CAIXINMEDIA

Inside The Crumbling Microsoft-China Love Affair

An antitrust investigation by Beijing authorities into the U.S. software giant was many months in the making, and may signal the end to a two-decade relationship built on billion-dollar deals.

Windows XP release in China earlier this year.
Windows XP release in China earlier this year.
Zheng Peishan

BEIJINGMicrosoft was once regarded in Beijing as the top foreign technology company that most values its relations with Chinese authorities.

But rumors had been circulating for months that there were problems between the U.S. software giant and the Chinese government. On July 28, the rumors were partly confirmed when China's State Administration for Industry (SAIC) suddenly initiated an investigation into four Microsoft China branches in Shanghai and Beijing, seizing documents and computers for antitrust inquiries.

According to You Yunting, an attorney at the Shanghai DeBund Law office, an antitrust investigation has been opened to probe alleged unfair trade practices and abuse of market dominance.

"Microsoft's relationship with China finds itself in a very bad situation," a Wall Street analyst told Caixin. "And it may get worse."

The problems began over services for the company's XP operating system.

Last year, Microsoft announced that it would no longer provide technical support for XP users, including system updates and security patches. This created potential security risks for nearly 200 million computers, including a significant number that belonged to Chinese state-owned enterprises and government departments. Meanwhile, Microsoft also raised the price of its Windows 8 operating system. Taken together, the decisions raised the ire of relevant Chinese government agencies.

Earlier this year, China's National Copyright Administration made direct demands on Microsoft that took into account China's current pricing policies, sales practice regulations and support to promote copyrighted software.

Microsoft China's subequent request for preferential policies led the Chinese authorities to criticize the company's lack of willingness to compromise. On May 16, China's state procurement center issued a notice saying that government computers were no longer allowed to install the Windows 8 operating system.

An industry analyst says the Chinese authority views Windows 8 as uncompliant with current government office policy. Not only are the costs considered too high, but Internet security is also a concern. For instance, Windows 8 allows content sharing through cloud services, which could easily lead to the leaking of government information.

The analyst says that unless Microsoft swiftly responds to the crisis, it will face even greater difficulties in the Chinese market. But it won't be easy because China accounts for only 10% of the company's overall sales. For the American giant, China is still a regional market ain which it does only about one-forth to one third of the business it does in North America. "The headquarters might ask, "Why should Chinese customers get a special deal?""

A great challenge

Over the past 20-plus years, Microsoft has always maintained good relations with the Chinese government. Since creating a Beijing office in 1992 and the Microsoft China Co. in 1995, the American enterprise has steadily grown in China, currently employing more than 3,000 full-time workers.

Microsoft founder Bill Gates attaches great importance to meeting with Chinese officials each time he visits China. In 2002, the company became a member of the China Software Industry Association, and signed a memorandum of understanding with the State Development Planning Commission to jointly develop China's largest foreign software cooperation project valued at more than 6.2 billion RMB ($1 billion). At the time, it was China's largest foreign cooperation project in the field of software.

The next year, Microsoft signed an agreement with China's Information Technology Security Certification Center allowing the Chinese government and specified accredited institutes to have partial access to Microsoft Windows source code and related technology information.

Relations between the two parties were further cemented in 2006 when then Chinese President Hu Jintao dined with Bill Gates at his home.

Meanwhile, Microsoft continued to forge relations with China's local governments. Since 2010, it has developed a strategic partnership with China's northeastern city of Jinan. Much of the company's annual global sales of hardware products, such as Xbox and Zune, originate from production in southern Chinese cities such as Shenzhen. It also launched an urban development program four years ago to establish further cooperation with various second-tier Chinese cities.

The crux

But since 2013, Chinese authorities began taking Internet security more seriously, while Microsoft held a tough stance on all issues related to XP and Windows 8. A sweet relationship was bound to sour.

IT expert Zhang Qunying says the crux of problem lies with Microsoft China.

First, it is not easy to run a software business in a country where piracy is rampant. "Microsoft should have adapted a special policy for a special market such as China," Zhang says. "Most of its Chinese market users are government departments. The company's Chinese CEO needed to explain this to the people at Microsoft headquarters."

Instead, Microsoft simply carried out its global policy in China, which included a halt to support and security measures of Windows 7 and XP that many Chinese government departments still relied on. This is the root of Beijing's discontent.

"The Chinese government is hoping to recover foreign companies' extra-national treatment while at the same time seeking greater investments and receiving more tax revenue from them through joint ventures," Zhang says. "But up until now, Microsoft China has proved incapable of convincing its headquarters to make such investments."

By contrast, Intel has factories in various places such as Dalian and Chengdu, contributing much more to China in terms of revenue.

Damaging a relationship is much easier than repairing it, and Microsoft's top priority now is to deal with China's aggressive anti-trust investigation.

The announcement also specified that senior Microsoft staff, including the vice chairman, high-ranking managers, and marketing and finance departments, are personally under investigation.

No more champagne and roses. The romance really is over.

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