Is Xiaomi the Apple of China?

Xiaomi is often referred to the “Apple of China”. Just how accurate is that? To better answer this question, lets first understand Xiaomi. I went through their prospectus and below are some of the things that stood out on their business model, financials and strategy.

The Basics

Xiaomi, which was founded by a group of 8 engineers and designers in April of 2010, is a Chinese internet company which manufactures smartphones and other electronics. Their mission is to build amazing products with honest prices to let everyone in the world enjoy a better life through innovative technology.

Though Xiaomi makes most of its revenue from hardware, they don’t view themselves as just a hardware company, but rather as an innovation-driven internet company.

Business Model

Xiaomi’s “triathlon” business model combines three things — innovative hardware, new retail and internet services.

Essentially their philosophy is as follows:

  1. Produce high-quality and innovative hardware with well-designed user experiences
  2. Leverage efficient and cost-effective new retail channels to sell said hardware at reasonable prices
  3. Provide engaging tightly-integrated internet services for these users which increases stickiness and provides a source of revenue

Each of these is worth going deeper into.

Hardware

Xiaomi produces hardware ranging from smartphones to laptops to smart TVs to smart speakers. On the smartphone side, for which they are most well-known, they are the fourth largest vendor in the world behind Samsung, Apple and Huawei.

In addition, Xiaomi is a formidable player in the IoT space. They manage an ecosystem of over 90 companies which produce additional smart hardware and lifestyle products. Together, they have over 100M connected devices, making them the largest IoT platform in the world.

One important point to note is while they do make a bulk of their revenue today from hardware, they sell the hardware as close to cost as possible. They view their as a source of users into their ecosystem which they hope to monetize via services. In fact, they’ve taken a pledge to never make more than 5% net margins from their hardware products.

“At this point, I would like to pledge to our existing and potential users: starting in 2018, Xiaomi’s hardware businesses’ overall net profit margin will not exceed 5% per year. If the net margin exceeds 5%, we will return the excess to our users.” — Xiaomi’s Chairman Lei Jun

New Retail

Xiaomi refers to the seamless integration of offline and online channels through technology as “New Retail”.

Xiaomi started off selling their phones via a direct online sales channel. This eliminates middleman and minimizes costs and in turn keep prices low. They are number one in both China and India in terms of online sales.

Additionally, they use their online channels to also help partners sell. (TBD)

A quote from Little Rice by Clay Shirky which helps illustrate the scale of their direct online sales model:

“[Xiaomi] has become the third largest ecommerce firm [in China] just selling its own products, after the general marketplace sites Alibaba and JD.com, and ahead of Amazon.cn”

They now have offline channels as well, but they’ve made sure too not reduce their efficiency while increasing accessibility. In 2017, their self-operated Mi Home stores generated the second highest average sales per square meter amongst retail store chains globally.

Internet Services

Most people think that Xiaomi began by selling phones. But in reality, even prior to having their own hardware, they developed a mobile OS built on Android which could be side loaded onto Android phone. And people actually did that, because it was faster and a better user experience than Android at the time. Today, MiUI as it is known is the default OS that powers Xiaomi phones and is tightly integrated with their hardware. MIUI has over 190M MAU which use it for 4.5 hours/day on average.

Xiaomi and MiUI have attracted a large fan base, who provide feedback and inform the future product development of the OS. The beta OS is updated every week, and the avid fans provide feedback/feature requests and spot bugs which are often fixed by the next release the following week.

The mobile OS aside, Xiaomi has developed a range of mobile apps which are extremely popular. These include Mi Store, Mi Browser, Mi Music and Mi Video. Per their prospectus: they have 38 apps with more than 10 million MAUs and 18 apps with more than 50 million MAUs as of March 2018.

How do they monetize these services, you might wonder? Two ways — advertising and value added services. Advertising accounts for 55% of the revenue in the segment, with Value added services accounting for the rest.

Value added services involves taking a share of the revenue generated on things such as in-app purchases, particularly from gaming, and also other subscription revenue from some apps such as Mi Music and Mi Video.

Financials

Xiaomi can be viewed as having three main business segments — smartphones, IoT and other products, and internet services.

Looking at the revenue graph above, a few things stand out — smartphones make up the bulk of revenue, but IoT and Internet Services are growing quickly. In addition, there was a drop in smartphone sales in 2016, but Xiaomi has been able to turn that around in 2017, which is pretty impressive.

