Section 13.1. What OSS Was and Is in China

13.1. What OSS Was and Is in China

With the Gross Domestic Product (GDP) growing at an average rate of 9.8% year over year (YoY) from 1979 to 1997,^[1] China has been pegged as a fast-growing economy. The high-tech industry had become the number-one pillar industry as of 2002,^[2] and is expected to contribute 7% to the country's overall growth in 2005.^[3] All of this is part of China's tenth Five-Year Plan, with the vision that "information drives industrialization" and ICT will continue to be a national focus onward.

^[1] http://www.stats.gov.cn/tjfx/ztfx/xzgwsnxlfxbg/t20020605_21437.htm.

^[2] http://www.ccw.com.cn/htm/news1/dt/inland/02_9_16_10.asp and http://www.chinabyte.com/20020327/1603813.shtml.

^[3] http://www.c114.net/policy/policyread.asp?articleid=249.

There are many growth opportunities within China's ICT, particularly in software and services, hardware, and telecommunications. Currently China is experiencing significant growth and success in hardware and telecommunications, notably with companies like Lenovo^[4] and Huawei Technologies,^[5] which are recognized as global industry players. The software industry, however, is slower to produce such success stories.

^[4] http://www.lenovogrp.com/cgi-bin/main.cgi?section=about&sub_section=chair_message

^[5] http://www.huawei.com/was/wps/portal/!ut/p/.cmd/cs/.ce/7_0_A/.s/7_0_1K4/_th/J_0_6A/_s.7_0_A/7_0_1JJ/_s.7_0_A/7_0_1K4

There are three key objectives to consider when examining the future of China's software industry:

Grow the local independent software vendors (ISVs) who can drive more PRC market success

China currently has many small and medium-sized software companies, 90% of which employ fewer than 200 people. Today the revenue generated by the Chinese software companies competing in the global market is relatively small, with the most successful local vendors generating approximately $70 million in revenue, only 1% of that of their leading global software counterparts.

Grow infrastructure software to take advantage of the specific needs of the PRC market

There is a perceived opportunity to develop specific infrastructure software for the Chinese market. Currently 85% of the local ISVs fall into the application software segment. China's software industry is largely reliant on multinational vendors, which are the predominant suppliers of infrastructure software such as operating systems.

Continue education on the importance of intellectual property (IP) rights to grow a healthy software industry

It will be important to continue to educate Chinese enterprises that software and services are not complementary to purchased hardware. Piracy is perceived by many organizations as the norm, particularly for popular software and tools. Sharing of such IP not only negatively impacts the vendor's bottom line, but also hurts the local software industry, making it difficult for vendors to build capital with which to compete and innovate. Today more Chinese companies have begun to develop original content, which means they will think more about adequate safeguards for their IP. This is borne out by the increasing number of patents and trademarks that are being filed in the PRC.

Other factors worth considering to improve and grow the domestic software industry include:

Minimize piracy by encouraging fair-priced software and services

China's World Trade Organization (WTO) entry means it will need to confront and contain software piracy. The government has adopted a multipronged approach targeting piracy to combat the issue of copyright infringement over time.

Enhance national security and decrease viruses and hacker attacks when running software

As China works to develop infrastructure software, it will continue to rely on what is available. To protect national security, China recognizes that it has to complement the core parts in the value chain of the software industry, as it sees the direct relationship between the software and hardware industries.

Grow a strong software industry in pursuit of IT industry growth

As software is where the profitability goes in the ICT industry, China needs to position itself to supply the innovation, new software, support, and usage models which the growing Chinese economy will need. By considering local needs of the various market sectors and using standards that would allow for international usage, Chinese software companies can build a home base of customers to support IT industry growth.

At this time, OSS has entered onto the PRC SW sage.

13.1.1. What OSS Means in China

Picture a generic software stack (Figure 13-1), with levels for the different types of software, starting from the firmware/basic input/output system (BIOS), all the way to the applications. OSS traditionally has focused on the operating system (OS) part and above; Linux has played a key role in the OS layer.

Figure 13-1. A generic software stack

The introduction of OSS in China can be attributed to a group of technical enthusiasts in the early 1990s. It is said that copies of Linux were brought back by Chinese visiting overseas from the University of Helsinki, UC Berkeley, and MIT, and quickly spread throughout universities and research institutions such as Tsinghua University and the University of Science and Technology of China.^[6] At that time, computer science students and professors focused on becoming familiar with the system and localization.

^[6] http://www.linuxforum.net/forum/gshowflat.php?Cat=&Board=linuxtalk&Number=492466&page=0&view=collapsed&sb=5&o=all&fpart=all&vc=1.

In 1997, OSS was officially recognized by the government with the development of "Free Software Research and Application Development," a sub-branch of the China Software Industry Association, along with a wide range of OSS communities, such as a free software databasefreesoft.cei.gov.cnand some other bulletin board systems (BBSs), newsgroups, and Linux User Groups (LUGs).

In 1999, the first Chinese Linux companyXteamwas founded and delivered to the industry the first commercial operation of Linux/OSS in China. Consequently a nascent market started on this initial engagement, which drew the attention of competition and keen interest from entrepreneurs.^[7] Companies such as Red Flag, China Software Network Technology Co., Ltd., and BluePoint, as well as multinational ones such as TurboLinux have since begun activities in China.

^[7] http://www.linuxforum.net/forum/gshowflat.php?Cat=&Board=linuxtalk&Number=492466&page=0&view=collapsed&sb=5&o=all&fpart=all&vc=1.

13.1.2. Status of OSS in China

Since 1999, China has placed a stronger focus on OSS. There are many different components in OSS, from infrastructure software like Apache (web server), MySQL (database), and JBoss (application server), to tool and application software. In China, many of the efforts and activities have focused on Linux.

