The Business Model of Xiaomi, China's Answer to Apple

The Business Model of Xiaomi, China’s Answer to Apple

To throngs of cheering fans, the CEO of a cellphone company sauntered onto stage wearing jeans and a black shirt to unveil THE sleek new phone of the season. The scene is . . . familiar. But, to most Americans, the company is not. Xiaomi is often compared to Apple due to its launch parties and its focus on design. However, it takes a distinctly Chinese approach to running its mobile phone business. And this model recently pushed Xiaomi past Apple in the Chinese mobile market share with 5% to Apple’s 4.8%. How does Xiaomi’s business model differ from Apple?

The Phone

Apple’s base business model in China is relatively simple: it sells high-tech, beautiful phones at a high price with high margins. The iPhone 5 retails for $860, and the new “inexpensive” iPhone 5 will retail for $733 in China, and Apple has the highest margins in the business. At similarly high prices, Apple has generated revenues of $19.6 billion from phone sales in China, Hong Kong, and Taiwan through the third quarter (Q3 and Q2, Q1).

Xiaomi has a beautiful phone with some good technology, but Xiaomi takes a different approach with their phone’s price. They sell their phone at cost for about $330, and they sell directly to customers in order to keep the price as low as possible. At less than half the price of an iPhone, and in a country where customers are more price sensitive than in America, the lower price of the Xiaomi phone helps build market share. But to what end?

The App Stores

Xiaomi sees themselves as similar to Amazon. Just as Amazon sells its Kindle near cost to drive profitable sales of books, Xiaomi sells its phone at or near cost to drive sales of apps, music, and video through its app store. The Google Play store remains banned in China, but Google’s Android operating system is the dominant mobile operating system. Xiaomi’s snazzy looking phones and slick marketing campaigns convince people to buy their phones, and the phones, of course, direct their users to Xiaomi’s app store. In many ways, this is the classic internet business model of building a user base with a nice product, and then monetizing it later with add-ons. Xiaomi’s monthly revenue from its app store doubled from April 2013 to August 2013, and Tencent, which has the largest app store in China, had $5 billion in revenues from its app store in 2012. Xiaomi’s app store is a big part of why it’s one of the 15 most heavily venture backed mobile startups of all time.

We know that Apple’s iTunes Store is successful with about $11.7 billion in revenue through Q3 of this year (see links to revenue above). But Apple has not published a geographic breakdown on where this revenue is generated. We do know that there is fairly sophisticated piracy of the iTunes store, but we just don’t know how much money Apple is making from iTunes in China.

But each company’s store is probably not what has driven Xiaomi past Apple in market share.

The Software

I’ll admit it. I’m a bit biased against the Apple mobile OS because it lacks the customization options of Android, and the look and feel of the phone is determined by the overlords in Cupertino. Apple makes a great OS, but I enjoy tinkering with how my phone looks and works. Apple is also notorious for how it takes for OS updates. Xiaomi takes a . . . different approach.

Xiaomi releases a new version of its OS, which is based on Android, on a weekly basis in response to users suggestions. Often these updates are based on polls on weibo. This customer interaction could be a big part of the emotional embrace of Xiaomi by the people who buy its handsets.

William Lewis is a tax and business attorney based in the Silicon Valley. He advises domestic and foreign clients on a range of business, tax, and estate planning matters. He can be reached by email at lewistaxlaw[at]gmail[dot]com.