Shunwei VP Duan Yu, Who Made Investments in Chinese Unicorns Huami and Ninebot, Shares Our Investment Approach and the Incubation Process for Xiaomi’s Ecosystem Start Ups
Article #3 in the Xiaomi Series (By Adam Bao)
Duan Yu is VP at Shunwei Capital, covering consumer mobile internet, smart hardware and all of our Xiaomi ecosystem investments. When he first joined Shunwei in 2013, Xiaomi’s ecosystem strategy was only just emerging, and so when he made trips down to Shenzhen, manufacturers were not used to and in some cases wary of the heightened level of VC money and attention. Since then, he has made 40 investments in smart hardware (Huami band, Ninebot, Yeelight, MINIJ, 8H), and has intimate knowledge in this area surpassed by perhaps only Lei Jun and Liu De’s inner circle.
Today we sit down with Duan Yu to get more clarity on Shunwei/Xiaomi’s investment approach and the ecosystem incubation process.
So we’ve talked a lot about the ‘Xiaomi Ecosystem’ strategy. Can you provide more details on the inter-operation between Xiaomi and its ecosystem companies. How does this process actually work?
Sure Adam. It’s a fairly standard process for most companies that we work with, from super early stage to more established. Before making an investment, we’ll connect the company with a dedicated Xiaomi PM to do some technical DD and kick the tires.
We’ll start with the product and determine what capabilities it should have. It needs to be differentiated enough to enter Xiaomi ecosystem (requirements in our previous Xiaomi ecosystem article). Cost is another consideration — the more features a product, the more expensive it will be — and Xiaomi seeks to always maximize the customer value proposition, which requires a balance between product capabilities, feature set, cost, and overall quality. 90% of companies we look at can’t move past this hurdle; they can’t get the product to a place where people actually want it, where the market will accept it.
Got it, so you’ll bring in your PMs to do some initial product and technical DD. What happens after you pull the trigger and put in some money?
At that point, we’ll bring in more of our folks to provide substantial Xiaomi feedback from the get go. The product needs to be truly special, and figuring out that initial product definition, that initial product/Xiaomi/market fit is crucial.
More specifically, we’ll get more hands on with design and product development. Industrial design is a big part of it… Remember, these aren’t just standalone products, these need to be good Xiaomi products. When the end user buys the product and puts it at home, it needs to feel and look right, so a lot of thought goes into this, and there are multiple stages of review by Xiaomi designers and engineers. We used to have 2 people working on this, but now it’s probably 20. Some products will require less attention, let’s say 1–2 months. The Xiaomi smart bulb and desk lamps are such an example (they won the 2017 Gold Award!). Xiaomi drones design obviously take a lot longer, perhaps up to half a year.
You bring up an important point. With so many companies within Xiaomi’s ecosystem, how does Xiaomi have the time to provide so much support? How do they allocate their design and engineering resources?
Well it’s actually not so bad. Remember, Xiaomi only invests in a few companies per period, so each batch of ecosystem companies gets quite a bit of attention. These companies won’t need nearly a much attention after this period. For the first product, Xiaomi can offer a lot of support, but eventually they’ll be more hands off.
OK understood. Design and engineering capabilities asides, what other strategic value does Xiaomi bring?
Xiaomi also provides significant value when it comes to supply chain and sales distribution. Firstly, there are numerous components that go into any one hardware product. Xiaomi knows all the vendors in Shenzhen and can help its ecosystem companies determine where to source quality components. Of course, Xiaomi also has tremendous buying power, so its ecosystem companies enjoy a ton of volume benefits.
And perhaps of the greatest value, Xiaomi provides a massive sales channel for its ecosystem companies. Firstly, Mi.com is one of the largest ecommerce sites in China, behind only Alibaba and JD, and the leader in selling innovative smart home goods and electronics. Xiaomi also provides 3 apps: the Mi app (小米商城), which is the mobile version of its Mi.com website; Mi Jia (Mi Home/米家), which can be thought of as the control device for smart products in the household; and lastly Mi Jia You Pin (米家有品), which is a mCommerce channel similar to the Mi app but focuses primarily on selling Xiaomi ecosystem and smart home products, including those from 3rd party sellers.
