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Can Xiaomi Get Its Mojo Back?

by LiuSha

June 20, 2016

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Once China’s biggest smartphone vendor, Xiaomi is now in decline. What can it possibly do to make a comeback?

Never had a Chinese domestic phone achieved such dizzying heights of success before Xiaomi came along. The smartphone vendor sold over 61 million phones in China in 2014, beating the immensely popular Samsung and Apple to become the biggest smartphone vendor in the country. It created sales records by selling hundreds of thousands of phones online within minutes. People were quick to claim that Xiaomi was China’s Apple and Lei Jun, founder and CEO of Xiaomi, was given a moniker: ‘Leibs’ which stands for China’s Steve Jobs.

But now Xiaomi is cooling down at a worryingly rapid pace.

The six-year-old company has peaked, analysts say, and the decline has set despite all the impressive tools in its arsenal, such as its unique flash sales and social marketing strategy.

In 2015, Lei announced that Xiaomi would sell 100 million phones that year. But it fell short of its ambitious goal, selling only 71 million, according to International Data Corporation (IDC). And in 2016, the shipment volume has continued to fall. In the first quarter of 2016, it sold 14.8 million handsets, compared to 16.9 million in the previous quarter and 14.9 million in the same period in 2015. As for 2016, so far Xiaomi hasn’t announced any goals.

In the first quarter of 2016, Xiaomi was displaced from the list of the top 5 global smartphone vendors, but in 2014, it was up there: No.3 on the global list and No.1 in China, according to IDC. Except for Apple and Samsung, the other three are Huawei and two relatively lesser-known brands—Oppo and Vivo.

Xiaomi’s position on the rankings differs depending on the methodology adopted by different research agencies. On TrendForce’s list of the top six smartphone vendors by global market share, Xiaomi is still the fifth-largest vendor with a market share of 5.5%, but down from the fourth position in the same period last year.

Now that Xiaomi’s impressive marketing strategy has somehow reached stagnation point and many vendors are selling similar phones, the company seems to be losing its edge.

‘Pigs Can Fly’

Lei Jun, 47, former engineer and president and CEO of Kingsoft, a Chinese version of Microsoft Office, has rich experience in China’s tech industry. He once said: “Even a pig can fly when it is hit by a tornado.” The quote, which became an instant hit with start-ups, meant that anyone can succeed by simply going with the trend of economic and social development.

And perhaps that’s what Xiaomi did.

In the go-go years, Xiaomi thrived on the popularity of e-commerce, social media and smartphones. There was another factor behind its success though: when it first came to the market, it’s feature-packed phones were indeed revolutionary, especially given their ridiculously low price point.

Smartphones started to become ubiquitous in China in 2009. The market had two extremes: high-end brands like Samsung and Apple with prices ranging from RMB 3,000 to RMB 5,000, and cheap, pirated no-name phones. What was missing was a phone from a decent brand with good quality and affordable pricing for college graduates, blue-collar workers and other low-income people.

And then people discovered Xiaom. It was chic and trendy. The price tag was low and had its own customized Android-based operation system called MIUI.

Founded in April 2010, Xiaomi quickly developed a cult-like fan following. It focused on software first, creating an online fan club with hundreds of smartphone-enthusiasts. Using their feedback and suggestions Xiaomi polished MIUII. The fans did their bit too by giving the company free promotion online.

Li Wanqiang, vice-president of Xiaomi, later wrote a book titled The Xiaomi Way, explaining how it formed and engaged what was called its “Mi Fan” community and let them offer suggestions to improve Xiaomi’s products. Xiaomi also created Mi Fan Festivals, where they celebrated and collected opinions and distributed free devices to test. Rapidly incorporating customer feedback became an important part of the Xiaomi model. Lei often says in public that Mi fans are “science geeks without high incomes,” indirectly indicating that their reviews of the phone are professional and credible.

Through those fans, the company receives free promotion online, especially on Sina Weibo, a popular microblogging platform. Word about Xiaomi spread fast. Given its ability to generate word-of-mouth publicity through fans, Xiaomi was able to avoid unnecessary marketing expenditure. It sold its phones in flash sales online, whipping up a frenzy for its latest models. With almost zero spending on marketing and brick-and-mortar stores as well as distributors, it managed to set the price of the RedMi model as low as RMB 899.

