Play Fair Day Analysis

1. Play Fair Day Analysis Jeff Marowits, Principal: jmarowits@keystonestrategy.com Irshad Allana, Analyst: iallana@keystonestrategy.com Joseph Quan, Analyst: jquan@keystonestrategy.com Analysis of competitive disadvantage experienced by licensed manufacturers in emerging markets with rampant piracy

2. About the Keystone Strategy study • To date, piracy research has primarily investigated licensing enforcement drivers, as well as the rates and impact of rampant piracy in emerging nations (like the BRIC countries) - specifically as piracy harms firms in developed markets such as the United States. • Microsoft commissioned Keystone Strategy to study enterprise piracy in a new way – by focusing on companies within emerging markets taking steps to play by the rules and reduce piracy. • ---- • Today, we release the results of Keystone’s first-of-its-kind study, in which we tackle the following critical issues regarding the future of piracy reduction and growth of innovation in emerging economies: • 1. The perceptions and attitudes (distinct from enforcement) of emerging market companies taking positive steps to reduce piracy and play by the rules. • 2. The financial impact of competitive disadvantage that firms playing by the rules face when their competitors engage in piracy.

3. Background

4. Central elements of Keystone’s analysis

5. Our study focuses on manufacturing firms because they are the drivers of rapid economic growth in emerging markets • In China, the world’s fastest growing economy, manufacturing accounts for almost 40 percent of GDP. Source: Local government websites, CIA World Factbook

6. Through extensive interviews with manufacturers, we were able to map the IT software deployments of a typical emerging market manufacturer System PC Operating System (Windows 7/XP) Security (McAfee Business) Content Word/Data Processor (Office) Data Management Database Server (SQL) Collaboration Collaboration Server (SharePoint) Messaging Server (Exchange) Manufacturing/Design General Engineering Design (AutoCAD) Manufacturing Process Design (PTC Pro-Engineer) Operations ERP- Project/Order Management (Project Pro) Supply Chain Management (Infor SCM) Customer Relationship Management (SAP)

7. Perceptions and attitudes of emerging market manufacturers playing by the rules

8. Key findings from extensive research and interviews with manufacturers in emerging markets • We studied the perceptions and attitudes of firms that play by the rules to understand the competitive landscape and their motivations (distinct from enforcement) with respect to IP • We arrived at four primary insights: • Protection of intellectual property is necessary for the growth of innovation • IT is a point of competitive advantage and differentiation – these firms are industry leaders in large part because of their use of technology • Firms are well-licensed because it’s the ethical decision; pirating software contradicts their corporate commitment to integrity and honesty • Licensed IT in particular has many technical benefits – it gives them the assurance of partnership with software firms which keeps their operations running at optimal levels 1 2 3 4

9. Leading international manufacturers that play fair in emerging markets provide a deeper understanding of perceptions and attitudes regarding intellectual property Source Hoovers, OneSource, company annual reports, comments by HNG and Severstal results of direct interviews by Keystone, Crystal SA (Fabrica) and Great Star data result of third-party research.

10. Value of IPR: Intellectual property protection is necessary for innovation growth in emerging markets “I see much improvement in piracy in Russia in recent years and I expect it will lead to more innovation and more software development since both of them are connected.” Evgeny Charkin, Chief Information Office at Severstal “The international community has attached even greater importance to IPR and innovation. China should never be lax in its IPR protection efforts as it moves towards a high-tech industry and other knowledge-based industries.” Dr. Zhipei Jiang, former Chief Justice of the Supreme Peoples’ Court IPR Tribunal “IPR [intellectual property rights] violations not only hurt businesses in Russia, but cost the Russian government billions of rubles in uncollected revenues from counterfeit products evading taxes and duties… IPR violations are barriers to new investment and impede Russia’s effort to join the WTO.” Peter Necarsulmer, President of Coalition for Intellectual Property Rights Source BRIC manufacturer interviews, IT case studies, comments by HNG and Severstal from interviews by Keystone, Crystal SA (Fabrica) and Great Star from third-party research.

