Xiaomi: a shaky start for the Chinese tech giant

Xiaomi: revenue rapidly rising but it remains firmly in the red

Having decided that it was not strong enough to keep up the rapid rate of growth it was experiencing, Xiaomi states it deliberately put on the brakes in 2016 so it could make sure the three key foundations of the business - innovation, quality and supply management – were laid, allowing impressive growth to resume last year.

Xiaomi: more than just a low-cost smartphone maker

‘Although our hardware business is essential to building our user base, we do not expect it to be the main source of our profits. We maintain excellent design and outstanding quality in our products, while pricing out products as close as possible to cost by selling them to users through highly efficient online and offline new retail channels. We then provide our users with comprehensive internet services,’ – Xiaomi.

Xiaomi was founded to invent a ‘very cool’ smartphone, but the company is simply laying the foundations by rolling-out its smartphones as it looks to place its operating system in the hands of as many people as possible, in order to flog what it believes to be the future of the business: internet services, selling the likes of online games and advertising space.

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Xiaomi’s smartphones and other gadgets have proven popular because they undercut rivals in terms of price, hence why it has performed particularly well in emerging markets (EMs). This includes India, where Xiaomi is the market leader rivalling the likes of Samsung, which is also trying to carve out a chunk of the world’s fastest growing economy for itself.

Xiaomi is so focused on its future business that it has pledged to keep its net profit margin on hardware below 5% to ensure it can keep undercutting the competition, promising to ‘return the excess to our users’ should it fail to keep margins down. It may seem odd to be talking about keeping margins down, but this helps expand the use of its operating system.

The reasons Xiaomi is chasing this strategy is clear considering that its internet services boast a gross margin of over 60%. But the firm has a long way to go before it can truly convince the market that is where its future lies: internet services account for just 9.6% of Xiaomi’s revenue, and 67.5% of its overall revenue that comes from smartphones is capped by its pledge to keep margins down.

There is evidence that the transition is working. While smartphones still drive revenue, it is much less so than it was back in 2015 when smartphones made up 80% of all sales and internet services accounted for just 5%.

Xiaomi’s operating system: MIUI

‘Compared to other internet platforms that acquire new users at high costs, we leverage the sale of our hardware to acquire users at a profit,’ – Xiaomi.

Meanwhile, its operating system has been designed as an open platform based on Android to allow a wide range of third party apps and content to be used. More importantly, its system means it can release its own stuff. The company has a ‘proven track record of developing killer apps’ – 38 of its own apps had at least 10 million MAUs in March while 18 of them had over 50 million. These include the likes of the Mi App Store, Mi Browser, Mi Music and Mi Video. Overall, there were 190 million MAUs using Xiaomi’s operating system in March of this year.

This concept is nothing new. Alphabet’s Android operating system powers 85% of the world’s smartphones and its dominance is unrivalled with at least seven apps including Google Maps, Chrome, Gmail, Google Play and Search all boasting over 1 billion MAUs. But its market leading position is the result of its aggressive push of Android onto smartphone manufacturers after Google’s failed attempts to release its own smartphones – something Xiaomi has had better luck with. While effective, Google has been punished for its aggressive stance, having been fined a record €3.4 billion by the European Union (EU) earlier this month for forcing smartphone manufacturers to pre-install its swathe of software into their products in order to gain access to its Android operating system.

The Xiaomi ecosystem: building a fan base rather than a customer base

‘We believe that our user base is differentiated by our “Mi Fans”, a large global community of passionate users who are intensely loyal to the Xiaomi brand, are highly engaged on our platform and actively contribute feedback and feature ideas to our product development,’ – Xiaomi.

Xiaomi has built a swathe of other products in addition to smartphones, some on its own and others in partnership with over 200 other companies. These products are all designed around IoT and the growing amount of connected devices appearing in homes around the world, with Xiaomi having invested in over 90 IoT partners.

