The Xiaomi Tribe

YEAR 2, VOL. 7, AUGUST 2012

The insider view of the

mobile market

In a Nutshell
Xiaomi, the Chinese handset maker, achieved impressive first year sales in a fierce handset market by innovating in supply chain management, sales channel, batch selling and combining hardware with software, services and accessories. It uses a complements strategy to keep phone prices low, while making money on accessories and services, and creating a tribal brand for the Chinese youth. If successful, the company will create a new profit recipe that may challenge Apple/Samsung duopoly. The emergence of strong handset brands with own sales channel, like Xiaomi or Apple, includes the risk for telcos to lose grip on the customer relationship. However, many of the techniques used by Xiaomi can be leveraged by telcos as well.

The Story
Xiaomi, the upstart Chinese OEM, has put itself in the spotlight with impressive early sales figures in its first year of existence. The company is entering extremely competitive market however. As we explained in the April 2012 issue of Mobile Insider Apple and Samsungs 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 manage to draw attention?

The Facts
The Xiaomi MI-One smartphone was released in August 2011. It was priced at RMB 1,999 (about $315) at launch. In August 2012, Xiaomi launched its second model, the MI-Two, at the same price of RMB 1,999. At the same time the Mi-One got a minor upgrade and was renamed to 1S, priced at RMB 1,499 ($235). The price of the original MI-One was lowered to RMB 1,299 ($205). In its first year, the MI-One sold over 3.5 million units, according to Xiaomi. The phone is sold in batches online, with a pre-ordering system. A batch of several hundred thousand phones typically sells out in a matter of hours. Xiaomi has reported revenues of nearly $1B in H1 2012 and analysts assume it to be profitable. This has led to an investment round in June 2012 where the company was valued at $4B.

Batches sell out in minutes

Dec 18, 2011 Apr 24, 2012 Aug 23, 2012

100K phones

150K phones

200K phones

sold out in 3h
Data source: Xiaomi

0h15m

0h30m

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Business model innovation is a sine qua non 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 VisionMobiles Telco Innovation Toolbox to create a uniquely tailored value chain for its customers. Xiaomi is certainly off to a flying start, at least in sale. Its profitability is still unproven, and since it is a private company, were not likely to get confirmation on its success 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 Xiaomis target customers. Integration across the value proposition 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 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) and the telco distribution channel is disintermediated (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. A complement strategy While handsets are clearly Xiaomis 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.

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Does Xiaomi stand a chance in the cut-throat handset market? Glad you asked...

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Minimizing supply chain costs (without cutting corners) 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. Its 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. 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 Xiaomis case, the target group are young, internet-savvy Chinese with a need to profile themselves socially. With this in mind, we can reexamine 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 dont add value for the target group. This basic hardware can then be customized - an

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The Xiaomi Tribe

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 consumers social needs. Messaging apps are a dime a dozen and dont have intrinsic value, but for Xiaomis customers they add to the group feeling: the app is one element in a consistent story.

company to become profitable. Xiaomi doesnt 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.

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Xiaomi as a tribal brand 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. Xiaomis tribe needs to be sizeable but not huge for the

Lessons for telcos The path taken by Xiaomi (and Apple and others before them) includes a major risk for telcos. If handsets morph into a different business model, where the handset brand is central, one of the last remaining control points for operators will be severely weakened. If operators dont lead the tribe, then they lose grip over the customer relationship. Sure, some commodity handsets will always remain, but the sale will be that much more difficult if a tribal alternative is available. The case of Apple has shown what happens in this scenario: by owning its own distribution channel and a consumer community, Apple has a lot of control over how its devices get positioned in telco bundles and shops, which has led to high and painful subsidy policies to attract customers. Telcos should think on how they can reuse some of the strategies outlined here. How can an operator leverage tribal communities or the economics of complements?

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The Xiaomi Tribe

Complementary goods The frameworks

In economics, a complemetary good is defined as a good or service with negative cross-elasticity of demand relative to another good or service. Put simply, a the demand of a core product is increased when the price of a complement is decreased. A good example is cars and gasoline. As the price of gas drops, people will be more inclined to choose cars for transportation, and hence the demand for cars will increase. From the car vendors perspective, gasoline is a complement to his business. In the telecom industry, complementary goods are used in several ways. Over-the-top (OTT) players and mobile platform owners generally have an incentive to reduce prices for telco services, which is a complement to their business. Affordable connectivity prices are a prerequisite to drive the adoption of platforms and OTT services. Complements can also be used to increase market power by using asymmetric business models. For example, Apple can keep the price for messaging and voice services like Facetime low or zero, while telcos cant. This is because these services are a complement for Apple, who derives its revenues from handset sales, while it is core business for operators.

Competitive Advantage
Michael Porter, Harvard
If you have a competitive advantage, your profitability will be sustainably higher than the industry average. You will be able to command a higher price relative to your rivals, or operate at a lower relative cost, or both. A product or service is made in a value chain a set of activities that each contribute to the users final experience. A company can sustain a competitive advantage only if it offers something that is both unique and valuable to its customers. Every activity in the value chain must be configured to support this unique value proposition, in such a way that the competition cannot or will not follow you. This implies that you have to perform the activities in the value chain differently than the competition if you want to create a difference in relative price or cost. The alternative is competition to the best, i.e. attempting to execute the same activities better than your rivals. The end result of this strategy is perfect competition: any gain on the competitors will be temporary and price will become equal to marginal cost, erasing any attractive profit potential. Book Competitive Advantage: Creating and Sustaining Superior Performance, Porter, Free Press, 1985

Two economic frameworks we used in this Mobile Insider, for your reference.

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The Xiaomi Tribe

ABOUT VISIONMOBILE
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VisionMobile Mobile Insider is a monthly publication that tracks the latest events in mobile and provides an analysis of what lies behind the publicized facts. Licence Copyright VisionMobile 2011. All rights reserved. Feedback For more information and subscriptions, contact: insider@visionmobile.com Michael Vakulenko is a Strategy Director at VisionMobile. Michael has over 15 years experience in mobile telecom and wireless Internet bile. with track record of product and technology innovation. He started his involvement in wireless in Qualcomm and later worked for number of wireless startup companies in Israel and in the US. Michael's broad professional experience spans mobile internet services, smartphone software platforms, handset architectures, cellular networks and wireless silicon.

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The Xiaomi Tribe

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