In the world of IP, China is America’s recalcitrant stepchild. Software piracy runs rampant to the point where if one wants to purchase a legal copy of Microsoft anything, one will simply run into the software stonewall of unavailability - at every major computer outlet in whichever city you please. These same places are happy to install a copy of Windows Vista on your computer for free, assuming you bought, say, a hard drive from them. Registered, licensed, and real software products over the price of a hundred dollars generally don’t exist. To narrow the focus, I am only going to approach the gaming industry, or the online gaming industry to be specific.

Currently, the three major companies for game consoles are Nintendo, Sony, and Microsoft. Microsoft has the most integrated online gaming service with its service dubbed Xbox Live, by which console users can connect and play with each other for a nominal sum - $8 a month, or $50 for the year. Nintendo and Sony have both neglected to set up a unified online server system that connects gamers to each other. Can anyone say market opportunity?

The essential hubris of American IP attitudes in relation to China comes into play here. Microsoft’s Xbox Live service shuts down your account and restricts access to online gaming if they detect that you have a modified machine. Hardware modifications by pirates - who are scattered all over the city of Beijing and are readily available - cost about $20, giving you access to play pirated games for about 6 RMB each (less than a dollar). This is a very extreme difference to the retail price of $60 per game for the newest generation of Microsoft consoles, the Xbox 360. In China, the volume of unmodified, original Xboxes is negligible. Given that the average college graduate makes about 3000 RMB a month in Beijing, 400 RMB for a retail game is obviously ridiculous and out of the question. After paying the price for an Xbox, it is almost unfeasible to not modify the machine, considering the price differences. As for Nintendo, Wiis come pre-modified when you buy them at stores, meaning you can’t even find unmodified Wiis, if Nintendo even had an online game service. Sony currently does not have the piracy problems due to its Blu-ray formatting, although things like this are just a matter of time. The PS3 will surely be modified in the future.

So how does the Xbox Live business model work, anyway? Xbox Live commits subscribers to monthly or yearly fees, fees that are not likely to disappear once a customer has the taste for online gaming with his game console. Online gaming is an essential feature, and without it consoles become almost like a computer without the Internet. The costs for Microsoft to provide this service are negligible, since all Microsoft has to do is set up servers that connect gamers to each other. In general, anybody who owns of of these consoles will want to play online. It is one of the primary features that this new generation of consoles claims to have, and turns the consoles into vehicles for repeat subscriber purchases.

So how would Microsoft make money here? Microsoft must realize that, given a per capita income of $1740, China will not aggressively pursue mom-and-pop shopkeepers who modify Xboxes and sell games for a dollar. Instead, Microsoft should focus on aligning the interests of the government to make Microsoft money. As of yet, Sony and Nintendo do not have established online gaming services for its consoles. Microsoft should approach China Netcom, the main DSL provider for urban areas, and have it grant exclusive rights to provide online game services to all console service providers. The way in which Microsoft would do this is by having China Netcom create a partnership company that would have these exclusive rights, while the company provides a username and password service that connected, say, the Xbox Live service to users that had a DSL account - virtually all Xbox, or any other console owners. Imagine that! The government suddenly has an interest in providing online services for games through its own SOE. Microsoft could simply add its monthly or yearly fee for Xbox Live service as a line item on China Netcom’s DSL bill. When Nintendo and Sony are good and ready to provide online game services, it would have to do so through Microsoft, who would already have established itself in this essential market. This would also allow Microsoft to open up its Xbox Live services to users who may have modified machines, in that since China Netcom is an SOE, Microsoft realizes that the revenue from the repeat services it would be providing will accumulate revenues that would otherwise be completely lost. This would all be internal to China, essentially relieving Microsoft of responsibility in punishing pirates, given that the modifications on these console machines never stop. The pirates in Hong Kong were active and engaging in sales when the first games on CD-ROM were being released in the 90’s. The mainland certainly won’t be able to stop it for the foreseeable future. There are revenue streams open, though. You just need the right kind of fishers.

In “Distribution, China’s Next Big Opportunity,” I described why I believe the area of wholesale and retail distribution represents one of the next big opportunities in China.

In short, provisions agreed to as part of China’s entrance into the World Trade Organization at the end of 2001 have opened up the country’s distribution sector to foreign investment. Previously, distributing products in China was off-limits to foreigners.

In the general merchandise category, Lianhua Supermarket Holdings, a local company, is China’s largest retailer. Carrefour is the leading foreign retailer and now has over 100 stores throughout the country, with plans to open 20 more per year. Following closely behind is Wal-Mart.

The general merchandisers have already become rather sizeable. Lianhua had sales of Rmb 44 billion ($5.7 billion) last year, and Carrefour was not far behind with sales of RMB 24.8 billion ($3.2 billion).

Now that the way has been paved, specialty retailers are arriving, one by one, to set up shop in the country. At the end of October, Staples announced that it has teamed up with UPS to launch new co-branded stores in China, Staples UPS Express. The new format combines office supplies and document processing services from Staples, the world’s largest office products company, with packaging and international shipping services from UPS, the world’s largest package delivery company.

The first two Staples UPS Express locations have already opened in Beijing. Two additional locations are planned to open in Shanghai by the end of 2007.

Earlier this year, Brown Shoe Company announced a joint venture with Hongguo International Holdings Limited, one of China’s leading footwear companies, to begin marketing footwear in China.

Over the next five years, the two companies expect to open more than 400 stores throughout China, along with department store shops carrying the Naturalizer brand, and more than 100 carrying the Via Spiga brand. The joint venture will set up a wholly owned subsidiary in Dongguan, Guangdong Province, where Brown Shoe currently maintains a sourcing operation with nearly 600 employees.

A similar Sino-foreign joint venture between global home appliance retailer Best Buy and China’s Five Star Appliance was announced in May, 2006. The combined company, known as Best Buy Five Star, plans to open one thousand new stores by 2011.

Day by day, the landscape in China’s major cities becomes more familiar, and less foreign. The foreign-branded restaurant chains were the first to bring that air of familiarity. KFC lead the way, followed by McDonalds, KFC, Starbucks, Pizza Hut and others. It is now just as easy to get a Big Mac, a bucket of chicken wings, a Starbucks latte or a pizza with pepperoni in Beijing or Shanghai as it is in any city in the United States. Now that the dam surrounding distribution has broken, I expect that we will see a flood of specialty retailers following in the footsteps of the food chains.