An interview by Microsoft’s Steve Ballmer caught the attention of some of us in the intellectual property community, including my friend over at IP Dragon (soon to be Doctor IP Dragon!) — I’ll get to his post in a minute.

First, here’s what Ballmer had to say about Microsoft in China and how IP protection is central to their bottom line:

China is in a class by itself: There is no software market to speak off. China is a lot less interesting market to us than India or Indonesia.

If you look at the numbers today, how we do in China vs. the U.S., we do about 10 times better in the U.S. per PC sold. Maybe 20 times. We do seven times better in India. China can’t get a lot worse. We haven’t given up on China, but from a Microsoft perspective, we do more business in India, we do more business in Korea.

I want to be optimistic about China…[however] the level of protection for IP is not very high. We keep working inside China, but we see better opportunities in other countries.

Pretty negative, as you might expect. The piracy numbers for digital media are well known (I’ve talked about the subject myself many times), but it’s important to tie that in to specific company revenue, not just vague pronouncements of lost profits by the industry.

For Microsoft, China is a huge market that simply doesn’t represent much in terms of their bottom line, and one of the main reasons for that is copyright infringement.

OK, so we already knew about the general IP protection problem in China. Do Ballmer’s comments tell us anything about how multinationals are factoring this in when making their China FDI business decisions? In other words, should Ballmer’s statement about focusing on other markets make China nervous that other multinationals might do the same?

IP Dragon’s post on the subject was essentially about general FDI trends and the effect of IP protection. Based on Ballmer’s comments, Danny is saying that perhaps until now, the benefits of being in the China market have outweighed the problems of IP enforcement:

The last years there seemed to be no relation between the level of protection and enforcement of intellectual property rights and foreign direct investments (FDI) in China.

[T]he intellectual property rights elasticity of FDI in China might have worked all the time, but the perceived opportunities in China were just too high to show any negative impact of the IPR protection and enforcement level on the FDI in China. For Microsoft the tipping point might just happened.

I think Danny’s point about there being “no relation” between the levels of IP infringement and FDI is a bit general, but I understand what he was trying to say there. Many companies have known that they will be ripped off, and yet come into the market anyway. China has simply been too strong a draw for many firms to ignore, particularly after their competitors jump in.

However, a distinction must be made for the specific type of investment made in China and how this can be effected by IP infringement. This point was made as a comment to Danny’s post by longtime China IP expert Nick Redfearn of Rouse & Co. (a competitor of mine – find the link yourself!):

It’s not that foreign companies won’t invest in China if there is weak IP protection, it’s what they will invest that will be determined by this. Of course they will want their manufacturing and sales offices there, with all supporting functions. And some level of localization-type R&D. But they will not bring in mission critical trade secrets or carry out the most cutting edge R&D. China’s weak IP protection regime restricts the quality of the FDI therefore.

Absolutely spot on. Restricting the type of IP that is used in China, or as Nick puts it the “quality” of IP, is part of my usual advice to clients. Manufacturing segmentation, premises security, HR restrictions — it all has to do with sharing of information and keeping IP in the smallest number of hands as possible; to the extent that the IP can be kept offshore, that’s the best-case scenario.

Taking Nick’s point about the type of IP involved, let’s turn back to Ballmer’s comments about Microsoft. Remember that software is a special kind of product, one that is easily copied and distributed, and that the ultimate unit price of unauthorized copies is essentially zero.

When the type of IP is copyright, and the product is digital media, the company involved does not have the luxury of restricting the quality of IP used in China. Some software firms will segment the programming process, or farm out different modules to a number of service providers; in the end, though, the final product is still digital media.

For the vast majority of software firms, that means that the copyright owners is pretty much screwed. This of course explains the frustration of Ballmer, his compatriots at the Business Software Alliance, and their cousins in the music and movie industries.

However, we need to keep in mind that for everyone else, that is anyone that does not produce copyrighted works on digital media, the IP infringement price elasticity issue (to use Danny’s terminology) is quite different. In other words, that tipping point that Microsoft may have reached in China really tells us nothing about similar calculations that are being made by other companies as they assess their China FDI strategies.

In a sense, I am saying that our response to Ballmer’s comments should be “That’s not applicable.” Microsoft, and the software industry, is a special case, and I hope that the news generated by Ballmer’s comments does not lead to incorrect assumptions either about the state of IP protection in China or the way that FDI decisions are made.