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YEAR 2, VOL. 7, AUGUST 2012

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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.

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.

In a Nutshell

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 Samsung’s 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?

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Batches sell out in minutes

The Story The Facts

Data source: Xiaomi

Dec 18, 2011

100K

phones

sold out in 3h

Apr 24, 2012

150K

phones

0h15m

Aug 23, 2012

200K

phones

0h30m

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.

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. It’s 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 Xiaomi’s case, the target

group are young, internet-savvy Chinese with a need to

profile themselves socially. With this in mind, we can re-

examine 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 don’t add value for the target group.

This basic hardware can then be customized - an

Does Xiaomi

stand a chance

in the cut-throat

handset market?

Glad you

asked...

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

VisionMobile’s 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, we’re 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 Xiaomi’s 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

Xiaomi’s 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

01

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02

03

05

04

company to become profitable. Xiaomi doesn’t 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.

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

don’t 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?

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

consumer’s social needs. Messaging apps are a dime a dozen

and don’t have intrinsic value, but for Xiaomi’s customers

they add to the group feeling: the app is one element in a

consistent story.

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.

Xiaomi’s tribe needs to be sizeable but not huge for the

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06

07

Two economic

frameworks we

used in this

Mobile Insider,

for your

reference.

The Xiaomi Tribe05

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 vendor’s 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 can’t. This is because

these services are a complement for Apple, who derives its

revenues from handset sales, while it is core business for

operators.

Complementary goods

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 user’s 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

Competitive AdvantageMichael Porter, Harvard

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ABOUT THE AUTHORS

Stijn Schuermans is a Business Analyst at VisionMobile.

Stijn has more than 7 years experience as an engineer,

product manager, strategist and business analyst in

technology companies. He holds an MBA from Athens

University of Economics and Business. His particular

focus is in understanding how technology becomes

value-creating innovation and which consequences this

has for mobile company strategy.

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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