High prices, false steps help Windows lose to Linux in China

When Bill Gates was questioned about Chinese support for Linux during an interview with Red Herring recently, he claimed that "our fastest growing server business is in China", which was surprising.

Gates was also extremely upset when the interviewer suggested that the Chinese liked Linux: "What the heck are you talking about? I think what you're talking about is that you're assuming that the American does a reliable job in reporting on China. I doubt you read the government's press release... what the press in [the US] wrote and what the facts are is 100 per cent different."

We were intrigued, so we decided to investigate what was going on in the software business in China.

We found that although Gates has made six sales trips to China, Linux is gaining ground. Graham Brant, Microsoft's general manager for Microsoft Hong Kong, said in May that Microsoft has a "a great market share [in China] but not a lot of revenue". Microsoft software is just too expensive for the market. With Microsoft not being able to ensure that Windows is pre-loaded on most PCs in China, the consequence is that the piracy rate is believed to be around 95 per cent.

Winning friends and influencing People - not

As a result of a series of political blunders by Microsoft, there has been considerable criticism of the company in the press and in government circles. In December, Microsoft lost a major piracy case against the Yadu Group on what it called a technicality, but the result was that Microsoft was castigated for its heavy handedness. MS Office 2000 is offered at $480 (compared with around $400 in the US), and this represents five months salary for the average white collar worker. Kingsoft word-processing software, which is specially designed for the Chinese market rather than adapted from a US version, costs about a quarter of the equivalent Microsoft product and has a market share of around 30 per cent.

In January, there was a report in the Yangcheng Evening News that major ministries were being banned from using Windows. Microsoft claimed this was not true, but hit back so fiercely in a press release that the newspaper said it may sue Microsoft for defamation. Qing Sihan of the Chinese Academy of Sciences clarified the situation, noting that the government "has not yet made a decision on what kind of operating system to recommend for computer networks, so different organisations and ministries make their own decisions".

Two Chinese Linux distributions have been developed with government support: Red Flag Linux (a project of the Academy of Sciences, in which Compaq is a junior partner), and TomLinux. There is additional support in that Jiang Mianheng, the son of Chinese president Jiang Zemin, plays a prominent role in the management of Red Flag. Yesterday, the China Daily reported that Chen Chong of the Ministry of Information Industry had said at the launch of a new edition of Red Flag that it would "break the monopoly of the Windows operating system in the Chinese market" and that "the Ministry would give its full support to the development of Red Flag Linux, as well as all the other Linux systems". Red Flag Linux has gained around a quarter of the server market since it was launched at the end of last year. The Chinese government also reported yesterday that software sales in the first half of this year grew to 9.1 billion yuan ($1.1 billion), with the domestic proportion being 30 per cent.

The penetration of Linux in China is impossible to assess accurately because it is of course copied from machine to machine, although one report attributed to a foreign PC executive suggested that around 10 per cent of new PCs in China will have Linux pre-installed this year. In four months at the end of last year, TurboLinux sold 20,000 copies through Federal Software Stores, ahead of Windows 98, NT, and Linux from other distributors. The Chinese Linux Softhouse web site reported early this year that TurboLinux had 47 per cent of the Linux market, Blue Point 25 per cent, and RedFlag 7 per cent (although this has probably increased considerably since the survey).

Taiwan running dogs booby-trap software

It did not help politically that Microsoft used Taiwanese programmers to localise the Chinese version of Windows 95, and it was claimed that they had embedded slogans such as "take back the mainland" and "communist bandits" in the product.

Then there was considerable concern when the story about the US National Security Agency possibly having a back-door to Windows for spying purposes broke earlier this year. There was grave suspicion in China that Microsoft might have included a key for the NSA in NT4 service pack 5, as a quid pro quo for getting approval to export NT to China. (see story) The deputy minister of information industries, Chen Chong, said at the time that China was very keen "to control our own destiny", while the People's Liberation Army Daily noted in February that "without information security, there is no national security in politics, economics, and military affairs."

A closer examination of Gates' claim for Microsoft's success in the Chinese Windows server business shows that Microsoft donated NT4 Server, SQL and Exchange and support for a Government online project in a single Chinese province, so it was not exactly "business". All that Microsoft seems to have received in return was an agreement that the provincial government would mandate the use of legal software.

Microsoft's Chinese revenue is small, and only some 450 people are employed there. It is claimed that there was an increase in revenue of 83 per cent in the fiscal year just ended, but the president of Microsoft China said it was the smallest of Microsoft's 65 subsidiaries. Brant said at the end of May that Microsoft's China operation was the sixth largest revenue-generating market, after Japan, South Korea, Taiwan, Hong Kong and India. Most of the Microsoft China revenue is from OEMs. By 2004, it is expected that the Chinese IT market will triple (it was thought to be $11 billion in 1999), with compound growth averaging 28 per cent between 1998 and 2003 according to IDC. Japan still accounts for some 70 per cent of Microsoft's Asian business, with around $2.5 billion in revenue.

There are nearly 100 people in Microsoft's research lab in China, and $80 million will be invested over the next six years, according to Gates. The lab is headed by the Taiwan-born Kai-Fu Lee and did not gain popularity when it poached research staff from key Chinese government projects. By donating software and services, Microsoft has been able to start some collaborative projects, such as at Harbin Industrial University where it is jointly developing a bilingual dictionary and automatic translation, but with both Mandarin and Cantonese being spoken, the problems are multiplied.

Microsoft is also a strategic partner with Tengtu International's joint venture with the Chinese government and Chinese technology companies for primary and secondary school education, which was approved late last month by the Ministry of Education. A dampener for Microsoft is that the intellectual property resulting from these collaborations is owned by the universities and non-exclusively licensed to Microsoft.

'Challenge the MS hegemony

The most damaging political blow for Microsoft was the acrimonious departure last year of Juliet Wu, the general manager of Microsoft China. She immediately set about writing a revealing book describing her experiences - Up against the wind: Microsoft, IBM, and me - which sold 100,000 copies in the first two months. Her main criticism was that Microsoft was unwilling to be sufficiently flexible in the Chinese market, which essentially required having lower prices and adapting software for the market beyond just localisation translation. Wu also accused Microsoft of being insensitive in its government relations. Wu's book was followed by Fang Xingdong's Arise and challenge the hegemony of Microsoft, which added to the grief.

Gates himself has been more diplomatic on the US front, with an article in the Washington Post in May advocating that the US should grant China permanent normal trade relations status. It is also quite possible that within a year China will be admitted to membership of the WTO, which would mandate the need for the Chinese government to take a tougher line against software piracy and enforce intellectual property rights - or itself face sanctions.

For Microsoft, there is a dangerous possible downside to this: the Chinese government might then decide to avoid any anti-piracy enforcement problems by declaring Linux to be the official operating system for the government in the future. If the world's biggest potential market went Linux, it is easy to envisage a consequent domino effect that would not just strengthen Linux in the rest of Asia, but have a profound effect in the western world as well. ®