Aiming at networked control systems with time-varying network-delay and data dropout, the design of state observer is studied in this paper. Based on hierarchical control structure, the design of networked control system with local state observer is presented. According to the proposed method, the sufficient condition for networked control system with hierarchical control structure meeting the separation principle is proved. The proposed method not only simplifies the design of networked control system, but also improves the control performance. Simulation results show the effectiveness of the proposed method.