1
Developing China’s software industry – crucial
government guidance and capitalizing on open
source opportunities on the road to “Innovation
2020”
Alexander Schenk (Student ID: 19447181) Asian Studies Program University of Hawaii at Manoa Fall 2013 Plan B paper Committee members: Associate Professor Cathryn Clayton, Professor Reginald Yin-
Wang Kwok, Associate Professor Lonny Carlile
Defense date: October 31st 2013, Moore Hall 319, 3pm-4:30pm
2
Introduction
Historically, China was long known as a nation of innovation. Printing paper,
gunpowder and the compass all originated from the Middle Kingdom. Fast forward to
2013 and China has become a global economic power with its sights set on
becoming a leading innovator once again. Add the global financial crisis of 2008,
which has made scientific innovation more important to economic success than ever
before, and the “innovation 2020 program”, an extension of the Knowledge
Innovation Program (KIP) launched by the Chinese Academy of Sciences in 1998,
has become the focus of long-term development by the Chinese government.
Members of the PRC’s top leadership have associated China’s long-term prosperity
with reforms toward an innovation-oriented technology system.1
The current five-year plan places emphasis on “indigenous innovation”, which the
government thinks it can foster by subsidizing “strategic” industries and strong-
arming foreign firms into transferring intellectual property to budding national
champions. 2 Materials science, information technology, public health and the
environment are among the priority areas of “innovation 2020“.3 The existence of
these five-year plans in China to this day illustrates the important role of the central
government leadership when pursuing a particular strategy of economic development.
1 See Chen, E. Yegin, “Technological Development and Cooperation in Greater China”, Managerial
and Decision Economics, Vol.16, No.5, Special Issue: Hong Kong: The Economy in Transition (Sep.-Oct., 1995), pp.565-579. 2 The Economist Newspaper Limited, “Innovation in China: From Brawn to Brain – If China Is to Excel
At Innovation, The State Must Give Entrepreneurs More Freedom” in
http://www.economist.com/node/21549938 March 8th 2012.
3 Nature – International Weekly Journal of Science,” China Sets 2020 Vision For Science” in
http://www.nature.com/news/2011/110201/full/470015a.html February 1st 2011.
3
The promotion of an innovation economy seems a reasonable strategy, given China’s
current economic situation. With rising blue-collar job wages in recent years, the PRC
is no longer a clear-cut favorite for cheap manufacturing labor. Other nations such as
Vietnam have become more attractive alternatives. It seems the time of cheap labor
in China is coming to an end. However labor costs are only one variable of the cost
equation. Unlike Vietnam, China has a reasonably developed infrastructure,
sophisticated supply chains and the advantage of scale.4
Yet critics of this plan, such as the OECD 5 , have argued that despite the
government’s recent investments into R&D, too little of that money goes into research;
the lion’s share is spent on development. “Innovation 2020” places a larger emphasis
on applied research and thus also “presents a major challenge to the management
and organizational capabilities of the academy [CAS6]”, says Richard Suttmeier, a
science-policy researcher at the University of Oregon in Eugene.7 Suttmeier argues
that most CAS institutes are focused on academic disciplines and lack the
infrastructure needed for commercializing research or directing it towards national
needs.
One additional major obstacle for potential private-sector innovators is piracy. The
enforcement of intellectual property rights in practice remains insufficient. The
favoritism shown toward certain state-owned enterprises further hinders innovation
by companies which are less connected to the central government by depriving these
4 The Economist Newspaper Limited, “Innovation in China: From Brawn to Brain – If China Is to Excel
At Innovation, The State Must Give Entrepreneurs More Freedom” in http://www.economist.com/node/21549938 March 8
th 2012.
5 Organization of Economics Cooperation and Development
6 Chinese Academy of Sciences
7 Nature – International Weekly Journal of Science,” China Sets 2020 Vision For Science” in
http://www.nature.com/news/2011/110201/full/470015a.html February 1st 2011.
4
firms of necessary capital. While expecting the government to forfeit its control is
mere wishful thinking, the degree of the top-down nature of the Chinese state has to
be significantly weakened in order to allow necessary room for experimentation. The
government has to let private investors risk money on ideas they think might work,
and bear the consequences of failure.8
This paper argues that software is a key industry that China must develop in its bid to
create an innovation-based economy. It illustrates the obstacles on the road to
developing this industry and the necessities of a government plan rather than letting
the “free market” determine the course of the industry. Additionally it examines the
nature of the central government’s intervention. Furthermore the research conducted
will characterize the type of software industry envisioned for China’s specific case
and highlight the sectors of the software industry where the PRC is destined for
success. Finally it offers possible measures to smoothen the development of the
software sector as far as possible.
China’s software sector – a key industry
When examining China’s country-specific structural advantages, its large labor force
is frequently pointed out. However, in the software field, it is not so much the sheer
number of China’s labor surplus that gives it a competitive advantage—as noted
earlier, rising blue-collar wages have made other nations such as Vietnam more
popular destinations for blue collar labor. Instead, it is the body of 470,000 well-
educated software professionals that can be steadily replenished and expanded from
the 37,000 computer science bachelors, masters and doctoral graduates each year
8 The Economist Newspaper Limited, “Innovation in China: From Brawn to Brain – If China Is to Excel
At Innovation, The State Must Give Entrepreneurs More Freedom” in http://www.economist.com/node/21549938 March 8
th 2012.
5
that makes China an interesting option for software development.9 Comparatively
lower white-collar labor costs than industry leaders like the United States are another
aspect of China’s competitive advantage.