And what about the investment itself. Could you also walk me through your typical process?
I can give you high level details here. Xiaomi and Shunwei Capital co-invest on almost all ecosystem companies. For early stage start ups, we’ll take a relatively larger stake (usually split evenly between Xiaomi and Shunwei), and then for more mature companies, we’ll take a smaller stake. We like to get a board seat so as to ensure that Xiaomi has a voice in the decision making process. Cheng Tian (Shunwei partner) and I sit on the boards of several companies, usually with another Xiaomi investment team member or product manager. For the most successful ecosystem companies, Liu De (Xiaomi ecosystem chief) will usually sit on the board.
From Shunwei’s perspective, approximately 1/3 of our investments are into Xiaomi ecosystem companies. While the first round is generally a co-investment with Xiaomi, on later rounds we’ll take a purely financial perspective and can choose whether to participate or not as appropriate. Similarly, the rest of our capital is managed as a typical VC to maximize financial return.
It seems to me that Xiaomi is a terrific, hands on strategic partner that provides not just financial value but also tangible technology and business value. But what happens when ecosystem company ‘grows up’ and grows out of the Xiaomi ecosystem?
The way I look at it, Xiaomi brings tremendous value to the ecosystem start up. In most cases, without Xiaomi’s support they would have never gotten to where they are. For the more successful ecosystem companies (e.g. Huami), they’re already unicorns and they’ll treat Xiaomi as large sales channel and continue to sell through them. At the end of the day, there’s money to be made. Xiaomi wouldn’t become a direct competitor either, as they’re more focused on ownership over core products (i.e. the smartphone), and the whole point of its ecosystem strategy is to populate its eCommerce channel with quality products from other companies, on which it takes a cut.
On the flipside, given that Xiaomi comprises such a large portion of sales, at first it can make it harder for ecosystem companies to go public. More specifically, in the Chinese stock market, the main client cannot account for more than 30% of revenue. For some ecosystem companies, especially during the growth stage, Xiaomi can be their largest sales channel. As such, they’ll need to diversify the customer pipeline as the company continues to scale, which is natural and something that all companies should do irrespective of being considered an ecosystem company or not.
There are multiple examples of ecosystem companies that become successful and build their own brands while continuing to enjoy Xiaomi as one of several sales channels. Xiaoyi (smart cameras) and Ninebot (self-balancing 2-wheeler) have achieved such success, with Ninebot having acquired its US rival Segway, and on its way to a potential US IPO.
How does the Xiaomi ecosystem compare to that of other companies globally?
At a high level, China’s BAT (Baidu, Alibaba, Tencent) build out their ecosystems according to their respective strategies. For example, Tencent might invest in gaming and social (e.g. $8.6 bn Supercell acquisition in 2016), while Alibaba might go on an acquisition spree or otherwise invest in eCommerce and payments players in China, Southeast Asia, and beyond. It’s an extremely competitive market, so there tends to be overlap in areas that are hot and get consumer attention (e.g. Baidu and Xiaomi are both investors in video platform iQiyi), but in terms of the hardware ecosystem, Xiaomi is very unique.
A relevant global comparison could be Apple. Apple and Xiaomi are both product companies, and smartphone first companies at that. But Xiaomi has its own ecommerce channel, with an ambition to sell through not just smartphones but also a host of electronic devices and smart home products, whereas Apple is 100% focused on its own, vertically integrated products. Furthermore, let’s not forget that most products, whether it be smartphones, sports cameras, drones, etc., are all made in China. Given their proximity to Shenzhen’s manufacturing hub, Chinese companies enjoy a much more efficient supply chain, and so they can leverage that to build and iterate much faster than a US player.
Thanks Duan Yu, very insightful and we look forward to having you join us again!