Weekly Update

How Xiaomi could generate real money in emerging markets

China’s Xiaomi may be the world’s third-largest smartphone manufacturer, but it isn’t going to threaten Apple’s crown as the top money-maker in mobile hardware soon. Reuters reported this week that Xiaomi made a profit of just $56.2 million on $4.3 billion in revenue last year, according to a filing with the Shenzhen Stock Exchange, generating a profit margin of less than 2 percent. Which is why Gigaom’s Kif Leswing perceptively wrote that while Xiaomi is often compared to Apple, its strategy of making growth a priority over profits is more akin to Amazon’s business model.

The problem, of course, is that the smartphone manufacturing market – particularly in emerging markets such as Xiaomi’s home turf – is a cutthroat space. Apple and Samsung combined to claim 108 percent of smartphone profits worldwide in the second quarter of 2014, Cannacord Genuity estimated in August; every other player is fighting just to break even. Apple enjoyed an operating margin of 28.7 percent for the fiscal year ending September 2013, according to the Reuters piece, while Samsung reported an operating margin of 18.7 percent last year.

Monetizing beyond hardware

As sudden as Xiaomi’s rise in the global smartphone market has been, mobile is clearly only one component of its larger strategy, just as books were only the beginning for Amazon. Xiaomi recently announced it hopes to invest $1 billion in online video, it has taken a stake in the U.S. fitness tracker manufacturer Misfit, and earlier this month it introduced a Wi-Fi-enabled air purifier as a part of a larger effort to pursue the smart home. It may even be on the verge of mass production of smart cars.

Each of those segments teems with potential, and it’s possible that Xiaomi hopes to become a kind of Amazon of the connected era, particularly in China and other emerging markets. But it also has the very rare chance to create a major – and very lucrative — mobile ecosystem.

Xiaomi’s smartphones run Android as well as its home-grown MIUI interface, which is the world’s most common forked version of Google’s OS. Handsets that are sold outside China can access Google Apps and Play services, but because Google doesn’t offer a customized version of Android for Chinese users – and because it blocks access to those services for phones running heavily forked Android – the smartphones Xiaomi sells in its home market access Xiaomi’s app store and content. Those apps are specifically written for Chinese users and feature localized offerings (such as Baidu Search and Maps), filling a void created by the unwillingness of Google (and Apple, for that matter) to offer a China-centric OS.

The challenge: Building ecosystems in other emerging markets

Xiaomi’s smartphone ecosystem – including handsets, apps and data services — has a solid foothold in the nation’s largest mobile market, then, but the company isn’t likely to gain much headway in mature markets such as North America and Western Europe, where Apple and Google continue to dominate and where selling smartphones with a forked version of Android is nearly impossible.

For Xiaomi to boost its profits outside its home market, it will have to not only sell phones but also to develop ecosystems in other large, emerging markets, eschewing stock Android in favor of its own flavor. That’s a huge challenge, to be sure – it will have to build strong relationships with content providers and developers in those markets, and it will have to circumnavigate headaches like the one it currently faces in India – and it still isn’t clear that’s what Xiaomi truly has in mind. But there’s a chance that its own, Android-based OS could become a major force in emerging markets outside of China.