SHANGHAI/SEATTLE In his first official visit to the United States in 2006, China President Hu Jintao arrived for dinner at Microsoft Corp. (MSFT.O) Chairman Bill Gates' house with a gift for the host.
Shortly before Hu's Seattle visit, the Chinese government had issued a decree requiring all personal computers manufactured in China to come with a licensed operating system before leaving the factory gates.
Now, nearly two years later, that gift keeps giving. The software company co-founded by Gates is seeing the benefits of more stringent intellectual property policies in China, with a decline in piracy rates and improved results at its mainstay Windows division.
China is by no means the worst offender.
More than a dozen other countries -- including Indonesia and Ukraine -- have higher software piracy rates, according to a study from the Business Software Alliance and IDC. None of those countries, however, offers the promise of China, the world's second-largest PC market, growing at more than 10 percent a year.
China's piracy rates, the level of pirated software in a particular country, dropped to 82 percent in 2006 from 90 percent in 2004, the study said.
"In China, where piracy is the way things are done with respect to software, any marginal money Microsoft gets back is super important," said Kim Caughey, portfolio manager and senior analyst at Fort Pitt Capital Group.
Reducing software piracy and selling more expensive versions of Windows are ways for Microsoft to generate sales growth that exceeds the overall PC market, a task made difficult since its global market share already tops 90 percent.
Microsoft said improvements in fighting piracy accounted for about $164 million of the $822 million revenue gain at the Windows client unit in the quarter ended September.
Windows is Microsoft's most lucrative product with an operating margin exceeding 80 percent.
"Every pirated copy that Microsoft converts into a paying customer all flows to the bottom line," said Morningstar analyst Toan Tran. "It could have a dramatic effect on its profit margin."
PIRATES AT WORK
Despite the progress being made, pirated software is still readily available on the streets of Shanghai.
Fuzhou Road in the former British concession near the Bund, an area famous for bookstores and art boutiques, is also locally renowned as a place to buy pirate PCs and software.
The small alleyways running off Fuzhou Road host dozens of pirate PC shops, which usually have no signs. Locals ask passersby if they want to buy "cheap" PCs or software before leading potential customers to the store.
Once a computer is assembled, the customer is given a list of pirated software options, ranging from Microsoft Office to Adobe Systems' (ADBE.O) Photoshop. If a software program is not there, it can be ordered.
The government decree requiring PC makers to pre-install an operating system sought to address the problem of Chinese consumers buying computers without software and then opting to buy less expensive counterfeit software.
Beijing went one step further, calling on any Chinese companies wanting to do business with the government to run properly licensed software.
"The whole situation is heading in the right direction," said Hao Jing, spokeswoman at Founder Technology Group (600601.SS), China's second-largest PC maker. "Pre-installing genuine copyrighted operating systems has become an industry standard."
Earlier this year, the Chinese police and the U.S. Federal Bureau of Investigation seized $500 million worth of pirated software, including counterfeit Microsoft and Symantec (SYMC.O) products, from a Chinese piracy syndicate.
"We've seen in the last two years significant emphasis on legitimate intellectual property use in China," said Cori Hartje, director of Microsoft's genuine software initiative.
Microsoft said it needs to do more in educating consumers to the benefits of getting genuine software like access to software updates and better security. Improved technology also serves to deter piracy.
Windows Vista, the latest version of its operating system, has been more effective in preventing piracy. Microsoft has said piracy rates for Vista are half the level of its predecessor Windows XP.
In Vista's first major update due out next year, Microsoft said it plans to close two primary methods used by software pirates to illegally copy Windows Vista.