Microsoft lock now "made in China"

By CNN's Kristie Lu Stout

HONG KONG, China (CNN) -- Software giant Microsoft has entrusted a state-owned software firm to create a security program for its Windows software.

The China National Computer Software & Technology Service Corporation (CS&S) will tailor an encryption program for Microsoft's Windows 2000 and Windows XP Professional products to be sold in the Chinese market.

Analysts say the move is aimed at pacifying large government or state-run clients at a time when the rival Linux operating system is making major inroads into the China market.

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"They are willing to play on Chinese government rules," said Ion Global analyst Frank Yu. "It's a positive for both China and Microsoft."

More encryption control for China

According to Microsoft, the CS&S security product is expected to augment existing security applications as a safeguard for secure data transactions for e-government and financial projects.

CS&S will develop and own the intellectual property rights of the encryption code.

Microsoft will support CS&S in the development process, by providing access to its Windows source code, hardware test tool kits and technical support.

After the product receives final approval from the State Encryption Administration of China, it will be bundled with Windows software for sale in China by late 2001-early 2002.

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Microsoft says the move is motivated by its mission to bolster the Chinese software industry.

"Microsoft is committed to partner with local industry and to meet local customer needs," Microsoft Greater China regional director Alexander Huang said in a statement.

"CS&S and Microsoft cooperation shows Microsoft's leadership in providing support for local customer and industry needs."

But industry observers say by supporting a local security solution, Microsoft is finally answering a long-standing complaint that poor encryption makes Microsoft clients vulnerable to hack attacks.

"The Chinese have always felt that Microsoft has all these security holes," said Yu. "That's why China for the longest time needed Microsoft, but didn't want to be too reliant on Microsoft since there are trap doors that hackers and the U.S. government can enter."

"By allowing a Chinese company to come in, they have more control over the encryption."

The Linux threat

Microsoft's security alliance with CS&S arrives as Linux steadily gains popularity in China.

Linux is an open source operating system developed by a community of programmers who openly share the source code in an effort to continually improve the language and is a free alternative to Microsoft's Windows.

"If China had its own way it would be Linux," said Yu.

Analysts say Linux is an operating system that, unlike Windows or other commercial platforms, can be modified by China for its own needs and even eventually exported back to the U.S. and other markets.

Chinese Linux programmers have been accused by the U.S.-based Linux firm Red Hat of not sharing their modified source code.

Red Hat is said to be struggling in the China market. It charges Linux coders for Linux documentation and technical support, and faces aggressive domestic players like Red Flag.

Red Flag has a key advantage over multinational software firms like Red Hat and Microsoft -- the blessing of the Chinese government. It has close ties to Beijing University's software affiliate Founder and the Software Institute of the Chinese Academy of Sciences.

"When you're backed by the government, it's much easier to get into Linux training and technical support for larger customers," said Alex Banh, deputy chief executive of Sun Wah Linux, a shareholder and distributor of Red Flag products.

Software sales in China are expected to grow by 31.7 percent year on year in 2001 to reach $3.66 billion, according to the Chinese government think tank China Center of Information Industry (CCID).

According to CCID, a large portion of sales will go to foreign software firms. It could take another five to 10 years before Chinese software companies generate significant domestic demand.