11. Value of IT: IT is a point of competitive advantage and differentiation – these firms are industry leaders in large part because of their use of technology “Software is critical to our business. Our board believes that it is a key differentiator of our business and a source of competitive advantage.” Evgeny Charkin, Chief Information Office at Severstal “IT has increased the efficiency of the whole operation, not just the production process. Things are much clearer when we have access to the information at the right place at the right time. In terms of information technology, everything in the business gets faster; all the production processes and supervisory controls are integrated and automated. And since glass manufacturing is a continuous process, it is important that the information is quickly available.” Bharat Somany, Director at Hindusthan National Glass & Industries Ltd Source BRIC manufacturer interviews, IT case studies, comments by HNG and Severstal from interviews by Keystone, Crystal SA (Fabrica) and Great Star from third-party research.

12. Ethical reasons behind licensed IT: Pirating software contradicts the corporate commitment of licensed manufacturers to integrity and honesty “When a company uses information technology illegally in its manufacturing process, there is without doubt an act of unfair competition, because some costs are avoided affecting the price of the final product. It is like avoiding payment of social benefits, evading taxes or not complying with the minimum environmental rules.” Jose Manuel Gutierrez, Manager of IT at Fabrica (Crystal SA) “We are a business with a very good reputation and strong ethics - we want to maintain that reputation. We do not steal.” Evgeny Charkin, Chief Information Office at Severstal “Transparency is something that starts vanishing pretty quickly when you [pirate software].  Not only do you hide from others, but you end up having things in your own company that are hidden from you… there is no accountability when you go in for pirated software.” Bharat Somany, Director at Hindusthan National Glass & Industries Ltd Source BRIC manufacturer interviews, IT case studies, comments by HNG and Severstal from interviews by Keystone, Crystal SA (Fabrica) and Great Star from third-party research.

13. Technical benefits of legal IT: Licensed IT gives companies the assurance of security and frequent updates, which keep their operations running at optimal levels “The way I see it, if you don’t actually buy the software, you have a black box – you can’t get any support on it and you cannot really build it up to be a solution which you would benefit from… No software is perfect and does need multiple iterations…That doesn’t work unless you paid for it and have a proper license for it that gets you instant access to updates.” Bharat Somany, Director at Hindusthan National Glass & Industries Ltd “This [incorporating IT] has been very essential to the improvement of our business processes.” Evgeny Charkin, Chief Information Office at Severstal “We will establish a long-term partnership with Microsoft to set up an effective software asset management mechanism. This mechanism will help make our software license management more dynamic, optimize the allocation of our software assets and provide better service to the company.” Great Star Industrial Source BRIC manufacturer interviews, IT case studies, comments by HNG and Severstal from interviews by Keystone, Crystal SA (Fabrica) and Great Star from third-party research.

14. Measuring the Impact

15. Keystone’s study calculates impact and key statistics that influence competitive disadvantage Methodology Step 3: Estimate the number of disadvantage-bearing PCs in well-licensed manufacturing firms Step 1: Estimate the total number of licensed PCs in manufacturing firms Step 2: Calculate the portion of licensed PCs that belong to well-licensed firms Step 4: Assess competitive disadvantage at a national level • Estimate extent of compliance of well-licensed firms 5 • Segment “well-licensed” firms as those with above-average compliance • Calculate annual software spend for disadvantage-bearing PCs • Determine lost ROI suffered by licensed manufacturers • Determine total number of PCs in manufacturing 1 3 7 Determine number of licensed PCs at well-licensed firms compared to those pirated at “poorly licensed” firms 6 Estimate number of licensed PCs in manufacturing firms 2 8 Determine number of licensed PCs in well-licensedfirms 4

16. Step 1: Estimate the total number of licensed PCs in manufacturing firms Total manufacturing employees * PC to Employee ratio 99M Manufacturing employees * 0.17 Ratio Total manufacturing employees from government statistical reports • PC to Employee ratio from Keystone analysis using survey data Number of PCs in manufacturing * Enterprise compliance rate = Total number of licensed PCs in manufacturing 16.6M PCs in manufacturing * 31% compliance = 5.2M licensed PCs • Enterprise compliance rate estimated through Keystone analysis of BSA piracy data Sources: BRIC government statistical reports, BSA Global Software Piracy Study, Keystone Strategy analysis

17. Step 2: Calculate the portion of licensed PCs that belong to well-licensed manufacturing firms Well-licensed firms characterized as those with a compliance rate higher than the national average Total number of licensed PCs in manufacturing * Percent of licensed PCs in well-licensed firms = Number of licensed PCs in well-licensed firms 5.2M licensed PCs in manufacturing * 79% of licensed PCs in well-licensed firms = 4.1M licensed PCs in well-licensed firms Percent of licensed PCs in well-licensed firms estimated from normal distribution adjusted with observations from internal Microsoft studies *Note: Licensed PCs are distributed among well- and poorly licensed firms; even poorly licensed firms license some PCs, though in smaller quantities Sources: Microsoft internal data on customer piracy rates, BSA statistics, Keystone Strategy analysis