IoT is still a relatively new market that no one has yet managed to dominate, giving Xiaomi every opportunity of grabbing a big slice of the action. In fact, according to Xiaomi, it has already got a head start over the competition, claiming it held a 1.9% share of the global IoT market in Q1 of 2018 compared to its more established players Amazon at 1.2%, Apple 1.0%, Google 0.9%, and Samsung 0.8%.

Its wide range of products coupled with heavy engagement with its customers (its MIUI forum has over 9 million MAUs) means 1.4 million people owned more than five connected Xiaomi products as of March this year. Again, this model is nothing new. Apple has been encouraging (or in many cases forcing) customers to buy other Apple products for years, as these are the only ones that work with that expensive iPhone they have purchased.

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But Xiaomi, following the same tact as it has done with its smartphones, is about offering quality hardware at a cheaper price. An individual can buy ten products to build their Xiaomi ‘ecosystem’ for somewhere between $1185-$2990, whereas a comparable collection of rival products would cost anywhere between $3200-$7864. Not only does Xiaomi undercut rivals but it allows its customers, or ‘fans’, to build a collection of products at a far cheaper rate, thereby encouraging them to buy more products.

Xiaomi outperforms rivals to take top spot in India

Xiaomi has a sizeable share of the smartphone market in its home country of China, but with established players like Huawei and OPPO having taken a chunk of the market Xiaomi is only the fourth largest smartphone maker. Its low-cost hardware and open operating system have proven more popular in other EMs, where Xiaomi ranks as the second biggest smartphone maker. The most important EM is India because of the emerging middle classes and rapid economic growth. Here, Xiaomi has been growing sales by as much as double the rate of its closest competitor Samsung, and has recently taken over as the market leader. 

According to research by Canalys, Xiaomi and Samsung each shipped 9.9 million smartphones to India in the second quarter (Q2) of 2018, the best quarterly performance for both companies. Together they now account for 60% of all shipments in India, compared to just 43% a year ago. But even with Samsung reporting an annual growth rate of 50% - the best on record since late 2015 – Xiaomi’s even more impressive growth saw the Chinese firm steal top spot from Samsung in Q2. In Q2 2017, Xiaomi had an 18% share of the Indian market to trail Samsung’s comfortable lead with 25%, but a year later Xiaomi has now overtaken its Korean rival, albeit marginally with both firms holding about 30% of the market.

Competition in India will heat up however, with Canalys reporting there is still untapped opportunities for ‘smaller and leaner smartphone vendors’, adding that the ‘climate is right for businesses to realign and re-enter the market’. That has been demonstrated by Apple, which is changing its strategy to focus on its brand first and volumes later.

Where next for Xiaomi?

‘We know it may take time for everyone to fully embrace our ideals. However, time is on our side,’ – Xiaomi.

Although the start of Xiaomi’s life as a public company has already seen the company overcome several challenges, its valuation is still being debated as investors try to grapple with its business model and strategy. For the time being, focus will remain on the performance of its smartphones. But with margins capped, investors needn’t focus on profitability but keep an eye on unit sales and the rate of growth. Like so many other young tech companies, a big challenge for Xiaomi will be maintaining the rapid growth that investors become used to.

Xiaomi’s recent efforts to improve its sales and distribution channels should go some way to maintaining (if not further improving) sales growth over the immediate future. In terms of online sales, Xiaomi holds a market leading position in both India and mainland China, and having built its online channel it has started expanding its bricks-and-mortar network of Mi Home stores.

But with Xiaomi still needing to convince the market that its future lies outside of the smartphone business that the company has been built on, all attention will be on Xiaomi’s ability to not only grow sales through its internet services business, but prove it can make some serious money from it. With its entire ecosystem of products operating under its one and all-important operating system, growing sales of its IoT products like smart speakers and cameras will be an important indicator for how its internet services division is potentially performing as the IoT platform lies at the heart of the unit.

Xiaomi may have won over its fans, but it has some way to go in winning over financial markets.