As seen in the market, the server side of Linux is relatively established in enterprise infrastructure, with a healthy growth rate. Increasingly Linux is being deployed for application servers and backend databases. This has been mainly seen in the financial services industry (FSI) and telecommunications. Vendors such as TurboLinux and Red Flag have taken an active part in these segments to grow their corporate revenues.

Since the Linux OS is the most well-used OSS in organizations, enterprises, and government bodies, a snapshot of China's Linux market is an appropriate way to study the market potential. Table 13-1 shows the key players in the market in China.

Table 13-1. Linux distributors in China

Type	Company	Background/description	Commonality
Local	Red Flag	Market leader in Linux client operating environment (COE) and second in server operating environment (SOE).[8] Co-founded by Software Research Institute of the Chinese Academy of Sciences and NewMargin Venture Capital in 2000. Got investment from CCID Capital incorporated under the Ministry of Information Industry in 2001. Offers a complete portfolio of Linux products for desktop, server, and embedded systems.	Strong government background. Fewer than 200 staff. Revenue mainly from government IT purchasing.
	China Standard Software Co., Ltd. (CS2C)	Ranks as third Linux distributor in COE and SOE markets, respectively.[9] Spun off from China National Software and Service Co., Ltd. (CS&S) in 2003. Focus on desktop, server, and office products.
	Co-Create	Joint entity formed by tens of local IT companies in 2001. Received investment from CapInfo in 2003. Targets Linux desktop and office suite.
	Xteam	First Linux distributor in China. Listed in Hong Kong Stock Exchange two years after the company was established. Transitioned to Linux server from its initial focus on Linux desktop. Focused on solutions for government and education after 2004 investment by Beijing Enterprises Holdings Ltd., which had a strong government background.	Government background.
	BluePoint	Transitioned from a pioneer Linux distributor to an embedded firewall provider.	No government background.
Foreign	TurboLinux China (TLC)	Existed as an American company, then acquired by a Japanese company. In 2004, local company Hinge Software became the No. 1 shareholder of TLC,[10] which made it a local entity. Strong in server side, especially in the telecommunications industry.	Presence in China.
	Novell SuSE	After the acquisition of SuSE Linux, Novell, with over a decade of operations experience in China, started its new Linux business locally. Focus on training with local institutions.[11]
	Red Hat	Leading distributor globally. Commenced operation in China in November 2004. Plans to invest $1 billion for development in China.[12]
	MandrakeSoft	Ranks as third distributor in the world.[13]	Plans to enter China.

^[8] Nielse Jiang, "China Linux 2005-2009 Forecast and Analysis." IDC, Feb. 2005.

^[9] Nielse Jiang, "China Linux 2005-2009 Forecast and Analysis." IDC, Feb. 2005.

^[10] http://www.smartpartner.com.cn/sp1/index/article.php?storyid=8334.

^[11] http://tech.ccidnet.com/pub/article/c308_a184083_p1.html.

^[12] http://www.ciweekly.com/ciweekly/inforcenter/A20041123364459.html.

^[13] http://www.chinabyte.com/homepage/219015092686028800/20050110/1898897.shtml.

In China, Linux distributors are broken into two camps: local and foreign.

In the local camp, there are five major distributors. The first three distributors, composed of the tier-one groups, make up more than 60% of the market share among local players. Although they have different characteristics and strengths, all of them possess certain commonalitiesi.e., they have government backing, fewer than 200 employees, and revenue coming mainly from government IT purchasing.

As to the rest, the main difference is that they do not have government backing. That may change the fate of these companies. Some have transitioned to new business, such as BluePoint. Some have turned to getting government support, thanks to capital infusions, as seen in Xteam. Still, there are some distributors who continue to fight for a ticket into the tier-one group.

Although there are many indigenous distributors in China, the market potential has attracted the attention of foreign distributors also. This group of foreign distributors in China includes almost all the leading global distributors: TurboLinux, Novell/SuSE, and Red Hat. Some other distributors, such as MandrakeSoft, are also expressing interest in making inroads into China.

13.1.3. OSS Business Models in China

Many people may wonder how companies make money based on open source products. There are different approaches, but one that has a proven track record is related to the service modeli.e., making money mainly in services while selling products for a reasonable price premium.

Several companies have positioned themselves toward the services business model. They may compete with each other by providing additional value-add or niche products. Open source distributors like Red Hat, SuSE, and Red Flag are clear leaders of open source Linux and have positioned themselves as services companies. These companies tend to get service-level agreements for support for the Linux distributions they supply to their customers. They have made their distribution as rich as possible, validate them on many platforms themselves, and get the help of many platforms through their OEM partners.

The other successful business model is proprietary applications above the open source products that run on top of open source distributions and link only dynamically with user-level libraries. Oracle server products, and Office products from Kingsoft, are clear examples of products that deliver value above the open source stack.

Other examples include set-top boxes like TiVo,^[14] and Linux-based cell phones. These products use Linux as an embedded operating system and provide dedicated proprietary services above the stack. These vendors can easily charge for their individual products, as they provide very visible value to end users. These companies clearly use the Linux operating system as the base for their solution stack, leveraging open source to bring cheaper systems into the marketplace.

^[14] http://www.tivo.com.

In China, both business models are common and advantageous. Red Flag, known as a services company, distinguishes itself from its competitors by focusing on providing value-add via localization for the PRC market. Other additional value that it provides is management and security solutions not available from other local vendors.

Red Hat, on the other hand, distinguishes itself with a large volume of ISV support and validated stacks from thousands of ISVs. This value-add may fetch additional customers, however the core of its business remains as a services company. Another key factor in favor of Chinese companies is the strong manufacturing base of consumer electronics and cell phonesleading to opportunities for value-added software on top of the OSS infrastructure.