[Chinese handset maker entrant Xiaomi is putting itself in the spotlight with impressive first year sales and innovation across hardware, services, brand and business model. Is this a promising attempt to create a new profitable handset business, following the Apple & Samsung profit recipe? VisionMobile analyst Stijn Schuermans investigates in this retelling of our relevant report.]
Xiaomi (pronounced “chow me”), the upstart Chinese handset maker, has put itself in the spotlight with impressive early sales figures in its first year of existence.
This article is based on an issue of Mobile Insider, a monthly publication by VisionMobile. that examines under-the-radar and forward-looking trends in mobile. Each issue focuses on a specific topic distilling the insights in an easy-to-digest 5-page format. Mobile Insider is part of Telco Economics, a range of strategy reports and workshops that deliver a 360° view on the new economics of the mobile industry and changing role of telcos in the era of digital ecosystems.
The Xiaomi MI-One smartphone was released in August 2011. The second model, the MI-Two, followed in October 2012. Both models were offered at launch for RMB 1,999 (about $315) – pretty modest considering its specs and performance. The phone is mostly sold in batches online, with a pre-ordering system. A batch of several hundred thousand phones typically sells out in a matter of hours; sometimes much faster.
In its first year, the MI-One sold over 3.5 million units, according to Xiaomi. A recent Tencent report puts 2012 sales at 7.2 million units and $2B in revenues. Analysts assume it to be profitable. This has led to an investment round in June 2012 where the company was valued at $4B.
Xiaomi doesn’t limit its ambitions to China, either. The company has plans to expand to North America in 2014 or 2015, according to Xiaomi spokesperson Li Wanqiang.
Business model innovation is a sine qua non
The company is entering an extremely competitive market. As we explained in the April 2012 issue of Mobile Insider – Apple and Samsung’s profit recipe – the handset industry is fast approaching non-sustainability. The commoditization pressures instigated by Android and a near profit duopoly by Apple and Samsung (the innovator and the vertically integrated follower respectively) deprive the other OEMs of oxygen for innovation and investment.
The emerging Chinese market in which Xiaomi is launching is price sensitive, and the rivalry among handset makers, both local (Shanzhai) and international, is fierce. Smartphones have become easy to copy. Advertising spends for new handsets run into the billions and distribution is mostly locked by powerful and demanding telcos. If Xiaomi were to compete head on with its established rivals, who have deeper pockets, established brands, supply chain power and much more experience, its chances seem pretty bleak. So how has this startup managed to draw attention?
We ended the Apple & Samsung Mobile Insider issue on a positive note: a duopoly can be avoided by companies that innovate to create a unique business model. Xiaomi is doing exactly that. It is using similar strategies to the ones described in VisionMobile’s Telco Innovation Toolbox to create a uniquely tailored value chain for its customers. Xiaomi is certainly off to a flying start, at least in sales. Its profitability is still unproven, and since it is a private company, we’re not likely to get confirmation on its profit story any time soon. Its strategic outlook is good, however. In the following paragraphs, we will describe several aspects of its strategy. While none of these elements are new or unique by themselves, as a whole they create a unique value chain, tuned to deliver value to Xiaomi’s target customers.
Xiaomi’s strategy dissected
Xiaomi is not just a hardware producer. Its products combine the assembly of hardware with software (a custom Android user interface called MUI), services (notably an instant messaging client), a large gamut of accessories and its own online sale channel, through which the majority of phones are sold.
Unlike Samsung, Xiaomi focuses on forward, customer-facing integration more than integration over the component supply chain. The fact that most Xiaomi phones are sold online is both rare in the industry and quite important to the company, as it gains direct access to the customer (like Apple achieves with its physical retail stores). By selling directly to the customer, Xiaomi also disintermediates the telco distribution channel (like Dell did with PCs in its early days). While the integration is not yet as extensive as Apple and Samsung, Xiaomi has clearly got the right idea.
While handsets are clearly Xiaomi’s core business, they are not the main profit center. Instead, the hardware devices are used as complements for other products and services. Handsets are sold at a low profit; initially even rumoured to be a loss, although recently analysts have refuted this. Meanwhile, Xiaomi creates fertile ground for selling accessories and (messaging) services, which presumably have much higher profit margins. This strategy strongly reminds of Amazon and its Kindle Fire (covered in the October 2011 Mobile Insider: “The Kindelization of Tablets”), or even of Blackberry with BBM in its glory days.
As handsets are a complement and not a main part of the value proposition, Xiaomi strives to produce them at low cost, but acceptable quality. Like Apple (but very few others), it has a limited model strategy, which reduces complexity and gives Xiaomi more leverage (through higher volumes) in its supply chain. Xiaomi sells phones in discrete batches, with pre-ordering. When a batch is sold, literally hundreds of thousands of handsets are sold in a matter of minutes. Not only does this create artificial scarcity (which drives demand), it also makes the supply chain process more manageable. It’s not likely that this technique can scale , but at the current low volumes it achieves the same goal of value chain control, without the large investment requirements (Apple owns substantial parts of the supply chain to achieve the same control). Finally, the Dell-like disintermediation offered by the direct-to-consumer, online-only sales model significantly reduces sales costs. Xiaomi phones are also available through more traditional (telco) sales channels, but at a 30% higher price.
Xiaomi’s recipe: a tailored value chain
According to Harvard professor Michael Porter, a sustainable competitive advantage can be gained if all the activities of the company are tailored to add value to the customer. In Xiaomi’s case, the target group are young, internet-savvy Chinese with a need to profile themselves socially. With this in mind, we can re-examine the strategies outlined so far. Xiaomi produces relatively inexpensive but good enough devices. As they are a complement, this hardware is not the most important part of the equation, so the focus is on simplicity and value for money, achieved by eliminating activities from the supply chain that don’t add value for the target group. This basic hardware can then be customized – an important social goal for youngsters – with a host of accessories, from covers to batteries in different colours. Xiaomi focuses heavily on the social aspect. The marketing is mostly word-of-mouth (and word-of-mouse), adding to a sense of community and belonging. Furthermore, one of the main selling points is a messaging app, further covering the consumer’s social needs. Messaging apps are a dime a dozen and don’t have intrinsic value, but for Xiaomi’s customers they add to the group feeling: the app is one element in a consistent story.
Marketing guru Seth Godin explains that the purpose of marketing is not to impose products on uninterested customers, but to stand up as the leader of a group that has formed around an idea. He calls this community a ‘tribe’. Once you lead a tribe ,you will have their permission to sell them souvenirs. It seems that Xiaomi is building a tribe, a loyal community gathered around the brand, similar to the fan base of Apple and earlier Blackberry. This is possibly a sustainable competitive advantage. It certainly has to be built and cannot be bought or copied, and the value of a strong brand has long been acknowledged. Xiaomi’s tribe needs to be sizeable but not huge for the company to become profitable. Xiaomi doesn’t have to sell tens or hundreds of millions of devices like Apple and Samsung, they just need to be differentiated, i.e. have a uniquely tailored value chain.
What do you think? Comments are welcome. Also – don’t forget to download the report.
– Stijn (@stijnschuermans)