Xiaomi: Just a Hardware Company?

Whether or not Xiaomi is just a hardware company or is truly an internet company as founder Lei Jun continually emphasizes came into question with last week’s Wall St. Journal report. The statistic that surprised many was the “94% of revenue made in hardware” figure. It was generally believed Xiaomi sold their hardware at cost with little to no margin and made their profits with internet services. However, if the Wall St. Journal report is correct, then that assumption has been flawed, at least up until now.  What’s fascinating, and perhaps enlightening, about what we learned from the report is they have effectively figured out how to still get average OEM net profit margins. Xiaomi’s BOM cost of their popular Red Rice Phone is about $85 and sells for $130. Their popular Mi3 has an estimated BOM cost of $185 and sells for $270. By being able to manage the supply chain and, after other hard costs, I estimated hardware net profits of approximately $23-$26 per phone sold.

What is interesting to ponder with relation to the Wall St. Journal report is why Xiaomi’s profit only increased 85% when handset shipments increased 200% YoY. One would think, given this hardware model they are employing, profits would scale with such a dramatic increase in unit sales. Clearly Xiaomi incurred some significant costs, perhaps in CapEx, or in global expansion efforts, which offset their profit growth.

Another explanation for the discrepancy in growth was a higher mix of products like the RedMi and RedMi Note which, in a BOM cost analysis I did by looking at their suppliers, suggests this product was sold well below the average of $23-$26 estimated margin per phone and may have actually been sold at a slight loss. In fact, non-public reports I have read hint that Xiaomi initially prices their phones at or just below cost but then quickly drives costs down allowing them to begin to yield margins that weren’t there initially. Xiaomi in this case is a lot like Dell, in that they only order the phones to be made once the sales are taken in. Xiaomi manages zero inventory and only builds phones in bulk for the orders they have taken. This is one reason the order availability is capped at a certain level. By managing supply chain tightly, and driving product costs down over time while capturing those margins in real time, they have effectively been able to generate the kind of hardware revenue the Wall St. Journal report indicates. That being said, they can not simply be a hardware company. And ultimately their growth prospects are challenged with just this business model. This is why they are seeking to raise capital. A cash infusion is necessary for Xiaomi to grow and grow quickly, which they’ll need to keep capitalizing on the mind share they currently have.

Ultimately however, I believe Xiaomi is still laying the critical groundwork to be the internet services company they desire to be. Being in the hardware business alone is not a sustainable business for many global OEMs. I have spoken with several high-up execs at Xiaomi and was told that, as of late 2014, they are generating around $21 million USD in revenue from their app stores (game app store, mobile app store, and books app store). Which means it is likely 2014 profits should have quite a bit more balance between hardware and services. Xiaomi is on pace to again increase handset shipments ~200% — yet the WSJ report only estimated a 75% increase in profits this year. The curious variable of why profits are not more closely matching explosive YoY handset shipments is a concerning element of the overall Xiaomi story.

Can Xiaomi go international? That remains to be seen. Their sales in markets outside of China have been nominal to date but there is increasing brand awareness in non-Chinese markets. Scaling internationally will be a challenge and they have to be more than a hardware company to do it sustainably. Xiaomi is in the news a lot but I still have my doubts about their long term fate. If China is the only market they are relevant, this is not a bad thing. Xiaomi can have a strong and profitable regional business and still be successful.

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Ben Bajarin

Ben Bajarin is a Principal Analyst and the head of primary research at Creative Strategies, Inc - An industry analysis, market intelligence and research firm located in Silicon Valley. His primary focus is consumer technology and market trend research and he is responsible for studying over 30 countries. Full Bio

6 thoughts on “Xiaomi: Just a Hardware Company?”

  1. Thank you for clarifying the situation. Xiaomi has always been an enigma, and although I still think we need more information to understand it, this analysis helps.

    The question I have is, if Xiaomi has not yet succeeded in being an Internet company, then will any other company ever succeed?

    That is to say, as OEMs find it increasingly harder to find margins, one possibility is that they will try to integrate Internet services and get their profits from that. At first glance, the current Xiaomi situation suggests that this may not be a viable business model, at least unless you can obtain large amounts of capital.

    I would like your thoughts on this.

    1. Several theories. Perhaps the ones best positioned for the the next billion are already Internet companies. Baidu for example, or Internet companies who will emerge from India. Maybe even flipkart for example. Their incentives or dependencies will never be on the hardware side but always on the Internet services side. This is where I feel the key monetization will happen in the lower mid- and lower tiers of the smartphone hardware world.

      These will also be highly regional. As I think you have read from me before, I truly believe the idea of a universal global Internet/services is a myth. Regional services are the key and they will look and act different in every region. A global company, to succeed, will have be be deeply embedded in each and every region and highly customized to that region.

      But your conclusion is right, one can not be a hardware company in the tiers Xiaomi is hoping to compete.

      1. I think I understand and I agree in theory.

        The issue that I have is that it seems Xiaomi hasn’t generated much profits from being an Internet company. Theoretically the profits should have come from the services, but is seems to have come from hardware.

        If I have not misunderstood, it seems like at least for now, Xiaomi actual results are contradicting the theory.

        1. Yes that is correct. Unless of course, that financial report was a well placed leak and not entirely accurate. 😉 You know I love a good conspiracy theory…

          But that is why I looked at the BOM, for a starting point. And using a few other data points could come up with some profit margin estimates. Whether its coming from hardware or internet services is the question.

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