On China’s Web, Microsoft Is On The Outside -2-

Mar.31, 2008 in Market Outlook

Last Update: 3/31/2008 7:44:54 PM

By John Letzing

While China is considered to be one of the world’s most promising Internet
markets, Microsoft Corp. (MSFT) has struggled to establish a strong position in
the region as it deals with both internal and external pressures.

The software giant has been without a permanent head of Chinese operations for
more than six months, following Tim Chen’s surprise resignation in September.
Since then, the company has deployed Venezuela native Eugenio Beaufrand, a former
vice president for Latin America, to oversee its strategically invaluable China
business on an interim basis.

As Microsoft searches for a permanent leader in the region, it is also struggling
for a better presence in one of the most promising but difficult global Internet
markets. One means of acquiring a more prominent position could be through its
proposed acquisition of Yahoo Inc. (YHOO), which holds an enviable 39% stake in
Hong Kong-based Internet holding company Alibaba Group (1688.HK).

But even if it does net the Alibaba stake, Microsoft, which has designs on the
global web market similar to its dominance in PC software, faces a difficult slog
in China, local observers say.

Published reports have suggested Microsoft’s image in China as heavy-handed will
prompt Alibaba to buy out Yahoo’s stake if the acquisition bid succeeds. In
addition, the advent of a Chinese anti-monopoly law in August is expected to
bolster the international influence of local antitrust regulators - raising
questions about whether they may then seek to send a disconcerting message to
foreign firms by scuttling the Microsoft bid.

Analysts and others familiar with the Chinese Internet market say the notion that
Microsoft has a specific image problem is belied by progress made in softening
local perceptions. In addition, Chinese firms like Alibaba are simply eager to
control their own destinies - no matter who the prospective foreign partner, they
say.

But while resistance to outsiders, high turnover of top executives and other
setbacks are common to foreign firms angling for a piece of the Chinese Internet
market, that market is no less enticing. Beijing-based research firm BDA China
Ltd. reported recently that China has surpassed the United States in total
Internet users, with strong future growth projected.

BDA analyst Liu Ning said that Microsoft has made headway in the local instant
messaging market, for example, though its 15 million users pales in comparison to
Shenzhen-based Tencent Inc.’s nearly 300 million. Overall, Microsoft and its U.S.
counterparts face a formidable challenge, Liu said.

“Due to regulatory constraints plus a common sense of home court advantage, local
players are better positioned,” Liu said. “Foreign players such as Microsoft
recognize this, but view China as too important a market not to engage with.”

A Microsoft spokeswoman confirmed that a search is underway for a permanent top
executive for China, but was unable to offer further comment on the company’s
strategy.

Great Leaps Forward?

Microsoft’s recent progress in cutting down on Chinese piracy of its PC software
is well documented; the company said in January that anti-piracy efforts were a
major factor behind an 81% jump in its second-quarter profit. But Microsoft faces
a separate set of challenges penetrating the local Internet market.

Peter Lu, an analyst with Beijing-based China IntelliConsulting, said Microsoft
has struggled in the past to connect with a local audience. Lu recalled that when
former Microsoft executive Christopher Payne came to China to discuss its online
search service some years ago, “all he talked about was technology.”

“It seemed to me he had no idea that search users in China might be very
different from those in the U.S., and China might not be a technology-oriented
(search) market,” Lu said.

In addition, the lopsided situation Microsoft faces in U.S. Internet search, with
Google Inc. (GOOG) alone holding more than 55% of the market, is even more skewed
in China.

Liu, of BDA, said Baidu.com Inc. (BIDU) dominates China’s search market with a
roughly 60% share, while Google has slightly less than a 20% share.

In terms of other online services, such as the market for hosted personal Web
pages, Microsoft’s Live Spaces was an early success. But Lu said that in 2005,
when Microsoft officially launched its MSN China portal through a partnership
with Shanghai Alliance Investment, a government-backed investment company, Live
Spaces became “unstable and many times inaccessible in China … resulting in a
great loss of its user base.”

Meanwhile, while Microsoft’s instant messaging service continues to gain “high
end” users in Beijing and Shanghai, outside of those major cities its use remains
limited to under 20% of the total Web audience, Lu said.

Turnover among the local top ranks has been active at Microsoft, as well. In
addition to Chen, other recently departed executives include Luo Chuan, a former
head of the MSN China portal. Luo was regarded as a competent manager stifled by
the parent company’s bureaucracy, Lu said. He moved on to the Chinese version of
News Corp.’s (NWSA, NWS) MySpace site last year. (News Corp. is the owner of Dow
Jones & Co., the publisher of this newswire.)