Another distinct advantage for the PRC’s budding software industry is the potential
involvement of both Taiwan and Hong Kong. The Taiwanese experience in particular
can offer some valuable insights for the PRC. Over the course of multiple decades,
the Taiwanese economy served as a low-cost and supplier able to react rapidly to
market needs, particularly in components and low value-added products.10 From
initial technology imitation, Taiwan began to gradually acquire the skills in
development and design to make necessary modifications and adjustments.11 The
transfer of technology, followed by a sustained effort for domestic development and
production, has led to the emergence of Taiwan as a global leader in consumer
electronics, computer and memory chip production and design. Moreover, Taiwan
has cultivated extensive technology linkages with leaders such as the United States
in order to have a source of technology transfer.12 Aside from merely utilizing its own
university graduates for software development, the PRC can additionally capture
some of the experienced Taiwanese labor force as an additional opportunity given
more competitive wages for software engineers on the mainland as well as the higher
overall dynamic of the Chinese mainland’s software industry. Similar to the overall
influence of the central government in China’s economic development, the successful
9 Ju, Dehua. "China’s Budding Software Industry." IEEE Software. May/June (2001): p. 92.
10
Chen, E. Yegin, “Technological Development and Cooperation in Greater China”, Managerial and Decision Economics, Vol.16, No.5, Special Issue: Hong Kong: The Economy in Transition (Sep.-Oct., 1995), p.567.
11
Chiang (1993) 12
Chen, “Technological Development and Cooperation in Greater China”, p.566.
6
government involvement in changing the industrial structure of Taiwan serves as an
ideal model that the PRC could profitably follow.
Taiwanese companies, on their part, are particularly interested in the potential market
for Chinese language software. 13 Interviews and published reports 14 indicate that
many Taiwanese (and Hong Kong) software firms are contracting software
development functions to Chinese organizations, particularly those tied to universities,
presenting further opportunities for cooperation.
Software and Development
The term “software industry” refers to an industry sector including businesses for
developing as well as maintaining software. Software itself is a set of instructions
directed at a computer’s processor to perform specific operations. Some of the most
popular contemporary business models in the software industry include “cloud
based”15 computing, “license based” (proprietary software) computing, and software
services focusing on training or consulting. This paper will view the Chinese software
industry from an industrial policy standpoint, meaning the focus will be on Chinese
software firms’ performance rather than the development of the industry for the
benefit of the whole economy (which would be the case in an industrial structure
policy approach).
For developing countries, the software industry presents an ideal mode for integrating
themselves into the global information and communication technology market due to
the industry’s nature of being labor intensive, which complements the large labor
13
An average annual growth rate of 25% from 1988 to 1991 14
Free China Review (August 1992), p.44. 15
With cloud computing a large number of computers are connected through a real-time network i.e. the Internet
7
surplus of most developing countries rather nicely, and the worldwide trend of
developed countries outsourcing a vast amount of low-end, software related tasks to
low-cost countries. 16 Furthermore developing the software industry in turn is
conducive to the development of the tertiary (services) economic sector. This
provides employment (and therefore an incentive to create) for an educated
workforce with higher wages. Most importantly, in China’s case, the software industry
provides more room for innovation through the exploration of opportunities provided
by open source software. Failing to innovate can result in losing ground to
competitors, increase difficulty in retaining key personnel or more generally
operational inefficiency. Innovation is a major part of what separates market leaders
from their rivals. Innovation also is helpful for identifying current or future business
opportunities. As a successful business, it is not only essential to respond to current
customer needs, but also to anticipate future trends and come up with products or
services that allow the companies to meet future demand effectively. Hence
innovation helps staying one step ahead of the competition. This is especially crucial
in saturated or rapidly shifting markets. If a company can’t compete on price, it will
need innovative products to stand out. The scale of a business’ innovation can also
be dictated by the amount of innovation by the competition. It is also important to
consider that many businesses survive by copying and adapting the innovations of
others. As a whole, innovation helps advance societies throughout the world. New
and innovative products have the power of increasing the standard of living and to
provide people with opportunities to improve their lives.
The nature of China’s software industry
16
Li, Mingzhi, Gao, Ming, “Strategies For Developing China’s Software Industry”, The Massachusetts Institute of Technology, Information Technologies and International Development, Vol.1, No.1 (Fall 2003),p.61.
8
In China, the legitimacy of the Chinese Communist Party has been linked to
economic development. Considering the huge strides China has made development-
wise since opening its doors to the international community as part of the reforms of
the 1970s17, it has become increasingly difficult to maintain the extraordinary annual
GDP growth rates of 7 percent. The PRC can no longer stay competitive through
mere cost advantages or rapidly customizing already proven product concepts by
creating copies.18 Therefore innovation is a crucial tool for the government to help
insure its legitimization of ruling China. Moreover innovation is a crucial tool for the
government to prevent the so called “middle income trap”, a stagnant economic
development state, where a country can no longer increase a certain level of income.
The limitation of income growth is brought about by the disappearance of competitive
low-wage advantages and the inability to compete on value-added due to diminishing
productivity. China will be looking to avoid the fates of Latin American countries or in
the Asian region Malaysia and Thailand who for decades have been unable to
achieve high-income status.19
As in the recent past, Chinese government policies currently are very supportive of
science and technology. Partially due to this, a large percentage of software and IT
firms have their origins in state- and state-supported sectors. Despite the fact that
China’s hardware manufacturing industry is better known globally, software has
17
The role of the government itself has evolved from a central planning/state-controlled one in the period 1978-85 to an innovation system focused on more advanced R&D during 1985-91, and finally, to the market-oriented reforms of 1992 to the present. The market reforms begun in 1992 involved significant regional experimentation where government control was significantly loosened, foreign investment dramatically accelerated, and the technology sector opened up to other (non-state) forms of ownership.
18
See Appendix 19 Reuters UK edition, “China’s Commitment to Growth will Drive the Global Economy” in
http://blogs.reuters.com/great-debate/2013/09/12/chinas-commitment-to-growth-will-drive-the-global-
economy/
9
become a more integral part of the official strategy for new industrial development. In
2011, the gross income of China’s software sector topped 1.8 trillion Yuan, which
accounted for about 15 percent of the global market.20 Putting a damper on this
enthusiastic trend is the fact that in 2010 about 78 percent of the PC software
installed in China was pirated, compared with a worldwide rate of 42 percent,
according to a report released by the Business Software Alliance in May 2011.
