Three Reasons Why Microsoft Stays on the Dark Side in China

The future for Google (GOOG) in China is pretty clear: Its search servers redirect to the Hong Kong operation, China puts the firewall hammer on traffic going to Chinese customers, and Chinese employees bail fast before they are irrevocably associated with Google and shunned by other employers. Some other companies -- domain registrar GoDaddy is one -- are either planning an exit or at least reevaluating their positions. However, Microsoft (MSFT) is staying the course. CEO Steve Ballmer and company are sticking in China, censorship or not, for three business reasons: research, manufacturing, and money.

Let's talk about straight business issues and not whether anyone is right or wrong. Although I think the moral and ethical issues are clear if you're not running a company involved in China, things get murkier when there's business to conduct and you have not only self interest, but a legally-mandated fiduciary responsibility to investors.

I may have been a bit harsh when saying that this was only a business decisions for Google, and it seems clear that the situation had an impact on company co-founder Sergey Brin, but given how long the company was willing to hold its nose, you know that morality can take a back seat to pragmatism. From purely business considerations, it would be much harder for Microsoft to pull out of China than Google.

I've argued that many, if not most, western companies could leave China and be financially better off in the long run. But Microsoft may be one of the few exceptions. Start with research. As I noted last month, 6.5 percent of all its patents have at least one inventor based in China. From some of the patents I've reviewed, these aren't unimportant advances either. Microsoft depends on the flow of innovation.

The second reason is manufacturing. Back in 2005, both Flextronics and Wistron started making the Xbox 360 in China. As of January 2010, the Xbox factory was still in China. Zune manufacturing happens in China. At this point, extricating the supply chain from the country would be difficult, expensive, and time consuming.

Third -- but really first -- comes money. Microsoft's financial filings give a detailed geographic breakout of revenue sources; in 2009, it was $33 billion from the U.S. and $25.4 billion from everywhere else. So it's impossible to even know how much revenue Asia as a whole represents. But consider that Microsoft's cash cows are Windows and Office. China depends on global trade and must be technically compatible with the rest of the world. That means using Windows and Office. You can guess that Microsoft is pulling some significant revenue from China's PCs. Furthermore, China builds many computers for big names in hardware, which means many license licenses for those major Microsoft products. The revenue might technically get booked to companies in other countries, but the deals don't get done if Microsoft can't deliver to the People's Republic.

It's my guess that the three factors make Microsoft an anomaly, and one of the few western companies that, for business reasons, absolutely must be in China. Maybe Ballmer and others are working assiduously for change behind the scenes , but somehow I doubt it.

Images: Flickr users Roger Bits and aanjhan, CC2. Image editing, Erik Sherman.