With the smartphone market becoming saturated globally, smartphone OEMs have been aggressively developing opportunities in the IoT (Internet of Things) segment since late 2018. The aim is to avoid over-reliance on the smartphone and hardware business, and to create new revenue streams in the upcoming 5G and IoE (Internet of Everything) era.
In September 2018, Vivo announced its IoT strategy with the launch of its first connected platform, Jovi IoT, hoping to take on the smart home market by enabling users to control their home devices with Vivo’s voice assistant.
In January 2019, Xiaomi announced a dual core strategy of Smartphone & AIoT (Artificial Intelligence + IoT) for the next five years with RMB 10 billion investment in AIoT.
In March 2019, Huawei announced the ‘1+8+N’ seamless AI life strategy, which involves integration of user experience across an entire ecosystem of devices including smartphones, tablets, PCs, VR devices, wearables, smart screens, smart audio, smart speakers, head units and other IoT devices.
In December 2019, OPPO at its developers’ conference unveiled an ‘IoT enablement action’, opening HeyThings IoT protocol, HeyThings IoT service platform and audio interconnection protocol. OPPO’s vision is to build an IoT ecosystem that covers all core categories of smart devices and four specific scenarios, namely personal, family, travel and office.
Since early 2020, other smartphone OEMs such as Oneplus and realme have also forayed into the consumer IoT sector with the launch of new product categories including smart bands, smart watches, TWS (True Wireless Stereo) and smart TVs.
Among the leading smartphone vendors, Xiaomi is an early mover to the IoT sector. Founder Lei Jun has eyed the consumer IoT sector from mid-2013, building a team comprising of engineers to scout for and invest in IoT device start-ups. As of Q1 2020, Xiaomi has invested in over 300 companies covering more than 2,000 product SKUs. In 2019, the IoT and lifestyle product sector grew 41.7% YoY to reach RMB 62.1 billion and account for over 30% of Xiaomi’s total revenue. The number of connected IoT devices (excluding smartphones and laptops) on Xiaomi’s IoT platform reached 234.8 million in 2019.
What are the investment philosophies of Xiaomi in the IoT and lifestyle product segment? What is the model of cooperation between Xiaomi and its investee companies? What is Xiaomi’s strategy to develop viral IoT products? What are the strengths and challenges for Xiaomi in the future development of IoT? Are there chances for latecomers to bridge the gap with Xiaomi?
To find answers to these questions, please refer to the full report ‘Xiaomi IoT Traction & Strategy: Deep Dive Analysis’ here.
It is a historical day for the eight year old upstart Chinese consumer electronics vendor Xiaomi as it filed for its Initial Public Offering (IPO) in Hong Kong
The company aims to raise several billion dollars which could drum up its valuation to tens of billions of dollars (see here – Further Analysis by Richard Windsor)
The timing is perfect for Xiaomi, as it made a strong comeback into its core segment of selling smartphones in 2017 after falling off the cliff in 2016, which is very rare in the mobile phone industry.
Xiaomi was the fastest growing brand in CY2017 with smartphone shipments surging 56% YoY (see here)
Xiaomi’s Business Model
Xiaomi reiterates being a “low-cost”player with the founder Lei Jun vowing to keep the hardware margins below 5%
Xiaomi essentially subsidizes or maintains a relatively low margin on hardware to bring more users into its ecosystem
Players such as Google or Facebook give away free services or software to acquire users (but TACs are much lower and margins quite high)
Xiaomi’s acquisition strategy is relatively costlier, but somewhat works in a commoditized or price-sensitive market
Xiaomi over eight years had amassed more than 170 million MAUs in its ecosystem by the end of 2017
According to Xiaomi, a Xiaomi user spends atleast 4.5 hrs a day on their Xiaomi device, which opens up an opportunity for Xiaomi to monetize
Once Xiaomi acquires its users, it tries to attract them to use or subscribe to their digital services from content to cloud, leveraging its MIUI OS built on top of Android (AOSP)
This works quite well in China where the bulk of the usage comes via its own version of OS, due to absence of the Google Play store.
