Microsoft," the representative said.

Microsoft is ahead of its U.S. competitors in the Chinese fledgling Messenger market, with about 15% of subscribers in 2004, according to Analysys.

In addition to generating ad sales, Messenger also can generate revenue through other services, like selling comic figures to enhance a message or providing links to send short messages to mobile phones if someone can't be reached by Messenger.

Analysys estimates that the Messenger market generated $800 million in revenue in 2004, with 86% of it going to Tencent.

"I think the approach is to use instant messaging as a key service that people will be attracted to and build something around it," Piper Jaffray's Rashtchy says of Microsoft's strategy. That said, Microsoft still will probably need to step up its search presence in China either through an acquisition or collaboration with a local company.

"I think Microsoft is respected

in China as a major international name," Rashtchy says. But "I don't think it is regarded highly yet as a big Internet name in China, with the exception of Messenger."

"I think they're likely to have some success given how focused they are on it," he added. "And it's still an early-stage game for the other U.S. companies as well."

Software Pirates

In software, on the other hand, Microsoft faces perhaps an even more difficult battle.

"In China alone, the second-largest PC market in the world, a country that will care about intellectual property for its own future development, piracy is well, well, well above 90%," Microsoft CEO Steve Ballmer said at the company's recent analyst day. "There are billions of dollars of growth opportunity merely by selling the value of legitimate software."

That may be so, but don't count on it anytime soon. In 2004, the software piracy rate in China fell minimally -- to 90% from 92% a year earlier, according to the Business Software Alliance.

IDC estimated software piracy losses of $3.57 billion in 2004 in China, which has the third-highest piracy rate.

(Interestingly, the U.S. sits at the top as the country with the highest estimated dollar losses due to software piracy, at $6.65 billion. To fight piracy worldwide, Microsoft launched a peculiarly named program called "Windows Genuine Advantage" that gives only users with legitimate, registered software access to support and updates.)

Despite pressure from the U.S., more protection of IP by the Chinese government is a long way off. "There is a movement toward more and more protection of intellectual property," Rashtchy says. But he figures it will take about 10 years for the amount of protection to be significant.

Part of the problem is that the Chinese government may not want to or be able to do much, says Ohio State University Business Professor Oded Shenkar, an expert on China and author of the book

The Chinese Century: The Rising Chinese Economy and Its Impact on the Global Economy, the Balance of Power, and Your Job


"There's definite thinking among some people in leadership that this is very beneficial for Chinese companies," Shenkar says of piracy. "Fake production" of not only software but also of everything from razors to motorcycles is a source of employment and a significant source of income for some localities, which sometimes wield considerable power against the central government, he explains.

The Chinese government can "do a lot of highly publicized raids for TV cameras, but I don't see them as being very serious about it," Shenkar says.

And even if the government becomes more serious, the result may not be as many billions of extra dollars as Ballmer suggests. In a note earlier this summer on software in China, SG Cowen analyst Peter Goldmacher said that Microsoft contacts estimated that each percentage-point reduction in piracy would yield only $10 million in sales.

So, at the extreme, Goldmacher noted, the Chinese market for Microsoft could be calculated at roughly $1 billion under current market conditions. That's only about 2.5% of Microsoft's $40 billion in sales in the past fiscal year.

Overstating Open Source

On the other hand, the Chinese government has shown some bias to Microsoft's open-source rival Linux, partially because of cost but also out of the fear of relying on a big American company for software.

But research firm Gartner has suggested that media reports of Chinese governments using and supporting Linux may be exaggerated. "Regardless of the potential savings for governments in emerging markets, we have seen much talk about the move to Linux and relatively little action," Gartner analysts wrote in a June report.

Outside of government, widespread use of pirated Microsoft software has been a hurdle to Linux adoption. Gartner estimated that 8% of PCs shipped in emerging markets in 2005 will be preloaded with Linux, and at least 80% of these machines will end up running a pirated copy of Windows soon after they are shipped.

Analysys, meanwhile, estimated that Linux commands less than 3% market share on Chinese desktops, but notes that similar to the U.S., Linux is enjoying more success among businesses on servers.

Indeed, it's probably in the business market where there is more opportunity for Microsoft to make money from software than in the piracy-plagued consumer market, Analysys' Zhang noted.

"In China, software outsourcing is growing very fast," Zhang noted, pegging the growth rate at more than 25%. Indian companies such as

Tata Consulting Group

are building a strong presence in China.

Microsoft recently got into the act this summer, too, by becoming a minority investor in a joint venture with Tata and two software park development companies.

"It's another way to build the installed base" of legal Microsoft software users, Zhang said.

But it remains to be seen whether that base becomes as big in China as the world's largest software maker would like.