The industry itself consists of mainly small firms, with weak capabilities. 21 While
China has strong capabilities in basic and applied research, it still lags behind many
other countries in innovation and productivity.22 Factors such as rampant software
piracy, high employee turnover and guanxi 23 – the network of dense personal
relationships – are contributing to the weaker capabilities of China’s software firms
and holding back the development of the industry overall.24 Yet the large size and
rapid economic growth of the Chinese economy and its increasing use of IT can
benefit the industry by providing demand for software. Additionally, the uneven
nature and poorer IT capabilities of many domestic customers could provide Chinese
software firms with better opportunities than multinational firms to serve these
20 China Daily USA,“ Software Providers Benefit From Anti-Piracy Campaign” in
http://usa.chinadaily.com.cn/business/2012-09/26/content_15783336.htm September 26th 2012.
21
CSIA (2000). Report on the Chinese Software Industry 2000, China Software Industry Association in Arora, Ashish, Gambardella, Alfonso, From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland and Israel. Oxford University Press. 2005.
22
Chen, “Technological Development and Cooperation in Greater China”, p.574. 23
Guanxi leads to strengthening not necessarily the company with the best product but rather the company with better connections to the government
24
Saxenian, A. (2003). Government and Guanxi: The Chinese Software Industry in Transition. London Business School: Global Software from Emerging Markets, May 2003. in Arora, Ashish, Gambardella, Alfonso, From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland and Israel. Oxford University Press. 2005.
10
customers. 25 Commercial enterprises such as banks and small and medium
enterprises have idiosyncratic processes and legacy systems that are difficult to
change. This opens the door for Chinese software firms making applications
specifically for these industries, giving them an edge over their multinational
competitors. A look at accounting software, an area known for its highly local
practices, shows two domestic firms (UFSoft and Kingdee) responsible for 60 percent
of production.26
Another possible strategy could be the utilizing of the country’s leadership in the
electronics industry and potential collaboration with global software giants to add
value to Chinese software companies’ bundling of Chinese software with hardware
and software manufactured by foreign companies. 27 For example, IBM signed a
marketing agreement with Red Flag to bundle IBM DB2 Express Database software
with Red Flag Linux for use by small and medium-sized businesses.28 By bundling
Chinese software with that of multinational corporations, both parties win: the
success of a complementary program that runs on OSS such as Linux will boost the
demand for some technology products and multinational corporations’ expertise in
such products in turn boosts demand for their portfolio.29
While foreign software companies dominate certain areas of the market, in particular
the Windows-based environment, some local companies have been able to develop
products in niche areas. Companies such as Kingsoft have advantages in application
25
Arora, Ashish, Gambardella, Alfonso, From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland and Israel. Oxford University Press. 2005. p.132 26
Arora, (2005), p.149
27
Kshetri, (2005), p.90. 28
Kshetri, (2005), P.91. 29
Ibid.
11
areas that require more intimate knowledge of the Chinese language or cultural
domain.30 Fields like operating and security software, with a combination of strong
government support and private demand are offering opportunities for domestic
software companies such as Red Flag. The government is increasingly targeting
areas such as Linux, security and middleware31 for such support. The goal has been
to insulate the country from the security problems inherent in using commercial (US)
software, as well as to gain a share of the very large market and to ensure that China
has its own ‘technology base’.32 Moreover the manufacturing sector, with its strong
growth and substantial capabilities, offers additional opportunities for China’s
software firms. There is also a rising demand for embedded software in electronic
products such as PDAs and mobile phones. The availability of substantial
engineering talent is one requirement for success, as is the availability of software
engineering talent, both of which China has in abundance.33
With about 160,000 software professionals distributed across over 6,200 software
companies, the average software firm size in China is extremely small, at about
twenty five software developers.34 Domestic firms command about 33 percent of its
domestic market, with official policy being to increase this to 60 percent by 2015.35
For the most part, China’s software firms can be grouped into two categories. The
30
Arora, (2005), p.150 31
Middleware is computer software that provides services to software applications beyond the ones commonly available from the operating system. It eases communication and input/output mechanisms for software developers, so they are able to focus on specific purposes of the application.
32
Ibid. 33
Ibid.
34
CSIA (2003). Report on the Chinese Software Industry 2002, China Software Industry Association. in Arora, Ashish, Gambardella, Alfonso, From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland and Israel. Oxford University Press. 2005. p.133 35
Arora, (2005), p.131
12
first are so called system integration (SI) firms. Systems integration involves large
custom projects where the software firms provide a combination of hardware and
software and services, including customized software. Of the sixty nine largest firms
with over US$1.21 billion in sales in 2000, thirty two were mainly engaged in SI, while
another nineteen were engaged in a mixture of SI and product development.36 In
2005, China’s revenue from Software and System Integration had reached $65.85
billion (390 billion RMB), and software export value reached 3.59 billion USD (21.93
billion RMB), respectively.37 The second type of firm focuses primarily on product
development, although for various reasons, also ended up doing SI and services.
Worth noting are that a number of companies were university or state supported spin-
offs, and the low level of software capability38 in the overall industry.39
In contrast, most foreign multinational companies sell financial or enterprise software
(SAP), middleware, and enterprise solutions (IBM), or packaged software for
desktops (Microsoft). However, since the majority of multinational software
companies are currently still exploring the Chinese market, they have not created
strong local operations dedicated to localizing and customizing their software. Herein
lie the opportunities for domestic firms at the lower end of the market.40
The majority of the Chinese software industry is concentrated in the nation’s largest
cities in the prosperous eastern part of the country, Beijing in particular, where the
36
Arora, (2005), p.133
37
Hu, Wangjin, Liu Luchuan, Chen Yu. "Software Outsourcing in Beijing: Basics, Trends and Implications." IEEE. no. 07 (2007): p.3235. 38
Capability was defined by what the industry itself uses, which was either some level of organizational capability, based on the Software Engineering Institute’s (SEI) Capability Maturity Model (from level one to five, where five is the highest level of attainment), or achievement of the International Standards Organization (ISO) 9000 quality standard. 39
Arora, (2005), p.139 40
Ibid.
