Xiaomi have only relatively recently moved to became the third largest mobile device manufacturer by selling good quality devices for less than competitor handsets. This plan has proven very successful and puts Xiaomi’s competitors under immense pressure to both match Xiaomi’s on-box specification and low pricing. From a business perspective, Xiaomi are operating their smartphone manufacturing at a very small margin. How small? Less than 2% percent, where Samsung returns almost 20% and Apple almost 30%. In 2013, Xiaomi recorded revenue of 26.6 Billion Yuan at an operating margin of just 1.8%. Given the businesses’ growth rate, that they are turning a profit is impressive by itself; Xiaomi have moved from zero to hero in a few short years as the private company was formed in 2010.
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Xiaomi doesn’t just sell smartphones, however. Far from it. They bill themselves as an Internet company and use the smartphone side of the business to encourage people to use their online services. Selling hardware close to cost is nothing new to the industry: Google tried something similar with the Nexus 4, Nexus 7 and Nexus 5 models and of course have the Google Play Store to make money from customers. There’s much debate in the industry as whether or not Xiaomi’s business model is sustainable in the medium to long term. Analysts cite that margins are likely to soften across the industry as consumers see smartphones more as a utility than a luxury and are not prepared to pay as much; this means businesses will have to work harder for each sale. Xiaomi’s marketing budget is considerably smaller than most of the competition, except perhaps OnePlus; there isn’t much slack to remove here. I do believe that analysts are missing a trick here: one of the reasons why the industry margins will need to soften is because of competitive, but low priced handsets from vendors such as Xiaomi.
However, we’ve seen evidence that Xiaomi’s honeymoon may be nearly over. The recent sales ban in India will last until at least February 2015, then we will likely have a series of legal cases between Ericsson and Xiaomi. Even if Xiaomi win the first legal case, if they’re to continue their expansion out of Asia and into the developed smartphone world, they’re almost certainly going to need to spend money on acquiring or licensing patents. If the research and development costs increase, this means that customers will have to start to pay more for the products. When forced to give customers a price rise, many businesses will take this advantage to widen their margins. And here, with Xiaomi’s margin so slim, a small change will make a big change to their bottom line. Nevertheless, I don’t see Xiaomi trying to adopt the Samsung or even Apple margin, but it’s entirely possible that future generations of Xiaomi devices will cost relatively more than older generations.