As one might guess given Xiaomi’s strategy discussed above, the hardware is pretty low margins. And that is exactly what we find. Internet services is a pretty high margin business — 60%+, while the two hardware segments are at ~10% gross margins. Aggregate gross margins are at 13%.

Overall, this means that while the revenue split is 90% hardware and 10% internet services, the gross profit is 60% hardware and 40% internet services.

The last bit left is to look at operating costs. True to their word, Xiaomi is run pretty damn efficiently. S&M, G&A and R&D are just a combined 7–9% of revenue, meaning that Xiaomi has a positive operating margin of 5% on its core business.

Note that I said core business, because if you look at Xiaomi’s own financials, they also have another source of profit which is pretty sizable — gains from fair value changes on investments.

These investments are generally passive equity stakes in companies that develop products related in some way to the Xiaomi ecosystem and include consumer goods companies, IoT companies, and so on. It has made over 210 investments including the number one powerbank, electric scooter and air purifier companies globally, and they also own sizable stakes in gaming, virtual reality and IoT hardware companies.

So how much money did they make from this? In 2015 and 2016, the gain on the investments were almost $2.5B RMB each, and in 2017 they were $6.4B RMB. Adding this back to their operating margins more than doubles the operating margin from 4.8% to 10.4%! One could say this isn’t really a part of their core operations, but the fact remains that is a key part of Xiaomi’s strategy, and has been paying off for them.

Global Ambitions

It’s worth discussing Xiaomi’s global ambitions, particularly as it has been of the more successful Chinese technology companies in going global. It has entered over 70 countries and is the number one in India in terms of smartphone market share and among the top 5 smartphone companies in 15 countries.

It has been able to compete well in these markets not just on price, but also on the quality of its products and user-experience.

In 2017, Xiaomi made over RMB30 billion globally (up over 200% from 2016) which represented almost 30% of their revenue.

I see a lot of potential room for growth for Xiaomi globally. On the hardware side, even if they don’t compete with Apple and Samsung in every market, I can see them competing in the IoT space and in other hardware products (think powerbanks, electric scooters and so on).

On the services side, today they primarily make their money in China but have a sizable untapped user base in India and Indonesia as evident from the excerpt below which presents a good growth opportunity.

For example, in each of India, Indonesia and Russia, on our smartphones, our Mi Music app ranked number one in the music category, in terms of MAU in March 2018, our Mi Browser app ranked number two in the browser category and our Mi Video app ranked number two in the video category.

Apple of China?

So now we’re in a good position to answer the question posed in the title — is Xiaomi the Apple of China?

Sure, Xiaomi is like Apple in some ways — it makes its own hardware and software which is tightly integrated and high quality. It also has a “cool factor” about it, and a very loyal fanbase. And it has definitely innovated in how it sell their devices too — from their online channel to their Mi Home Stores just like Apple did with their Apple Stores.

A Mi Home Store in Singapore. Source: lesterchan.net

But in terms of its business strategy, it diverges from Apple quite a bit. While Apple does have a growing services business, it’s fair to say that the main way Apple makes its profits is through its hardware, which tend to have gross margins of 60%. Meanwhile, Xiaomi’s strategy is to make their phones and other hardware as accessible as possible for the cheapest price possible.

In some ways, they view their phones and other hardware as a source of users¹ into the Xiaomi ecosystem, which they will then monetize through services (and also through investments in other companies which they allow into the ecosystem).

Their hardware strategy is much closer to Amazon or even Google, where the devices are in some ways just an endpoint to the ecosystem rather than a source of profits.

The below excerpt from Lei Jun’s letter struck me as very similar to Jeff Bezos’s belief about working hard to charge customers less and focusing on things that don’t change.

As Xiaomi continues to progress, we ask ourselves: what has remained constant in the ever- changing business world?
Our answer is that users have always expected amazing products at honest prices.

And let’s not forget about their investments — over 210 investments in a wide variety of companies the gains on which which have contributed to over half their operating profit. So perhaps Xiaomi is also like a VC fund, and a very good one at that.

So there you have it. Xiaomi is like the Apple of China. But also like the Amazon of China. And like the Sequoia of China. Or maybe Xiaomi is just Xiaomi — a unique entity both in China and beyond.


¹ That they acquire their customers at a profit then while most companies face large customer acquisition costs is in some sense pretty amazing. However, an internet company with ~200M MAU isn’t really worth $80-100B by itself…