18. Step 3: Determine the number of disadvantage-bearing PCs in well-licensed manufacturing firms • * Note: onlylicensed PCs in well-licensed firms above the compliance rate of average poorly licensed firms contributes to the disadvantage Number of licensed PCs in well-licensed firms * (Percent compliance of well-licensed firms – Percent of compliance of poorly licensed firms) = Number of disadvantage-bearing PCs at well-licensed firms 4.1M licensed PCs in well-licensed firms * (54% compliance of well-licensed firms – 12% compliance of poorly licensed firms) = 1.7M disadvantage-bearing PCs at well-licensed firms • Extent of compliance above average poorly licensed firms is obtained by calculating the difference between the average well-licensed and poorly licensed firms’ compliance rate • Average compliance of well-and poorly licensed firms estimated from internal data for emerging market countries Sources: Microsoft and Keystone Strategy internal data, BSA Global Software Piracy Study, Keystone Strategy analysis

19. Step 4: Assess competitive disadvantage created on a national level Number of disadvantage-bearing PCs at well-licensed firms * Software cost per PC 1.7M disadvantage-bearing PCs at well-licensed firms * $2,194 per manufacturing PC Software costs from Keystone analysis of software costs and usage rates in manufacturing firms; prices from official local resellers Total software costs for disadvantage-bearing PCs in well-licensed firms / Enterprise software lifecycle * Potential return on invested capital = Annual competitive disadvantage created by piracy $3.75B software costs for disadvantage-bearing PCs in well-licensed firms / 5 year software lifecycle * (1.1164) ROIC = $837M of annual competitive disadvantage created by piracy Enterprise software lifecycle of 5 years used to determine annual competitive disadvantage Return on Invested Capital is a conservative average from financials of emerging markets manufacturers Sources: Licensed software resellers in BRIC nations, Microsoft support site, IT professional interviews, financial data from emerging market companies

20. Key insights into competitive landscape of Chinese manufacturers playing by the rules China Step 3: Estimate the number of disadvantage-bearing PCs in well-licensed manufacturing firms Step 2: Calculate the portion of licensed PCs that belong to well-licensed firms Step 4: Assess competitive disadvantage at a national level Step 1: Estimate the total number of licensed PCs in manufacturing firms • Well-licensed firms, on average, are 42% more compliant than poorly licensed firms $750M in annual software costs for disadvantage-bearing PCs in well-licensed firms • 79% of licensed PCs belong to well-licensed firms • 16.6M PCs in manufacturing 1 3 5 7 • $837M of annual competitive disadvantage across China 5.2M licensed PCs in manufacturing firms 4.1M licensed PCs belong to well-licensed firms The gap between and poorly licensed firms is 1.7M licensed PCs 2 4 6 8 Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

21. Conclusion

22. Emerging market financial measures of annual competitive harm to manufacturers playing by the rules – annual disadvantage = $2.9B globally / $1.6B in BRIC nations $837M $505M Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

23. Breakdown of total BRIC manufacturing employment and competitive harm - aggregate software lifecycle competitive disadvantage = $8.2B in BRIC countries Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

24. How does the unfair financial competitive disadvantage translate into pirating firms’ ability to make investments by avoiding legitimate costs? How many plants can pirating firms construct with their unfair advantage? $837 Million = complete construction of 66 major manufacturing plants, or over 82 million square feet of industrial land How much equipment can pirating firms buy with the $$ from their unfair advantage? $837 Million = 12,700 molding machines for a plastics manufacturer How many employees can pirating firms hire with the $$ from their unfair advantage? $837 Million = 217,000 employees for a year Sources: BCG manufacturing report, machinery reseller websites, BRIC government labor statistics reports, Keystone analysis