13
bulk of FDI are made. Yet more and more other industrial cities such as Xi’an and
Shenyang are gaining recognition for their strong software firms and industries.41
Characteristic for these regions are the presence of universities with strong IT
programs, government support for the industry and vibrant industrial or commercial
activity.
Not only did the government have a direct influence on software R&D and the
formation of software firms in the PRC but it was also deeply involved in how the
hardware industry grew.42 This had ramifications for software companies in two ways:
First, some of the larger hardware companies such as Founder (a private enterprise
which commercialized university researched technologies) have developed software
arms or are combining software and hardware in systems integration activities.
Second, some hardware manufacturers provide business to software firms, (to run on
their products) ranging from desktop applications to embedded software. In the
Founder example, the company started developing electronic publishing systems,
relying partially on research from the government-funded Project 748 at Beijing
University, which was created by the State Planning Commission to deal with a
perceived critical need in 1974 for a Chinese language information processing
system based on Chinese character fonts. 43 Therefore the government had a
profound influence on firms through provision of intellectual capital, training, research
funding and incentives.
41
Arora, (2005), p.141 42
Ibid 43
Arora, (2005), p.141-142
14
One important structural characteristic is the increased emphasis on open source
software (OSS)44 development and deployment. OSS is attractive as a business
model because it has lower initial costs, slower obsolescence of basic infrastructure
features and therefore a lower total cost of ownership. Red Flag is a small company
employing about 100 people. In 1999, Red Flag began to research Linux, an open
source software substitute for Microsoft’s Windows and other proprietary systems,
and by 2000, the company was in operation.45 The fact that companies producing
operating systems such as Red Flag had CAS backgrounds indicates the importance
of scientific knowledge to the production of operating systems. It also indicates the
importance that the government placed on the development of key technologies.46
While OSS is by far easier for China to implement, the Middle Kingdom will likely face
international pressure to educate their customers and emphasize proprietary
software.
Government procurement is another commonly implemented government tool in the
PRC. A range of policies are in place to address fostering the software sector’s
competitiveness.47 The government keeps a list of key software enterprises eligible
for preferential tax treatment with recent procurement policies strategically further
supporting specific firms deemed to be doing software in the national interest, such
as Red Flag’s Linux.48
44
Such as Linux
45
Lovelock, P., Petrazzini, B., and Clark, R. (1997). The golden projects: China’s national networking initiative. Information Infrastructure and Policy, 5 (4), 265-277. 46
Arora, (2005), p.142-143 47
Arora, (2005), p.145-146 48
Arora, (2005), p.146
15
China’s software industry can exploit the country’s overall growth in numerous ways.
For instance, the sheer size of the economy provides opportunities for the
emergence of sizeable software companies. Additionally, widespread growth across
multiple sectors allows the software firms’ entry into the majority of them, in the
process diversifying the software sector as well as individual firms. Finally, with the
growth of specific sectors, the software firms also have opportunities to specialize in
sector specific software applications (see the banking sector or telecommunications
for example).49 The competitiveness of the market has also been increased by the
entry of a large number of companies, potentially causing firms to either attempt
diversification across software sectors or specializing in specific areas.
In a broader sense, the existence of the “Great Firewall” of China, meaning the PRC
government’s strategic intervention in censoring internet content, also presents an
excellent business opportunity for software companies. By offering virtual private
network (VPN) services, companies are catering to the growing desire of China’s
internet users to access the numerous international websites and services that are
blocked within China, including Facebook, Youtube and Twitter. Originally, VPNs
were designed to offer businesses or individual users a secure means of logging on
to corporate computer systems in public areas such as airports. VPN software lets
the user “tunnel” with the help of a server in a country without any internet restrictions
and encrypts information under an anonymous computer address to prevent
monitoring.50 New companies in the VPN segment are focusing their sights on the
384 million internet users in the People’s Republic of China. By selling their products
to users on a monthly or yearly basis, as well as by offering free software to end-
49
Arora, (2005),p.147-148
50
The New York Times, “Software Makers See A Market in Censorship“ in http://www.nytimes.com/2010/01/16/technology/internet/16vpn.html January 15
th 2010.
16
users but charging advertisers, VPN service providers have been able to take
advantage of popular demand.51 In this sense, due to products such as OSS and
VPN, China’s software industry is uniquely positioned to provide short-term remedies
for deeper rooted and broader problems regarding China’s legal system (which will
be addressed in the following sections). However, given the dominant role of the
central government in developing the software sector i.e. through procurement, the
success of companies trying to side-step specific government control through VPN
technology will undoubtedly be challenged.
Why government involvement is important for China – learning from Taiwan
As part of the four Tiger economies’ (Taiwan, Hong Kong, Singapore and South
Korea) development during the Asian “miracle” from the 1960s to the 1990s, the
Republic of China (ROC) more commonly referred to as Taiwan was able to achieve
rapid sustained economic growth rates, with high levels of equal income distribution
and export oriented policies. During this period, the overall involvement of the
government in industrial politics was essential. Given similar structural conditions,
some aspects of Taiwan’s development into a global software power offer valuable
policy implications for the People’s Republic of China.
