Scrrrunch time for Indian smartphone makers

“We have more money than they do. And now we have their people. We can out-subsidize them. We’re selling 14,000-rupee phones at 11,000. They don’t stand a chance. Sales are like potato chips”, he said. “You see, without the potato chips, it’s just a packet of hot air.”

Scrrrunch! He finished the last potato chip and crumpled the packet before throwing it out of the taxi window onto the main road. I was taken aback by his confidence, yet unconvinced. His brand was new, and the market still didn’t differentiate much between the various Chinese brands. What made him so confident? He was the head of Marketing for a leading Chinese brand of smartphones in India, and I’d just happened to share a taxi in Bangalore with him. It was pure coincidence — Uber Pool assigned him randomly to my taxi, on my way back to office. I don’t remember the date, but I had casually met a venture capital investor for coffee, just before this taxi ride. And the investor’s words came right back to me when I saw my co-passenger’s swagger.

“Yes, we looked at one Indian smartphone manufacturer too”, said the investor. “Past sales are good, but they’re struggling now. They’re achieving less than half of their sales target this year. And they have hardly any repeat buyers, because many users graduate out into other/ better phones. I’m not sure how they’ll fight the new Chinese brands entering the market.” I didn’t give his views much thought, as our meeting was about something else altogether. But now, I was hearing another perspective to the story. And it matched.

Another day, another meeting. This time with a senior sales manager at one of the leading Indian smartphone brands. “80% of our phones are sold in India’s top 6 cities”, he said, as we sipped hot coffee by the Bangalore roadside. “With Flipkart and other sites selling phones there, our traditional control over offline distribution networks is no longer a competitive advantage.”

“Yes, but you still have feet-on-street, sir. Sales leaders like you”, I joked.

“Ha. Chinese brands are paying well. If they come to me, I’ll accept it before you finish your coffee.” I almost spat out my coffee in shock.

Within a week, three different people had told me the exact same thing. I decided it was time to learn more about this. Here’s what I found.

The Overtake Manoeuvre

In the 12 months of 2015, Chinese brands doubled their overall India market share to 18 per cent, while Indian brands fell from 48% to 43%. In fact, some of the fastest growing brands in India are from China.

This trend has gained speed this year. According to Counterpoint Research, in Q1 2016, the Indian smartphone market grew at 23% vs Q1 2015. The big 4 Indian brands either underperformed the market or stayed level, with Micromax being the sole exception.

Fundamental differences

What are the big differences between Chinese and Indian smartphone makers? I found seven:

1. Manufacturing: Indian smartphone brands don’t make their own phones. They buy them from China and trade them in India, leaving them with no control over the value chain and no economies of scale from their own impressive growth in the last 9 years or so. While some brands have started to assemble Semi-Knocked Down (SKDs, almost fully-made phones) kits in India due to zero import duty on SKDs vs 12% duty on finished phones, the primary work of making the phone is still done abroad.
2. Financial strength: Chinese brands have a decade of built-up surplus profits from their much-larger domestic market. This gives them deep pockets full of investible funds
3. Inventory management across markets: Chinese brands sell in multiple neighbouring markets, from China to SouthEast Asia to India. There are tangible price differences and arbitrage opportunities across these markets. This gives them the ability of being aggressive in making large batches of devices, because leftover inventory in one market can be transferred to another. Indeed, many of the cheaper models in the Indian market were originally made as part of a larger batch for China. Making larger batches, in turn, allows them to further reduce unit costs. In contrast, Indian brands are sold primarily in India, with only a fraction of their sales coming from Eastern European and ASEAN markets.
4. Backward integration: The Chinese mobile hardware ecosystem is far more vertically integrated and self-sufficient than India. For instance, in recent years, global mobile chipmakers such as Qualcomm and Intel have ceded massive market share to local players such as Spreadtrum, Rockchip (for tablets), AllWinner and RDA Micro. Together with Mediatek from Taiwan, these chipmakers now own a large part of the low-end chip market for sub-$150 devices, including some LTE devices which used to be the speciality of international players such as Qualcomm. In fact, international chipmakers have had to become investors in Chinese chipmakers. In the Indian market, Spreadtrum has achieved 30% market share in just a year and a half.
5. Branding: Chinese brands are investing heavily in achieving top-of-mind recall in the minds of Indian consumers. They understand that buying a smartphone is a semi-emotional decision. People may have tight budgets but they still want to feel like they made a smart decision and bought a really good phone. Indian brands, with the sole exception of Micromax, have invested very little in brand-building. The driver for users to buy their phones is price and availability, rather than brand aspiration or trust. Increasingly, buyers view these phones as compromise purchases.
6. Sales Costs: Chinese brands have been quick to embrace online sales channels that have far lower operational costs, allowing better unit economics. A part of the savings is passed on to consumers as well, resulting in lower phone prices. Such a strategy is useful mainly in tier-1 cities.
7. Strategy: Some Chinese brands adopt a relationship approach to the smartphone business. Companies like Xiaomi have proved their ability to monetize their users beyond just selling them the hardware, through e-commerce and other digital services. This also allows them to subsidize the off-the-shelf price of the phone, helping to fight the price war as well. Indian brands, meanwhile, are aware of this model but haven’t adopted it yet. It is puzzling why.

In summary, the entry of Chinese smartphone makers has posed important questions for Indian brands, the answers to which might lead to a massive improvements in their functioning. The days of merely trading in hardware to win a local price war against western brands are over. This is a big opportunity for Indian brands to step up and strengthen themselves, which could make them globally competitive.

Later, I ran into the senior sales manager again. We decided to have the famous Andhra meals at Nagarjuna in Bangalore. I told him about my plans to write a blog post about this.

“I actually think Indian brands can win, not only in India but even in other markets”, he said. “But they will have to change the way they’re going about things currently. They’ll have to pay better, hire smarter people, focus on greater local value-addition in the product, and embrace online channels and technology better. Indian brands have a big lead on others in terms of understanding local customers better, knowing the local culture better. That’s a pretty big lead. Particularly in the lower end of the market, because that’s where most of the market is.”

He took a break between sentences to eat his pappadoms (appalams) with his sambhar rice.

“That sounds like good news”, I said. “So Indian brands do have a chance to turn things around.”

“Sure, but I hope they see it that way too”, he smiled, and took another bite of the pappadom.

Scrrunch!

And that’s when I noticed how similar the sound of crushing pappadoms is to a crumpling packet of potato chips. And I hoped his packet wasn’t empty.