gates.jpgIt took Microsoft over a decade and billions of dollars of lost revenue to learn how to do business in China. And it could be another decade before China takes its rightful place as Microsoft's biggest software market.

That's the frank admission that Microsoft chairman Bill Gates gives in this Fortune story on Microsoft's new softly, softly approach to engaging with China.

The story angle is hardly that new — three years ago NewsWeek ran a similar article — but Fortune has been lucky enough to get to ride around with Gates during his latest trip to China.

On one such limo trip, Gate says he is certain China will eventually be Microsoft's biggest market, though it may take ten years. Projected sales this year are already three times what they were in 2004, yet still less than annual revenue in California. Microsoft will not disclose figures, but Fortune estimates China revenue will exceed $700 million in 2007, about 1.5% of global sales.

When Microsoft first entered China, in the early 1990s, it though Chinese businesses and consumers would be queueing up to buy its software. But Microsoft underestimated the impact of piracy and the outright hostility in some government quarters toward the US software giant.

Microsoft sued Chinese companies for using its software illegally but lost regularly in court. Its China executives came and went, and the company risked becoming a case study of how not to do business in China.

Microsoft originally saw China as one more emerging market that would rapidly fall to its Blitzkrieg marketing and aggressive sales campaigns. But the reality was very different and by the end of the 1990s the company had only established the slimmest of beach-heads in China.

Guanxi (The Art of Relationships): Microsoft, China, and Bill Gates's Plan to Win the Road AheadGates then changed tack and decided that China needed handling in a very different way. He appointed a high-level Microsoft executive Craig Mundie to spearhead his China charm offensive and hired former Secretary of State Henry Kissinger to help open doors.

Mundie told leaders that Microsoft wanted to help China develop its own software industry, an urgent government priority. A research centre was established in Beijing to show that China had a lot to offer Microsoft besides licence revenues. Incidentally, the research centre is the subject of a recent book Guanxi (The Art of Relationships): Microsoft, China, and Bill Gates's Plan to Win the Road Ahead.

On the subject of software licences, Gates decided to drop the lawsuits and instead slash the price of Microsoft software such that there was no longer much incentive to copy it. Gates openly concedes that tolerating piracy turned out to be Microsoft's best long-term strategy, as it means that Windows is used on an estimated 90% of China's 120m PCs and the threat from Linux is much easier for Gates to dismiss these days than a few years back.

The Fortune article argues that Microsoft's China strategy is clearly paying off, at least if measured by the number of new customers that Microsoft gets each year — more than 24m PCs will be sold in China this year. But the company gets only $7 for every PC in use in China compared with $100 to $200 in developed countries, because of the differential pricing.

Gates no doubt reasons that, in the long-run, its better to have 24m new users who are happy to pay Microsoft $7 each then 1m users who begrudge pay $$200 each.

Its products are not easily “fungible” so once Microsoft can persuade China's businesses and consumers to willingly pay for its software — no matter how little — then it is guaranteed a future revenue stream, albeit not a particularly profitable one.

In return, however, Gates gets something that is much more valuable: the red carpet treatment from China's government leaders and the feeling that Microsoft is playing a leading role in shaping the modern China.

Few other western businesses can afford to take such a long-term view of China. Even fewer have a chairman who is used to having the Chinese premier as dinner guest.

So, it will be interesting to see exactly how Microsoft plans to build on the enormous amount of goodwill and guanxi that it has spent so heavily to acquire in China.

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