For example, the Taiwanese government introduced the Assistance Program for
Strategic Industries (APSI) in 1982. Initially, 151 products were selected as strategic
products for development. By December 1987, the number had reached 214.52 The
majority of the products selected were electronic or information products. To
51
See Appendix “Number of Facebook users in China” which hints at the numbers of VPN availability and subscriptions in the PRC. 52
Chi-Ming, Hou, San Gee, “National Systems Supporting Technical Advance in Industry: The Case of Taiwan” in Richard R. Nelson (editor) National Innovation Systems: A Comparative Analysis, New York, Oxford University Press. 1993. p.395
17
implement its “pick the winners” strategy the government set aside NT$ 20 billion,
which was given to firms in the form of loans. These loans were spent on the
installation of machinery necessary for the selected products’ production. During the
1980s many other assistance programs were introduced additionally. Moreover other
non-financial assistance programs aimed at providing consultancy services for the
upgrading of managerial technology. These programs were created by various
government sponsored institutions. This strategy strongly resembles China’s
strategic development of specific industries.53
A number of institutes and councils in the administrative structure of the government
are charged with the responsibility of advancing science and technology in general
and in industrial technology in particular. Out of all the research institutions, the
National Science Council plays the key role in the development of science and
technology. It is charged with designing research strategy and plans promoting basic
research, recruiting research personnel and coordinating research work undertaken
by the various government agencies. Furthermore it is also responsible for granting
fund to researchers at colleges and universities throughout Taiwan. With already
many similarities to this research institution, the Chinese Academy of Sciences can
potentially broaden its scope of responsibilities.
In Taiwan one of the major disadvantages for small and medium enterprises was
their lack in size and hence their inability to have their own marketing channels.
Overseas mergers were viewed as the quick fix solution in most cases by many
entrepreneurs. The purchase or control of a foreign marketing company with an
already established marketing network was considered favorable to setting up a
53
Ibid.
18
marketing network from scratch.54 One of the major policy tools of the government is
the providing of low-interest loans or part of the investment capital needed so that
private companies can engage in overseas mergers.55 This strategy offers a possible
strategy for Chinese start up software companies to eventually better establish
themselves in the high end of the Chinese software market, which is currently still
dominated by foreign firms.
Overall, the Taiwanese experience illustrates successful government involvement in
changing industrial structure which is a potential model that the PRC can profitably
adopt.
Obstacles on the road to developing China’s software sector
Despite the tremendous development opportunities that the software industry
provides, one has to examine the current limiting factors on the road to development.
For instance, not all government policies necessarily have favorable outcomes.56 The
strategic targeting and supporting of selected firms and software sector by the PRC
government has had mixed results in recent years. While government procurement in
certain product markets has been beneficial to get companies started, too much of
this kind of support might make them fully dependent on continued government
assistance. System integrators that have relied too much on large government
contracts may not be able to foster other customers, and so their growth may be
limited in the future.57
54
Chi-Ming, (1993), p.404 55
Ibid. 56
CCID (2002). 2001-2002 Annual Research Report on China’s IT Application and Demand Market in Banking Industry. Executive Summary.
57
Arora, (2005), p.146
19
Another problem is that despite local software firms having a lot of work through
highly customized, domestic-oriented systems and systems integration work; it is
difficult to derive scale economics from such uneven markets. Furthermore the high
level of competition Chinese software firms face, is another problem. While the
increasing presence of foreign firms at the high end market in specific sectors poses
additional challenges, many local firms are left to compete at the low end of the
software industry. Despite the seemingly large number of firms, in a number of
product sectors, good software firms are few in number, and so a further reduction of
the population of firms or consolidation is possible.58
China’s large, fairly well-trained pool of human resources is an important reason why
it has been able to move into the majority of software sectors more or less effortlessly.
Yet despite the theoretical knowledge to handle basic tasks and analyze relatively
sophisticated data, the Chinese software workers lack the software process skills of
their competitors i.e. India. Only about 10 percent of the IT workforce has experience
with complex programming tasks, and project management ability continues to lag
behind that of India’s.59
In addition, the value of Capability Maturity Model (CMM) certification (the main
measure of organizational process capability) is not yet recognized by most Chinese
software companies, who tend to view CMM as a lower priority for producing
products with only one firm (Neusoft) at the highest CMM level (5) in China. The
companies most interested in exporting software will be the ones seeking higher
CMM certification earlier.60
58
Arora, (2005), p.155 59
Far East Economic Review, July 11, 2002, p.38. 60
Arora, (2005), p.156
20
Lastly and perhaps most importantly from a non-Chinese standpoint, the enforcement
of intellectual property rights (IPR) by the Chinese government is frequently
mentioned in articles regarding Chinese innovation.
In order for China to actually take advantage of its software sector’s potential, it will
have to address a number of issues that are currently hindering it from exploiting its
opportunities.
While the Chinese government has recognized innovation as a strategic priority, it
has so far not identified the potential of OSS in the development of the software
sector. As far as innovation is concerned, as of July 2011, then-Premier Wen Jiabao
noted that “Chinese capacity for indigenous innovation is weak, Chinese industrial
technology is at a low level, and both Chinese basic and cutting-edge research are
relatively unimpressive.”61 Foreign R&D centers in the PRC have led to Chinese
companies focusing more on innovation through competition.
Chinese companies must identify the necessity of developing strong brands and
improved margins through capable innovation-driven leadership while the central
government has to identify the software industry as an opportunity to foster further
sustainable economic growth. Until this is identified as a goal at the national level,
little sustained development can be expected.
A second obstacle worth mentioning is the dominance of foreign companies of the
high end market. The annual growth rate of 18.9 percent in the first half of the 2000s
appears to be a testament to China’s software development success story; however
if one considers that foreign companies account for a market share of approximately
61
China Daily USA,“China Meeting Software Protection Obligation” in
http://usa.chinadaily.com.cn/business/2013-04/26/content_16454057.htm April 26th 2013.
