Microsoft Backs China Development Center

Microsoft continues to invest in China to expand its business in the promising market and to strengthen government ties that could help future expansion plans. But CEO Steve Ballmer warned recently that software piracy is holding back Microsoft's revenue there.

Microsoft said last week it would open a software-development center in Beijing with Lang Chao International Ltd., a Chinese computer distributor and software developer in which Microsoft took a $25 million stake last month. The Beijing center will perform software-quality-assurance testing on Microsoft products, a Microsoft spokeswoman says. Lang Chao is listed on the Hong Kong Stock Exchange and majority owned by the state-run Langchao Group.

The center's opening comes a month after Microsoft and Indian software development company Tata Consultancy Services Ltd. disclosed a joint venture to establish an IT-outsourcing company in Beijing early next year that will serve the banking, manufacturing, and telecommunications industries. TCS holds a majority share in the venture, and Microsoft and three Chinese companies are minority partners.

Microsoft and other tech companies, including Accenture, Google, and IBM, are expanding research and development in China to take advantage of the country's booming economy, low labor costs, and talent-breeding universities. Indian technology consulting firms Infosys Technologies, Satyam Computer Services, and Wipro Technologies also have Chinese operations. Just last week, Infosys said it would set up development centers in Shanghai and Hangzhou, investing $65 million over five years in them and having 6,000 engineers on staff. Infosys already employs 250 workers in China.

Microsoft entered the country in 1992 with a sales office and opened a research lab in Beijing in 1998. In 2002, it invested $750 million through China's state planning department to train hardware and software engineers.

But the investment didn't deter the Chinese government from choosing the Linux operating system over Windows for its PCs, says analyst Paul DeGroot at market researcher Directions on Microsoft. "Western companies find the Chinese market very complex," he says. "When you deal with the government, you may find they're dealing with your competitor." Microsoft's deal with Lang Chao could be an inexpensive way to learn more about the Chinese market and make bureaucratic connections. "You need to have an insider who can help you," DeGroot says.

Making business in China even trickier for Microsoft is the country's high level of software piracy. Ballmer recently told a meeting of financial analysts that the company generates very little revenue in China compared with the size of the PC market there. "Piracy is rampant in emerging markets," he said, adding that more than 90% of software in China is counterfeit.

Meanwhile, competition for talent in China is heating up. Last month, Microsoft sued a former executive, Kai-Fu Lee, and Google, after Google said it would hire Lee to head a research-and-development center in China scheduled to open in the third quarter. Lee joined Microsoft in 1998 and established its Beijing lab; Microsoft's lawsuit says Lee violated the terms of his contract by joining a competitor within a year of leaving the company. A judge recently ruled that Lee can't immediately perform the duties for which Google hired him until further hearings next month.