Why Did China Launch an Anti-Monopoly Probe Into Microsoft?

Microsoft (NASDAQ: MSFT  ) is getting crushed between a rock and a hard place in China. On July 28, the Chinese government raided its offices in Beijing, Shanghai, Guangzhou, and Chengdu. The following day, it officially opened an anti-monopoly probe into the tech giant regarding Windows and Office.

Back in June, China's State Administration for Industry and Commerce (SAIC) started investigating Microsoft following an industry complaint that Windows and Office caused compatibility, bundling, and document verification issues. If Microsoft is found guilty of these charges, it could be fined up to 10% of its revenue, although it isn't clear if the fine applies to Chinese or global sales.

Source: Wikimedia Commons.

Microsoft's streak of bad luck in China
This isn't the first time Microsoft has been targeted in China. In May, the Chinese government abruptly banned purchases of Windows 8 systems, declaring that they were riddled with spyware that could be exploited by the U.S. government. The decision was also likely a response to Microsoft ending support for Windows XP, which is still widely installed on government computers. China's Ministry of Industry and Information Technology has been working with U.K.-based Linux vendor Canonical on its own Linux-based OS, Kylin, as a potential replacement for Windows systems.

China's distrust of American tech companies mirrors America's distrust of Chinese ones. U.S. regulators are still scrutinizing Chinese PC maker Lenovo's proposed $2.3 billion purchase of IBM's low-end server business over national security concerns.

These mutual suspicions aren't simply fueled by paranoia. Back in 2007, Seagate's hard drives manufactured in Thailand were reportedly modified by a Chinese subcontractor with a virus that sent stolen passwords back to China. The compromised drives were shipped to Taiwan and the Netherlands. Meanwhile, China has supported its cyberspying accusations against the U.S. by citing leaks from former NSA contractor Edward Snowden.

History is not on Microsoft's side
Microsoft is clearly becoming collateral damage in the ongoing battle over data privacy between the U.S. and China. Unfortunately, China knows exactly how to strike down Microsoft -- through antitrust litigation.

Microsoft has been highly vulnerable to antitrust probes. The company spent 21 years fighting antitrust battles against the U.S. government. At one point, the government tried to split the tech giant in half, but eventually withdrew the demand. Microsoft also lost an antitrust case in the European Union in 2004. It spent the following eight years appealing the case, resulting in a slight reduction of the fine to €860 million ($1.15 billion) in 2012.

In both cases, the accusations were similar -- that Microsoft abused its market-leading position by bundling its own software like Internet Explorer and Windows Media Player into Windows. The new accusations in China are more nebulous. Apart from claims that Windows and Office were not "open" enough (although they were never "open source") and had compatibility issues, it's unclear how those problems constitute anticompetitive business practices.

Barely any revenue from the world's largest PC market
China overtook the U.S. as the world's largest PC market back in 2011. Considering that 83% of Chinese Internet users access the web from a version of Windows, according to research firm CNCC, it would make sense to assume that Microsoft generates plenty of revenue from the country.

But that's not the case at all. The Business Software Alliance (BSA) reported that China had a software piracy rate of 74% -- which takes a huge bite out of Microsoft's Chinese revenue. While Microsoft doesn't disclose Windows revenue by country, former CEO Steve Ballmer stated in 2011 that revenue from China was only equivalent to 5% of U.S. sales. That makes China's "fine" of 10% of Microsoft's revenue seem bitterly ironic.

Microsoft, which has $85 billion in cash and equivalents, can certainly pay whatever fine the Chinese government dishes out, but the probe could hurt Microsoft's two other big pushes into the country -- Windows Phone 8.1 and Xbox One. Microsoft recently launched Windows Phone 8.1 in China, which stars a Chinese-speaking version of Cortana, its answer to Apple's Siri. The company will also launch the Xbox One in China in September. Considering that CEO Satya Nadella considers both Windows Phone and Xbox One as part of his "One Windows" initiative, cybersyping accusations could spill over to those two platforms and impact sales.

The Foolish takeaway
In conclusion, the Chinese antitrust probe won't cripple Microsoft, but it's certainly a frustrating roadblock. It also highlights the challenges Microsoft faces when diplomatic relations become entangled with tech businesses.

Microsoft isn't the only one in trouble in China. Mobile chipmaker Qualcomm is also being probed and could be fined $1.13 billion for monopolistic practices. Tech giants Google, IBM, Cisco, and Apple have all been called "pawns" of the U.S. government by state media. If Microsoft wants a piece of the Chinese market, it needs to rethink its strategies, and decide -- just like Google did in 2011 -- whether or not it can survive in China's increasingly hostile business environment.

 


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