With this strategy, Xiaomi generated more than US$1.5 Billion in revenues in 2017 from its services segment
The Services segment, however, contributed to just 9% of the total revenues which is still minuscule, to tout the premise of services-driven business model
Having said that, Xiaomi is seeing around 60% gross margins on services, compared to a mere 9% gross margins on hardware, so it is definitely a lucrative segment, if they can scale it significantly
The current ARPU for services business was close to US$9 per year in 2017, which is slightly low when compared to other internet or integrated players
However, Xiaomi also looks to other opportunities beyond smartphones by cross-selling its IoT & Lifestyle productsvia its retail strategy e.g. Air Purifiers, Smart TVs, Weighing scales, Smart Home solutions, etc.
The rough average spending on IoT Lifestyle devices is close to US$40 per year per smartphone shipped in 2017, though at relatively lower gross margins than services
This is how the business model for Xiaomi works, but at relatively lower margins and potentially could be replicated by other deep pocketed, bigger scale players such as Huawei or Samsung or BBK
This is a chink in Xiaomi’s armor from a business model robustness perspective, as it is hardly based on any sort of IP or differentiating R&D which would not amuse many investors to begin with
Xiaomi’s pre-IPO performance
Xiaomi started off well in its early phase with an ascent for the first three years, post which competitors such as Huawei and others caught up in terms of low-cost + ecommerce business model and slowed down Xiaomi’s growth
Further, lack of IP and scale also hurt the supply chain to procure key components to meet demand if any for some hit models in 2015 and 2016.
However, this was streamlined by early 2017 which was one of the reasons for the growth spurt
India the second largest smartphone market (see here) has been the key reason for Xiaomi to make a comeback, as competition fizzled out in online space and the “value for money” products from Xiaomi hit the right note with price-sensitive growing middle class Indian consumers
Online segment was important in India because almost a third of country’s smartphones are sold online and Xiaomi raced to capture close to half of that segment (see here)
Further, during the year Xiaomi also expanded its reach beyond India and China and started shipping to 72 other markets globally in 2017. This also drove some uptick in volumes and decreased dependency on the Chinese market where it has been struggling against Huawei’s Honor, OPPO and vivo brands
However, smartphones still contribute to almost 70% of the total Xiaomi revenues, which climbed to US$18 Billion in 2017 up 68% annually
Smartphones (+65% YoY) and IoT/Lifestyle (+88% YoY) grew faster than the important Services segment (+51% YoY) in 2017
Having said that, the hardware growth drove the overall installed base of Xiaomi devices higher, which it will look to monetize during the devices’ lifetime
Xiaomi has the momentum in hardware in India, so will continue with “India first” strategy and build hardware as well as services (e.g. content) ecosystem in India and scale it elsewhere
Obviously, Xiaomi has also entered other developing markets in Europe and Asia last year. Further expansion plans in Africa and Latin America later this year, will drive the global installed base for the Chinese vendor
Scaling its razor-thin margin business model of acquiring users using low-cost hardware, requires consistent capital infusion.
Further, to differentiate, Xiaomi has to build an Intellectual Property (IP) arsenal, and thus has to consistently invest in R&D. This requires significant capital, but is not possible with thinner gross margins
Whereas players such as Apple, Google, Amazon or Facebook have significantly higher gross margins and are able to consistently re-invest into R&D to differentiate and scale
Xiaomi will also need capital to invest in developing AI technologies and related infrastructure to process all the data coming from close to a couple of hundred million users to help it build meaningful services and differentiated experiences
With this IPO, we can see Xiaomi using this capital to scale to more markets globally, which demands greater localized investments and expenses
At the same time, Xiaomi will have to be prudent about not spending too much capital on subsidizing devices further or on marketing or channel development initially
This is not possible with sporadic private rounds of funding, hence, Xiaomi needs to go public for a more crowd-sourced capital infusion
This also gives Xiaomi an opportunity to acquire key companies and become more integrated like Huawei or Samsung or Apple
Additionally, we believe since Xiaomi is riding high on a wave which prompts exiting investors also to push for Xiaomi to go public and the initial investors thus can cash in on the potential leap in valuation
In a nutshell, Xiaomi should look to focus on opportunities to grow its service business which is very central to its business model, expand into newermarkets and above all focus more on R&D and IP development
Xiaomi is in a great position irrespective of its $30 Billion valuation or $100 Billion valuation to cash in on the momentum and continue selling low-cost hardware and acquire users. However, at the same time Xiaomi will need to wisely and substantially invest in R&D and ecosystem development. We still forecast hardware to contribute to a significant chunk of revenues for next two years, though services revenues should contribute to a 20% level by the end of 2019.
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