21
60 percent this feat becomes less impressive. 62 Considering Microsoft’s initial
struggles after entering the Chinese market in 1992, for example, it is not hard to
believe that it will most likely not support the development of OSS in China. It took
the company a while to abandon its typical approaches used in the U.S. and
European markets and to adopt a China-specific business model characterized by
low pricing and loosening its stance on intellectual property matters. In fact, tolerating
piracy was actually viewed as Microsoft’s best long-term strategy, since Windows is
now used on approximately 90% of China’s 120 million PCs.63 The most important
factor for Microsoft’s eventual success was the close partnership with the Chinese
government. “If a foreign company’s business strategy matches with the
government’s development agenda, the government will support you, even if they
don’t like you”, according to Tim Chen, previously of Motorola, who was hired by Bill
Gates in 2003.64
The adoption of its own five-year plan, modeled after China’s development strategy
of setting objectives every 5 years, further reflects Microsoft’s adaptation of its
business practices to suit the Chinese environment. With more than 24 million PCs
sold in 2007, in addition to the 120 million already in place, it seems that Microsoft’s
China strategy is paying dividends.65 Unfortunately for Chinese software businesses,
this also means the crushing the hopes of domestic software companies trying to
enter the high end market.
62
Barney, Sebastian, Wohlin, Claus, Hu, Ganglan, Aurum, Aybüke. “Creating Software Product Value in China”. IEEE Software. July/August (2009): p.84.
63
CNN Money, “How Microsoft Conquered China”, in http://money.cnn.com/magazines/fortune/fortune_archive/2007/07/23/100134488/ July 17
th 2007.
64
Ibid 65
Ibid
22
The third, and perhaps most severe, obstacle to sustained development of the
Chinese software industry is the thorny issue of intellectual property rights
enforcement.
The term “software piracy” is defined as “the unauthorized copying of an
organization’s internally developed software or illegal duplication of commercially
available software to avoid fees”.66 For license-based software companies focusing
on proprietary software in their product portfolio, it represents the most severe
problem in the modern software industry.
When applied to the dissemination of software, copyright and patents are the
dominant forms of legal entitlement. 67 Copyright applies to software in a similar
fashion to any other creative production. 68 It prevents others from copying and
distributing the software without compensation accruing to the creator.69 Patents are
applied to software to prevent others from reproducing its unique internal structure.
They have been mainly applied to specific software code or routines that allow the
software to perform certain unique functions. Patents, unlike copyright, provide
protection against reverse-engineering and independent discoverers.70
66
Chiu, Hung-Chang, Hsieh, Yi-Ching, Wang, Mei-Chien, “How to Encourage Customers to Use Legal
Software“, Journal of Business Ethics, Vol.80, No.3 (July, 2008), p.583.
67
Leaffer (1999)
68
17U.S.C. §117 69
McGowan, Matthew K., Stephens, Paul, Gruber, Dexter, “An Exploration of the Ideologies of Software Intellectual Property: The Impact on Ethical Decision Making”, Journal of Business Ethics,
Vol. 73, No.4 (July 2007), pp.415.
70
Leaffer (1999)
23
The patent office of the PRC leads the world in patent applications, more than
800,000 of which were filed in 2008.71 Granted, the majority of these patents are for
so called “petty” patents, meaning mediocre technology under minimal review and
therefore only receiving patents for a 10-year term. However, Chinese companies are
beginning to file “invention” patents more frequently. These patents are rigorously
scrutinized and receive 20 years of protection, as in the West.72 The increase of
patents in turn has led to a rising number of legal disputes. Since 2006 more patent
lawsuits have been filed in China than anywhere else, even litigious America.73 For
the most part such legal disputes involve domestic companies, but recently foreign
companies have received a fair share of lawsuits against them. For example,
December 2008 the South Korean conglomerate Samsung was ordered to pay
compensation to Holley, a Chinese telecom firm specializing in utility energy meters,
power transmission and transformation products.74
According to a 2005 Global Software Piracy survey by the Business Software
Alliance (BSA), the global piracy rate had reached 35%.75 For China specifically, the
U.S. research firm IDC estimated that about 80 percent of software sold in China in
2008 was pirated. 76 Despite decreasing numbers, the 2008 level of piracy was
71
The Economist Newspaper Limited, “Intellectual Property in China: Battle of Ideas – Chinese
Companies Are Enforcing Patents Against Foreign Firms” in
http://www.economist.com/node/13528318 April 23rd
2009.
72
Ibid.; See chart in Appendix 73
The Economist Newspaper Limited, “Intellectual Property in China: Battle of Ideas – Chinese
Companies Are Enforcing Patents Against Foreign Firms” in
http://www.economist.com/node/13528318 April 23rd
2009.
74
Ibid. 75
See http://www.bsa.org/globalstudy/upload72005-Global-Study-English.pdf 76
The New York Times, “Software Pirates in China Beat Microsoft to the Punch” in
http://www.nytimes.com/2009/10/19/business/global/19iht-windows.html?_r=1& October 18th 2009.
24
nevertheless double the global average and about four times the average of
developed countries such as Japan or the United States. Therefore, if China wishes
to further develop its software industry—especially its proprietary software
producers—it is imperative to encourage customers in Asian markets to use legally
obtained software.
But doing so requires understanding the reasons that drive the high piracy rates in
certain markets. As Matthew Cheung, analyst at the research firm Gartner, puts it:
“The big issue that is driving piracy in China today is price. If you’re trying to sell as
program that costs 2,000 yuan to a student living on 400 yuan a month, that’s simply
not going to work out for most consumers”, said Matthew Cheung, an analyst at the
research firm Gartner.77 As a result, Microsoft cut the price of the Office 2007 Home
and Student Edition from 699 yuan to 199 yuan in 2008.