But gradually others started aping Xiaomi’s model, chipping away at its competitive advantage. And soon people got tired of flash sales and marketing gimmicks. The novelty had worn off.

Jin Di, research manager with IDC China, says that Xiaomi’s sales are falling partly because of market changes and fierce competition. Apart from big foreign brands like Apple and Samsung that have traditionally been popular in China, the market is also seeing strong competition from tech stalwarts like Lenovo, ZTE and Huawei. And now, to add to the mix there are also many smaller brands like Oppo and Vivo that are quickly rising up the popularity charts. The market is getting further fragmented by new players like LeEco, originally an online video company that has jumped headlong into producing smartphones.

To add to the confusion, the smartphone market is decelerating in China. Data from IDC shows that the year-on-year growth of smartphone shipments was 62.5% in 2013 and the figure dropped to 2.5% in 2015.

Apart from market changes, there are also problems with Xiaomi’s own product quality, differentiation and strategy, says Jin. The phone now is no different from others on offer in the market: it has no special features or technology. (Xiaomi did not respond to CKGSB Knowledge’s interview requests.)

Since 2012, when Xiaomi released the Mi3, many users complained that the phone constantly restarts by itself. And the Mi 4c, released in 2015, has received complaints on the Mi fan’s online forum, with users saying it would suddenly halt operation, and after several months, the speed would become very slow. This year people complained that the screen of Xiaomi’s latest model, the Mi5, easily bends and breaks.

But because Xiaomi has always been cheap and had been ‘scarce’ for a long time, people still say that the phone has a good “price/performance ratio”.

The Changing Strategy

While Xiaomi was focusing on selling online, its competitors, Huawei, Oppo and Vivo were doing the opposite: expanding their retail footprint through stores and distributors. As a result, they have gradually gained ground.

“Xiaomi has failed to reach people in lower-tier cities and towns while its competitors have expanded far and wide,” Jin says.

Both Oppo and Vivo, with similar features and pricing as Xiaomi, have forged tight relationships with retailers and distributors. Apart from their own stores, they also contract local selling agents, through whom they keep close ties with phone retailers and electronic appliances stores like Suning and Gome. By the end of 2015, people could buy Oppo phones in 200,000 stores nationwide and Vivo also covered over 200 cities.

Despite more Chinese people preferring to shop online, 74% of phones were still sold through brick-and-mortar stores in 2015, according to statistics from Beijing PuTian TaiLi Telecommunications Technology, China’s largest mobile phone distributor.

Just recently, Xiaomi has teamed up with China Unicom and its phones will be sold in over 4,800 China Unicom retail outlets nationwide. Xiaomi is also producing a Redmi 3X, especially customized for China Unicom, and priced at RMB 899.

Currently around 60% of Xiaomi’s phones are sold online and 40% through retailers. To catch up, Xiaomi is expanding cooperation with mobile retailers and electronic appliance stores and also increasing the number of Mi Homes, its own stores, from 20 to 50. An internal document revealed by Reuters says that Xiaomi aims to sell 58 million handsets in 2016 through offline stores, double the number it sold through offline channels in 2015.

This expansion won’t be easy for Xiaomi.

Due to their low price and wafer-thin margins, salespeople don’t find it lucrative to promote Xiaomi phones to customer, says Jin.

On the other hand, Huawei, Oppo and Vivo have both expensive and cheaper phones through which salespeople make a higher commission and thus have an incentive to push their phones.

The year 2014 was an exception though. At that time, Xiaomi was riding the popularity wave. If you tried to buy a Xiaomi phone online, it would almost always be out of stock. Local phone stores had a lot of Xiaomi phones in stock, which they had obtained from either big scalpers or distributors. And they would sell the Xiaomi Mi4, which cost RMB 1,499 online, for a whopping RMB 2,400.

“Phone stores were willing to promote and sell Xiaomi when it was scarce,” says Jin, adding that now that Xiaomi has stopped using the tactic of “hungry marketing” (creating demand by reducing the number of phones sold, hence making the phone scarce and more desirable) and everyone can buy it online, retailers have lost their incentive to sell Xiaomi, as they cannot sell the phone at a higher price anymore.