Other recent departures affecting Microsoft’s presence in China include Kai-Fu
Lee, a former executive who left to head Google’s China operations in 2005.
However, Lu cautioned that high executive turnover is common among local
subsidiaries of large foreign Internet and media companies.

One Microsoft initiative that may be showing some promise is the establishment of
a local Internet research center. The Beijing-based lab features a search
technology center that uses local engineers to study Web user behavior, and was
seen at its opening in 2006 as a means to develop better Chinese-language
services.

Lu said positive results may be evident. When he was invited recently to examine
Microsoft’s local map service, he said he was “impressed very much by their
understanding of (local) users.”

Open Sesame?

Liu, of BDA, said it’s unlikely that acquiring the Alibaba stake would lend much
to Microsoft’s local Internet effort. Liu noted that Alibaba’s most prominent
business, online commerce site Alibaba.com Ltd., is unrelated to any Microsoft
business.

Lu, however, noted some possible uses of Alibaba for Microsoft. For example, he
said that Microsoft could negotiate a deal to place its own portal operations
under Alibaba’s management, in a manner similar to the way Alibaba currently
manages Yahoo China.

Though Yahoo China’s performance has lagged recently, Lu said, Microsoft would
still benefit from its deeper experience in local marketing and promotion. For
example, Lu said, Alibaba Chief Executive Jack Ma is precisely the sort of local
executive Microsoft needs, with his vision, strategic insights and government
relationships.

Other benefits Microsoft could see in China by winning the stake in Alibaba would
involve its lesser-known, closely-held aspects, such as the Alisoft on-demand
business software company. Alisoft could be used by Microsoft to help distribute
its own on-demand software, which is distributed via the Internet, Lu said. That
could enable Microsoft, which has relied on software sales to larger Chinese
corporations and government agencies, to receive an entry to Alisoft’s many small
business customers, he said.

However, Haim Mendelson, a Stanford Graduate School of Business professor who has
studied the Chinese technology market, wondered whether such opportunities could
ultimately prove more of a distraction than a benefit.

Mendelson also noted that Alibaba’s core strength to date has been in online
commerce, in the manner of an eBay Inc. (EBAY). “EBay is not what Microsoft wants
to be,” Mendelson said. “What Microsoft wants to be is in the portal business.”
The Alibaba factor, he said, is “more of a nuisance.”

Image Problems

Questions about Microsoft’s reputation in China have been raised recently in
light of reports that Alibaba may avoid partnering with it by buying out Yahoo’s
stake. But Microsoft has made strides in recent years to project a kindler,
gentler local image.

An Alibaba spokesman declined to comment.

While it may once have been seen as a behemoth with an unusually overbearing
attitude, that isn’t necessarily true today, said Raj Kapoor, a managing director
with venture capital firm Mayfield Fund who invests in Chinese start-ups.
“Microsoft’s reputation has gotten better worldwide, and China is no exception,”
Kapoor said.

Mayfield Fund has established a partnership with Beijing-based GSR Ventures, and
has raised two investment funds for local deals. Most of Kapoor’s companies,
including local travel site Qunar.com, see Microsoft as more of a potential
partner than a threat, he said.

Other issues that local start-ups face, including whether or not to develop on a
platform related to Microsoft’s pervasive and proprietary technology, are
approached with an open mind, Kapoor said.

“They look at things pretty practically,” he said of his companies, “there’s a
national pride, but when it comes to working with foreign companies operating in
China I don’t think there’s any particular bias against Microsoft.”

John Gantz, an analyst with International Data Corp., noted that Microsoft has
built a number of local bridges in China. Gantz estimated that Microsoft has
invested roughly $1 billion in local research and development centers and other
programs for technology exchange. It also has entered into partnerships with
local Chinese firms, including computing giant Lenovo Group Ltd. and invested in
television maker Sichuan Changhong Electric. “Microsoft is not seen as the evil
empire it might have been once,” Gantz said.

Still, Kapoor noted that even if a foreign company works hard to understand the
ways of the local Chinese market, that is no guarantee of success.

“There is a certain feeling in the Internet technology community of national
pride and an understanding of their culture that is better than that of foreign
companies,” Kapoor said. “And the data support that, it suggests that domestic
Chinese companies have won in every case.”

-By John Letzing, Marketwatch.com; 415-439-6400; AskNewswires@dowjones.com

(END) Dow Jones Newswires

March 31, 2008 19:44 ET (23:44 GMT)

Did you like this? If so, please bookmark it,