In terms of the software industry, intellectual property protection (IPP) has proven to
be especially important regarding innovation. From a software company’s perspective,
“the fundamental issue is encouraging customers to use its legal software, which
suggests that a company must develop its retention programs, not just traditional
anti-pirating attempts, to enhance customers’ intentions to use its legal software.”78
In 2012, according to Tian Lipu, director of the State Intellectual Property Office, the
number of new filings for software copyright registration in China hit a record high,
reaching 139,000 applications. In 2008, the number was a mere 45,000.79 Moreover,
77
Ibid. 78
Chiu, Hung-Chang, Hsieh, Yi-Ching, Wang, Mei-Chien, “How to Encourage Customers to Use Legal Software“, Journal of Business Ethics, Vol.80, No.3 (July, 2008), p.583. 79
China Daily USA,“China Meeting Software Protection Obligation” in
http://usa.chinadaily.com.cn/business/2013-04/26/content_16454057.htm April 26th 2013.
25
the production value of China's software industry has grown from 75 billion Yuan
($12.03 billion) in 2001 to 2.5 trillion Yuan last year, indicating that the country's
software protection efforts are becoming more effective.
The successful lawsuit of the Chinese Chint Group against French Schneider Electric
on April 15th 2009 further illustrates the eagerness of Chinese companies to protect
their patents against Western companies as well. 80 Moreover, the increase in
Chinese companies pursuing patents abroad is an indicator that the firms intend to
protect their technology even when exporting to developed countries. In 1999
Chinese firms won 90 patents and 1,225 in 2008. Compared to, for example, IBM, an
American technology market leader, which receives about 3,000 patents annually,
that is still relatively few; but a growing trend is still nevertheless noticeable. In
addition, the PRC government’s anti-piracy campaign has spurred a wave of
business opportunities for software providers: county level and higher authorities will
join the governmental departments at the central and provincial level in their use of
licensed software by the end of 2013, according to Duan Yuping, senior official of the
National Administration of Copyright.81
The government’s 2013 IP plan, released recently by an interdepartmental agency
consisting of 28 Chinese government organizations, is intended to fulfill the daunting
tasks of intellectual property creation, protection, utilization, management and
promotion of awareness.82 Despite the lower number of measures on the annual IP
80
The two companies settled in an infringement case, with Schneider Electric awarding Chint over $23 million. 81
China Daily USA,“ Software Providers Benefit From Anti-Piracy Campaign” in
http://usa.chinadaily.com.cn/business/2012-09/26/content_15783336.htm September 26th 2012.
82
China Daily USA, “Government Unveils 2013 Intellectual Property Plan” in
http://usa.chinadaily.com.cn/business/2013-03/27/content_16349483.htm March 27th 2013.
26
plan compared to 2012, Huang Qing, the director of the protection and coordination
department at the State Intellectual Property Office, praised the positive improvement
of more thoroughly defined targets. The new plan aims to integrate IP strategies with
policies for various industries. It calls for increasing efforts in terms of IP risk
assessment and advisory functions in some emerging industries of strategic
importance.83 In addition the plan aims to emphasize the much needed cooperation
among government departments. Qing came to the conclusion that “on the road of
innovation-powered development, the intellectual property strategy plays an
important role in commercializing the fruits of innovation.”84
Potential measures to ease the development of China’s software
industry
The majority of the challenges China is facing regarding the development of its
domestic software industry are by no means insurmountable. Government
supervision of start-up companies becoming too dependent on their assistance,
individual companies’ decision to potentially cooperate with foreign multinationals to
gain access to the high end market as well as continued government investment in
better training and education of personnel with an emphasis on highly valued project
management abilities are a couple of measures that can increase the efficiency of the
competitive landscape of the domestic software market.
The problem of intellectual property right enforcement and subsequent pressures
China is facing from the international community are perhaps the most daunting task
83
Ibid. 84
Ibid.
27
ahead. The opportunities provided by open source software perhaps offer a way for
China to side-step these pressures and potentially change the competitive landscape
in the software market altogether.
Open source software in China
Open source software development in China, such as Red Flag Linux 85 , is a
supervised process with the government playing a vital role in sponsoring, nurturing
and using OSS. Out of the limited numbers on OSS in China, Red Flag Linux is the
most striking with a software market share of 30 percent. Founded in 2000, Red Flag
Linux has been steadily increasing its product portfolio and seems poised to be an
effective alternative to Microsoft’s Windows operating system in China. Currently the
product of Red Flag Linux consists of Red Flag DC Server 5.0 (红旗数据中心服务器
5.0), Red Flag Linux Desktop 4.1 (红旗 Linux 桌面版 4.1) and Red Flag Linux
Workstation 5.0 (红旗 Linux 工作站 5.0). The resemblance of Red Flag Linux and
Windows NT is aimed to ease the transition of operating systems according to Red
Flag Software Co., Ltd. As indicated above, Red Flag Linux from its inception was a
government initiative aimed at developing China’s OSS industry. The two largest
financial shareholders – government-owned Shanghai New Margin Venture Capital
and CCIDNET Investment, a venture capital arm of the Ministry of Information
Industry, further highlight the government’s involvement.
The use of Linux related projects are preferred at both the central and local
government levels since they emphasize the independent copyright owner and thus
are worth pursuing further. Furthermore the main reasons behind the Linux trend are
85
The only reported financially successful open source project in China
28
security and nationalistic concerns86, as well as to develop China’s own operating
systems and eventually break Western domination and monopoly-Microsoft in
particular. With Microsoft operating systems (Windows), application (such as
Microsoft Office or Internet Explorer) and a well-documented history of eliminating
small players in any field in which it wants to have a presence, the challenge
becomes obvious. Once such a monopoly is established, it is difficult for smaller, less
experienced market entrants to be competitive. Not surprisingly, culturally and
politically, some members of the Chinese government are a little paranoid of having
proprietary code, fearing secretly embedded codes in Microsoft software that the U.S.