What’s more, selling offline means Xiaomi will lose the cost advantage it got by bypassing distribution costs.

“Its business model is that is sells at a very cheap price with a slim margin. At first, it won’t make profits and then after one year, the component prices drop and the phone price remains unchanged, so it can start to profit. But that won’t work in the offline market,” says Jean-Louis Lafayeedney, director at Haitong Securities International Securities Group.

Other than distribution costs, Xiaomi has to spend money on expanding its own stores, sales training and so on. “Expanding the offline market is possible, but it will then totally change its business model and marketing strategy, and it’s not going to make money,” Lafayeedney says, adding that working offline makes it just a regular smartphone vendor.

However, Xiaomi might have one more trick up its sleeve: it doesn’t want to be a smartphone maker only. “In the past five years, Xiaomi has been laying the foundation of its ecosystem and now it’s almost complete,” Lei said in an interview with the 21st Century Business Herald, a Chinese publication. By investing in many start-ups that produce smart home appliances, Xiaomi is trying to build an ecosystem: one that can connect with and control everything in the house using one interface—the Xiaomi phone. Xiaomi is placing big bets on The Internet of Things (IoT), a network of internet-enabled devices widely heralded as the future of technology and human life.

A Fragile Ecosystem?

If you look at Xiaomi’s online store, you will find a variety of products: a set-top box, a fitness tracker, a wifi router, an air purifier, a rice cooker as well as many other smart home appliances. The latest product to join this curious mix is a drone. At the price of RMB 2,499, Xiaomi’s drone is a lot cheaper than market leader DJI, which has 11 different types of drones and an annual sales volume of over RMB 3 billion At the launch event, Xiaomi’s drone suddenly fell down mid-flight, much to the embarrassment of the company. Although Xiaomi explained it away saying that it was an “auto landing” caused by low battery, many people found the product, with only 28 patents untrustworthy, especially after the launch debacle. In contrast, DJI has over 200 technology patents.

As for the set-top box and wifi routers, Liu De, co-founder of Xiaomi, told Caixin magazine that they did not “achieve the success we expected.”

Xiaomi’s ecosystem is still pretty much a work-in-progress. But it is already showing signs of weakness. Ultimately the question is: will the strategy work?

“Building an ecosystem makes sense, but there have to be enough number of users, at least 300 million, to hold the terminal, in this case the smartphone, to form an ecosystem. Because the point of an ecosystem is to have large enough amount of family and house-related data, based on which the company could provide and sell value-added services,” says Yin Sheng, former associate editor of Forbes China and a well-known expert on China’s tech industry, who started to question Xiaomi’s business model and valuation three years ago.

If Xiaomi cannot sell its phones well, any new concept it boasts about will not work, says Yin.

Jack Chen Xinlei, a professor at CKGSB, thinks that the ecosystem strategy has distracted Xiaomi and diluted its efforts, making it “care for this and lose that”.

“However, for Xiaomi, it has to say it’s something more than a smartphone vendor to be favored by venture capital,” says Chen, adding that the ecosystem concept is the reason why Xiaomi enjoyed such a high valuation of $45 billion in 2014. “But now the value is down to $15 billion.”

The starkly low valuation figure of $15 billion was first revealed by Wang Zeqi, CEO of Shenzhen Fenda Technology, on Weibo in late 2015, when Xiaomi’s sales volume fell short of expectations. The number became the subject of much discussion among business people and was later denied by Xiaomi.

There are two major problems with Xiaomi, Chen says. One, Xiaomi did not focus on making a good phone and without consolidating its position in the smartphone industry, it impatiently expanded into other areas.

The other is its low market positioning. “People who buy Xiaomi are low income people like college students and blue collar workers. They are not loyal buyers. Once they have money, they will move to brands like Apple and Samsung,” says Chen.

So far Xiaomi Notepro is the company’s most expensive phone. Lei Jun also said that it was a high-end phone. At first it was sold at RMB 3,299 and five months later the price was lowered to RMB 2,999. Not long after, it was again lowered to RMB 2,599. While the company has boasted of the sales records of the low-end RedMi which has sold over 25 million phones, it never publicized the sales volume of Xiaomi Notepro.

