July 30th, 2007

Microsoft's success in China

Posted by John Carroll @ 1:57 pm

Categories: Economic Policy, Microsoft, Open Source

Tags: Consumer, Revenue, Government, Microsoft Corp., Microsoft, John Carroll

Microsoft appears to be making inroads in the Chinese market. According to a blog post over at Tech Republic, Microsoft, through aggressive price reductions and a willingness to grant more access to source code, has managed to convince the Chinese government to use Windows and Office. Similarly, Microsoft has opted not to go on a piracy offensive in China, though it does try to minimize demand for pirated wares by offering a $3.00 Windows / Office bundle to students.

Of course, in talkbacks to the post over at OSNews, there were plenty of sour grapes. Some think it’s unfair that Microsoft charges Chinese consumers less than they charge  richer markets. The complaints exaggerate the situation somewhat. Most consumers in developed markets don’t pay sticker prices for Windows and Office, opting to acquire Microsoft software included as part of a new computer purchase.

Granted, such OEM pricing still costs more, but then again, all products are priced at different levels depending on the target market.

I noted in a previous post the practice of SKU proliferation, wherein Microsoft offers a number of product packages priced at different levels.  That’s normal business activity in most markets, whether the product is cars, printer paper or cheese. You find ways to maximize revenue by figuring out the optimal price, in terms of potential revenue, to charge an individual consumer. In so doing, you maximize the share of revenue which falls under the demand curve by charging the most a given consumer is willing to pay (or at least the closest approximation possible of that maximum). It’s the way software companies make money, and Apple, Adobe and Oracle are as “guilty” as anyone else of similar practices.

Charging a price based on local market conditions in a given country is an outgrowth of the same economic principal that drives SKU proliferation. Most Chinese consumers can’t afford developed-market prices for proprietary software, because it consists of a much higher percentage of an average user’s income. If a company like Microsoft wants to yield any revenue from that market, they need to lower prices. As local incomes increase, Microsoft can and will raise prices, but that, too, is normal business activity. Lots of things are cheaper in Mexico or the Phillipines than in the United States, because companies want to make money in those markets, and pricing at developed market levels simply makes no sense.

Alternatives to multi-level pricing do exist. A flat international price might make rich world consumers happy, but would seem an expensive luxury that would throttle growth of the company that practiced it. Likewise, consumers can opt for free (as in cost) software, a category which would have included Red Flag Linux. The Chinese government, and most chinese consumers, have opted not to do that. Microsoft has made a credible response to the challenge of free (as in cost) competition in the largest market in the world, and that is the real reason people are so incensed by Microsoft’s success in China.

It certainly has little to do with perception that Microsoft “validates” the Chinese government by opting to respond to its demands. The blog reports an instance where David Fitzpatrick stumped Mr. Gates by asking how Microsoft could reconcile China’s suppression of speech and human rights with Microsoft’s business relations with the government.

The answer is simple (IMO), even if it didn’t fly to the tip of Mr. Gates tongue. As I’ve argued before, there are two approaches to dealing with a problem government. You can isolate them, which is essentially what the United States has done with Iran and Castro’s Cuba. Alternatively, you can engage them, allowing trade to flow as normal and counting on citizens to make their own changes when they are ready to make them, as we did with Taiwan and South Korea.

Clearly, the latter option has proven more useful. You don’t have to like a regime with which you are dealing. You just choose not to penalize its citizens, allowing them the economic growth they deserve and counting on a familiarity with freedom in their economic lives to drive demand for freedom in political expression. It happened in Taiwan and South Korea (both of which were ruled by military regimes until the mid-80s), and can happen in China.

You don’t validate a government by opting not to starve a country’s citizens of trade with the outside world. You just treat a country’s citizens as masters of their own destiny. They will change their government when they are ready to change it.