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

The software giant (MSFT) has been without a permanent head of Chinese operations for more than six months now, 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's 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.

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 antimonopoly 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 (NWS) MySpace site last year. (News Corp. is the corporate parent of MarketWatch, the publisher of this report.)

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. (1688.HK), 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 entrée 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's not 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 supports that, it suggests that domestic Chinese companies have won in every case."

  (END) Dow Jones Newswires
  03-31-08 2311ET
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