“These low-income buyers of Xiaomi have no purchasing power to buy the other products Xiaomi is selling [i.e., the smart home appliances],” Chen says.

Although Xiaomi’s online store has many smart home products that are developed by start-ups which Xiaomi has invested in, they’re often not the leading names in their industry. If Xiaomi’s brand gets tarnished due to some reason, these products can easily pull out and operate under their own brand names and sell on other e-commerce platforms.

Although Xiaomi claims to earn money through software services rather than devices, in 2015 its software revenue also fell short. It set a goal of making $1 billion through its internet services like online games and financial services, but it turns it could make only $564 million, Reuters reported.

So far it cannot rely on its software revenues alone, it’s still a company making money through hardware, says Lafayeedney.

So What’s Next? 

Most experts reached by CKGSB Knowledge share the opinion that Xiaomi should really do much more to improve its phones. So far the company’s value is only based on its marketing strategy and business model, but it has little in the name of core technology, the bedrock that gives a tech company its prowess.

Lei Jun has also realized the company has run into problems and has to make some changes. Apart from planning offline stores and developing sales channels, it has to pay more attention to develop its core technology.

In May 2016, eight days after the latest Xiaomi phone Mi Max was released, Lei sent an internal letter to his staff, announcing that he would personally take charge of the mobile phone development and supply chain management team. Zhou Guangping, co-founder of Xiaomi and who worked as chief engineer of Motorola’s R&D center, was designated as chief scientist.

Lei said in the letter that Xiaomi has to do a lot of prospective research on the mobile phone side to improve the technological prowess of the company. “We hope Guangping can make innovations and breakthroughs in the new position and bring us more pleasant surprises in exploring the frontiers of science and technology.”

However, Fang Xingdong, a friend of Lei’s who belongs to the first batch of tech entrepreneurs in China, says that “Lei missed the chance to get Xiaomi listed at its peak.” “Without enough capital, it bears the burden of having to sell more and also maintain capital. That will affect its R&D work,” he adds.

“Xiaomi is facing a competition from products rather than business models. To solve its problem, Xiaomi has to focus on producing high-end products, but it also has to risk losing some customers and profits. If it’s determined enough, it’s in a much better situation than Oppo and Vivo were two years ago. It just depends on how much it’s willing to sacrifice,” says Chen.

Can Other Markets Save Xiaomi?

Going global is a way to make up its revenue, and so far Xiaomi devices have entered 10 different countries: Malaysia, India, etc., in Asia; Russia in Europe and America. In late 2015, it also announced its plans to go to Africa. Accoding to GSM Association, smartphone users will increase most rapidly in the countries south of Sahara.

According to Lei’s plan, Xiaomi aims to become one of the top 3 smartphone vendors in India and then expand to Indonesia, Brazil and eventually enter in Europe and US market (so far in some markets it is only selling accessories and other devices apart from phones).

Lafayeedney feels that Xiaomi can easily get a foothold in such fast developing smartphone markets. “So far it has done a good job in India. Because India’s smartphone market is developing and changing fast, it’s easy to grab market share. Yet it’s going to be tough because many local brands are [also] growing quickly,” says Lafayeedney.

A big obstacle faced by Xiaomi is the lack of patents. “Without patents it cannot sell online in the US, Australia and other developed countries,” says Lafayeedney. But the company has realized that. In 2015 end, it had over 2,000 patents. In March 2016, it bought 332 patents from Intel and more recently it bought 1,500 patents from Microsoft.

Chen says that Xiaomi still has a chance to make it big, but it has to think clearly about what its differentiation is. The methods it has used to become big in China won’t work effectively in overseas market, where it will face even fiercer competition.

Big telecommunications vendors like Huawei and ZTE have been doing business in Africa for years and in India, there are many local brands, as well as Oppo and Vivo that have higher-end phones.

“It will have similar problems as in the domestic market. Without knowhow, it still cannot get recognition in the long term even if it manages to sell a lot in a short time,” Chen says.

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