19 July 2019
Xiaomi founder and CEO Lei Jun has positioned his company as a provider of value-for-money products. Photo: Bloomberg
Xiaomi founder and CEO Lei Jun has positioned his company as a provider of value-for-money products. Photo: Bloomberg

Xiaomi’s business model has a fatal flaw

Chinese smartphone maker Xiaomi (01810.HK) closed at HK$16.8 on its trading debut on Monday, down 1 percent from its issue price.

This despite rare words of support from no less than Financial Secretary Paul Chan Mo-po , who graced the listing ceremony. Xiaomi has been compared to technology giant Apple, but the truth is, the Chinese firm has a deadly flaw in its business model.

I’ve pointed out in a previous article that Xiaomi is trying to copy the business model of US supermarket giant Costco. Xiaomi intends to lure a large number of users with very affordable products and then monetize its user base by providing online services. The company even stated in its listing prospectus that the net gross margin of its hardware products will be capped below 5 percent.

Apple has a similar element in its business model. Its iPhone, iPad, and Mac products have about a billion users. They are also users of iOS, Apple’s operating system, as well as other paid services such as iCloud, iTunes and App Store.

In the second quarter of this year, Apple earned US$9.2 billion from software and services, making them the company’s second largest revenue source.

Xiaomi, on the other hand, has more than 190 million users worldwide. That figure is around five times the number of Costco’s members or a fifth of users of the Apple products.

In that case, Xiaomi should be valued at five times Costco’s market value or HK$3.6 trillion, while a fifth of Apple’s market value would be HK$1.4 trillion.

This might suggest that Xiaomi still has huge upside from its current value of HK$376 billion.

However, things are not that simple. The value of a Xiaomi user might be different from that of a Costco member or an Apple fan.

Apple users are less price-sensitive and they are more willing to pay for other services, such as software, music, games and movies.

Also, the majority of Costco shoppers are middle class. They have a larger disposable income to renew the membership and pay for other services.

By contrast, most grassroots families in the United States live from paycheck to paycheck, and they can only afford small-package products, which are priced higher. They also don’t have extra money to pay for the annual Costco membership.

Xiaomi has positioned itself as a provider of value-for-money products. Most of its smartphones are sold at around 1,000 yuan (US$151). As such, most of Xiaomi users are sensitive to prices. It would be far more difficult to persuade them to pay for other services.

That reveals the biggest challenge for Xiaomi. The company has to figure out ways to convince its users to pay for online services in order to make its business model work.

The full article appeared in the Hong Kong Economic Journal on July 10

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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