25. Conclusion

26. Keystone Strategy’s findings from its study of competitive effects on manufacturers in playing by the rules in emerging markets with rampant piracy • Microsoft commissioned Keystone Strategy to study enterprise piracy in a new way – by focusing on the impact of widespread piracy on those companies within emerging markets that are taking steps to play by the rules and reduce piracy. • ---- • Through interviews and third party research, Keystone’s study highlights important implications from the perceptions and attitudes of manufacturing firms regarding IP: • Protection of intellectual property is necessary for the growth of innovation • IT is a point of competitive advantage and differentiation – these firms are industry leaders in large part because of their use of technology • Manufacturers are compliant because it’s the ethical decision; pirating software contradicts their corporate commitment to integrity and honesty • Licensed IT in particular has many technical benefits– it gives them the assurance of security and frequent updates which keep their operations running at optimal levels

27. Financial impact of competitive harm to manufacturers playing by the rules by region – aggregate competitive disadvantage = $2.9B annually and $14.4B over software lifecycle $1,975M $9.9B $546M $2.7B $356M $1.8B Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

28. About Keystone Strategy

29. Keystone works closely with academic experts to deliver high-impact, data driven solutions to global companies and government institutions Focus Strategy and policy built around industry leading experts and experienced consultants Industries Focus on industries driven by science and technology Operations In recent months, Keystone engaged with clients in the Americas, Europe, Middle East and Asia Experts Leading affiliates at top institutions including Harvard, MIT, Stanford, Wharton and Berkeley Clients Innovative global companies, governments, and government institutions Offices Boston, San Francisco, Chicago, Abu Dhabi, New York, Seattle and Milan

30. Keystone is a global consulting firm with deep expertise in manufacturing supply chains and software piracy in emerging markets Manufacturing Expertise Worked with several clients to develop an expertise in global manufacturing and supply chains Intellectual Property Protection Analytical reports have served as evidentiary support in several anti-trust and damage recovery cases Software Piracy Developed comprehensive understanding of software usage and piracy in emerging market manufacturing environments Anti-Piracy Outreach and Enforcement Supported anti-piracy legislation in the U.S. and created strategies for targeted anti-piracy campaigns globally

31. Appendix: Country-by-country analysis of emerging markets

32. Appendix: Individual Country breakdown (ordered by region and impact) BRIC China, India, Brazil, Russia Asia Pacific Thailand, Vietnam, Indonesia, Malaysia Latin America • Mexico, Peru, Chile, Colombia Central & Eastern Europe • Poland, Turkey, Ukraine, Romania, Belarus

33. Key impact statistics illustrate piracy’s significant, unfair impact on Chinese manufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $837 Million = 217,000 employees Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

34. Key impact statistics illustrate piracy’s significant, unfair impact on Indian manufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $505 Million = 215,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

35. Key impact statistics illustrate piracy’s significant, unfair impact on Brazilian manufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $186 Million = 20,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

36. Key impact statistics illustrate piracy’s significant, unfair impact on Russian manufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $115 Million = 15,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

37. Key impact statistics illustrate piracy’s significant, unfair impact on Thai manufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $55 Million = 24,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

38. Key impact statistics illustrate piracy’s significant, unfair impact on Vietnamesemanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $52 Million = 22,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

39. Key impact statistics illustrate piracy’s significant, unfair impact on Indonesianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $27 Million = 16,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

40. Key impact statistics illustrate piracy’s significant, unfair impact on Malaysianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $15 Million = 2,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

41. Key impact statistics illustrate piracy’s significant, unfair impact on Mexicanmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $76 Million = 10,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

42. Key impact statistics illustrate piracy’s significant, unfair impact on Peruvianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $36 Million = 13,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

43. Key impact statistics illustrate piracy’s significant, unfair impact on Chileanmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $22 Million = 1,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

44. Key impact statistics illustrate piracy’s significant, unfair impact on Colombianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $19 Million = 4,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

45. Key impact statistics illustrate piracy’s significant, unfair impact on Polishmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $46 Million = 4,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

46. Key impact statistics illustrate piracy’s significant, unfair impact on Turkishmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $39 Million = 5,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

47. Key impact statistics illustrate piracy’s significant, unfair impact on Ukrainianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $31 Million = 8,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

48. Key impact statistics illustrate piracy’s significant, unfair impact on Romanianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $18 Million = 3,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank

49. Key impact statistics illustrate piracy’s significant, unfair impact on Belarusianmanufacturers playing by the rules The substantial, financial unfair advantage of software pirates over firms playing by the rules can be used for many purposes, including hiring thousands of employees. $8 Million = 20,000 employees for a year Sources: BLS, BSA, CIA World fact book, Government statistical reports, Keystone Strategy analysis, Manufacturer and software seller interviews, Microsoft internal data, UNIDO, World Bank