Government can manipulate to a point where it can bring down China’s computing
infrastructure. 87 OSS offers a lower cost alternative to Microsoft’s monopolized
proprietary software. Hence promoting open source software (OSS) as a government
strategy to foster the software industry is suggested frequently.88 Given the support
by different levels of government, OSS products can expect a fairly broad user base.
In short, OSS provides the Chinese people with an alternative method for software
development that is considered as an effective measure to counteract the problems
linked to software in China such as piracy, security and high cost. Additionally the
educational and instructional use of OSS promises major potential for the Chinese
public at large and for institutions of higher education in particular.
86
Marson, 2005 in Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762
87 Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in
http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762
88
See Li “Leveraging the Open Source Software Movement for Development of China’s Software Industry”, (2004). & Ju, "China’s Budding Software Industry." (2001).
29
Financing has been one of the driving forces behind open-source software
development in China.89 Interestingly, higher education institutions in China have
always had severe financial constraints similar to their Western counterparts in terms
of base budgets for information technology (IT) licensing fees, training, and support
required for application software. 90 Besides various financial constraints and
considerations, open-source software also is viewed as an opportunity for China to
utilize millions of talented, university-educated individuals in its quest to develop its
own brand of copyrighted software to combat the monopoly of Microsoft in China’s
software market.91
One recent development worth mentioning is the “localization” of OSS systems from
Western countries, meaning the customization of software into Chinese.
Overall open source software simultaneously could solve the piracy problem as well
as change the competitive landscape of the software industry altogether. With an
increased awareness and competitiveness in the OSS field, the competition outcome
can improve the overall social welfare.92 Given the general availability of open source
software as well as the OSS technology features themselves, China should adopt a
multi-pronged approach involving domestic OSS development in addition to allying
itself with foreign software firms. The education-related OSS movement will not only
address financial constraints faced by most educational institutions in China but also
89
Miro International Pty Ltd, 2006; Wang, 2004 in Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762 90
Hu, 2005; Yeats,2005 in Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762 91
China Economic Net, 2004; GEEK.com, 2000; MacNewsWorld, 2003 in Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762
92
Li, Mingzhi, Lin, Zhangxi, Xia, Mu, “Leveraging the Open Source Software Movement for Development of China’s Software Industry”, The Massachusetts Institute of Technology, Information Technologies and International Development, Vol.2, No.2 (Winter 2004),p.56.
30
promises to build upon and expand the social and intellectual capital that each
participating organization has to offer.93 Chinese colleges and universities can also
be seen as 'greenhouses' for open-source course management systems and other
software that not only meet the specific needs of participating institutions, but, equally
important, nurture and encourage the initiative and innovation of the tens of millions
of talented individuals studying at colleges and universities within China.94
Also, in broader terms, just because the PRC is competing with multinationals, does
not mean it should not consider possible opportunities for cooperation. Such
alliances between Chinese and foreign software firms will help both sides gain
benefits from becoming co-competitors in niche markets of mutual benefit. 95
Furthermore these potential alliances could help cooperation with international firms
and thus also open new foreign markets for the Chinese software companies.
Despite the recession in the United States and Europe, the demand for software
outsourcing is still increasing as companies are struggling to cut costs. The central
government of China has to work together with universities and businesses to take
advantage of this outsourcing opportunity.
Conclusion
93
Guohua, Pan, Bonk, Curtis Jay, “The Emergence of Open Source Software in China”, in http://www.irrodl.org/index.php/irrodl/article/viewArticle/331/762 94
Ibid. 95
Li, Mingzhi, Gao, Ming, “Strategies For Developing China’s Software Industry”, The Massachusetts Institute of Technology, Information Technologies and International Development, Vol.1, No.1 (Fall 2003),p.70.
31
The software industry as a whole has developed rather rapidly with many new
entrants in the last couple of years. The significant government support has
generated many software companies and provided work for their offerings. Similar to
the software industry, government intervention had previously played a role in the
development of the hardware industry, which now represents a potential source of
customers for their software counterpart. Continued government support is essential
for the still early stages of the software industry in China. But the handholding by the
government could potentially cause long-term problems as it could lead to technology
picking and be used to support the weakest companies.
In theory China’s large domestic economy provides opportunities to the domestic
software industry in terms of a critical mass of work and in terms of opportunities from
other sectors, at the same time, however, the market has also brought about
opportunities for foreign competitors.96
Resulting from the merging of these factors, specific sectors and types of software
activities tend to be emphasized more than others i.e. manufacturing, certain types of
business software (banking in particular). All these areas are made possible by the
lesser level of multinational dominance since multinationals tend to first try to sell the
same technology without specific modifications for the Chinese market conditions,
which limits their scope to the upper end of select markets. This by no means should
encourage domestic software firms to be “too local”, because specializing only in
local practices hinders the companies to upgrade themselves or gaining economies
of scale since they are only working with unequal customers.
96
Arora, (2005), p.160
32
Given recent OSS trends there are a number of opportunities for research and
development within higher education in China and beyond. Considering China’s
enormous potential for online learning, the influence of China in the OSS movement
will be extensive and potentially relentless.97
Summing up, a thorough study of China’s software industry is not merely an
examination of the development of a key in the PRC’s economy; it also provides a
unique perspective on intellectual property issues, the role of the CCP central
government in continued economic development, and China’s position among
developed economies in the US and Europe as well as other developing countries in
Southeast Asia. All of these aspects are “hot topics” in contemporary Chinese studies
and the examination of China’s software sector contributes to each aspect.
Unfortunately the length constraints of this paper do not leave sufficient room to
examine all of these topics in more detail, but further research in the field would
provide important contributions not just for the business community, but for anyone
interested in the political economy of the People’s Republic of China.
All in all the software sector is an important strategy for China’s overall economic
future, in addition to being a great vantage point from which to understand the
Chinese political economy at this key moment of transition from a manufacturing-
based economy to an innovation/information-based economy.
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