At shops in Shanghai's bustling Xinyang market, fake Apple iPhones and Bose speakers sit neatly alongside bootleg copies of Microsoft's new Windows 7 operating system, a week before its official launch.

Which version do you want? Ultimate? Normal? English or Chinese?, beckons one shopkeeper, proudly pointing out her ample supply of discs packed in unmarked white boxes.

Microsoft may be baiting the world as it prepares to launch the newest version of its Windows franchise, but Chinese have been able to buy pirated copies this month for just 20 yuan ($2.93) each -- a fraction of list prices as high as $320.

Windows 7's early release in China underscores the challenge major software makers face trying to make money in China, the world's second-largest PC market.

Research firm IDC estimates about 80 percent of software sold in China was pirated last year. While that figure is falling, it is still double the global average and about four times that of developed markets such as the United States and Japan.

The big issue that is driving piracy in China today is price, said Matthew Cheung, an analyst at Gartner, another research firm.

If you're trying to sell a program that costs 2,000 yuan to a student living on 400 yuan a month, that's simply not going to work out for most consumers.

In a nod to such pressures, Microsoft cut the price of its Office 2007 Home and Student Edition to 199 yuan last year from 699 yuan. It will sell its low-end Windows 7 Home Basic version for 399 yuan, modest by Western standards, but still 15 times higher than pirated copies.

Violation of intellectual property rights has been an ongoing sore spot in China's relations with its major trading partners, even as it cracks down on rampant piracy of everything from fake Gucci bags to bootleg software.

A Chinese court jailed four people in August for spreading their bootleg Tomato Garden version of Microsoft's Windows XP, in what China's official Xinhua news agency called the nation's biggest software piracy bust.

A lot of people are used to getting away with it for a long time, said Steve Vickers, president of FTI-International Risk. There are signs that law enforcement is picking up, and that should help things improve.

The Business Software Alliance, a trade association created by the software industry, says the sector lost more than $6.6 billion in China last year to piracy, second only to the United States.

FOR BETTER OR WORSE

Most experts agree that piracy in China is a long term issue, but many add conditions should improve as software makers slash prices, users become more educated and living standards rise.

Piracy in China is reducing year by year because the government is placing more attention on it and prices between the real and fake have narrowed, said Qian Liyong, director of the EU-China Project on the protection of intellectual property rights, based in Beijing.

Gartner estimates China software piracy rates will fall to as low as 50 percent by 2012, almost on a par with developed Asian markets such as Hong Kong.

Customer education is also taking off in China as many now realize the dangers of installing pirated software that sometimes comes with viruses and spyware.

This is a long term issue, 10-20 years, it's not just going to go away in an instant, said Edward Yu, chief executive of research firm Analysys International.

In a bid to tackle the problem, Microsoft last year launched an unconventional campaign in China that caused a black screen to be displayed every hour for users of pirated Windows XP.

But that just caused thousands of irate Chinese to migrate to free software from domestic companies like Kingsoft Corp, leaving Microsoft with its own black eye.

Some believe such free web-based software, supported by advertising, may ultimately help to reduce piracy in China by letting third parties pay for development costs.

Because of the Internet, we are seeing a trend that software is by and large becoming free for consumers from point to point, Yu said.

($1=6.825 Yuan)

(Editing by Doug Young & Ian Geoghegan)

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