Tipping point?

The new year began on a high note for Microsoft. As revelers were gearing up for New Year’s Eve, a court in Shenzhen announced the conviction of a counterfeiting ring that Microsoft estimated had cost the company US$2 billion in sales.

Microsoft immediately lauded the 11 sentences – between one-and-a-half and six-and-a-half years – as the toughest penalties China had handed down to counterfeiters. Industry watchers were similarly impressed.

"I think it’s an important milestone," said David Wolf, head of the consultancy Wolf Group Asia. "It’s a demonstration that [Microsoft’s] anti-piracy efforts on an enterprise level are clearly getting better."

Wolf said the convictions represent the first major victory for Microsoft’s Genuine Software Initiative, as well as a growing awareness in the company that a one-size-fits-all strategy to battling piracy across the globe has been ineffective in China.

As such, the convictions are the fruit of a multi-faceted strategy in China that includes deeper engagement with the government, and both carrots and sticks for the consumer.

Microsoft China declined to comment, but said in a statement that the convictions were an example of the firm’s cooperation with government bodies, local law enforcement across the world and "hundreds of Microsoft customers and partners."

Persistent piracy

Despite the government’s attempts to rein in illegal software, the pirates have struck back. China’s software piracy rate was 82% in 2007, costing the software industry an estimated US$6.6 billion, according to the Business Software Alliance. That compares to roughly US$3.9 billion in industry losses from China in 2005.

Ian McGuinn, head of research for JLM McGregor in Shanghai, a consultancy, said that given widespread piracy in China, the media may have overstated the importance of these convictions. Nonetheless, he sees them as part and parcel of Microsoft’s evolving China strategy.

"They took a lot of hard knocks for the first 10-15 years here," he said. "Initially they were trying to sell their products here like they were selling everywhere else."

In addition to convincing computer manufacturers to sell PCs with pre-installed versions of Windows, McGuinn and others cite a refined government relations strategy as evidence of the company’s growing sophistication in China.

Wolf said the leaders of Microsoft China in the early days were often "young turks" who, though capable, lacked the subtlety required for building a strong relationship with China’s government. Since then, the company has traded na?veté for sophistication.

"[Now] they look at how they can make the government a partner, how they can show the government the value of what they do," Wolf said.

This is not to say it’s all been a smooth ride for Microsoft. The firm in October attracted controversy in China by blacking out the screens of users who had updated pirated copies of their software. The move led to a public outcry and was questioned by officials from the National Copyright Office.

While some industry watchers claim the blackouts were a wake-up call to consumers, particularly white-collar workers who depend on Microsoft software for conducting their business, others believe it was a strategic misstep.

"It seems that Microsoft is sending a message that they have the power to stop you from using pirated versions [of their software]. But in China, Microsoft’s public image is not that good and when they do this there will be some backlash," said Matthew Cheung, a senior analyst with Gartner in Hong Kong.

Sticks and carrots

The company followed up the controversy in December by slashing prices on some of its products in China – in what one analyst described as the carrot following the stick. The price of Windows XP Home was docked to RMB399 (US$58) from RMB960; prices for the home and student versions of Office 2007 were lowered to RMB398 from RMB698.

But doubts remain as to whether the price cuts will have an impact on piracy. They might also have unintended consequences, said Gartner’s Cheung, as lower prices prompt domestic firms to accuse Microsoft of monopolizing the market.

Microsoft watchers in China are now waiting to see whether the convictions are the first in a series of successful prosecutions, or are simply taking one pirate off the street to make room for another.

"We won’t know whether this is going to show some business results for at least another year," Wolf said.