Deep Dive: Xiaomi (XIACY, 1810 HKG)
More than just cheap phones
Summary
Xiaomi has an ambitious goal to surpass Samsung to become the #1 smartphone brand in the world (shipment basis) by 2024.
We believe Xiaomi is less like the “Apple of China” and more like the “Costco of smartphones”. We explore the key aspects of this business model, including services monetization and an ecosystem strategy leveraging an “investment + incubation” model.
Most investors seems to understand Xiaomi’s market share growth story, but may yet be underappreciating its monetization potential. Bull case can be built on handset premiumization and services revenue growth outside of China. The recent global fallout of Huawei and the shift in ad spending allocation triggered by the rollout of Apple’s iOS14.5 are worth noting as business tailwinds for Xiaomi.
Smartphones are still a tough business at the end of the day, which is why having good management is crucial. Founder/CEO Lei Jun is one of China’s best tech CEOs. If you are bullish on Xiaomi, Lei Jun must be a big reason why.
Our price target for FY24 is HK$24-33, for 3-year CAGR of between 13-26%.
Context
Mainstream media has often referred to Xiaomi as the “Apple of China”. If you take away only one thing from this report, it is to please please rid of this lazy analogy. The two companies have different strategies and serve totally different end-markets with almost no overlap. We take issue with this as it gives a misleading impression that Xiaomi is some kind of a copycat company. This is not only not true, it is harmful in obtaining a proper understanding of the business. Here, at Value Punks, we will try to give Xiaomi the treatment it deserves. Let’s build some context first!
Xiaomi was founded in 2010 by Lei Jun and a seasoned team of seven other co-founders (out of the eight, five are still with the company today including Lei Jun). The opportunity they saw at the time was simple. Apple was selling the best phones in the world, but at a price that was not affordable by the vast majority of the Chinese population. Emerging markets needed emerging market prices! For smartphones, the Chinese market was split in two extremes - you had either high-end phones that were prohibitively expensive, or you had cheap phones that were hardly usable. The “affordable and good enough” category was waiting to be captured (Clayton Christenson would be proud!).
From the beginning, Xiaomi cultivated an image of being an honest brand, favored by the young, hip, and the geeky who were all drawn to the brand for its high value-for-money. Xiaomi sold its phones exclusively through its own online store, minimizing distribution cost. Despite being a low cost maker, Xiaomi successfully built a spirited brand and a vibrant community of loyal users. Its community (called “Mi-fans”) became a passionate contributor of product feedbacks and ideas. Xiaomi positioned the community at the center of its product development, which is a culture that is still at the core today.
There is an anecdote of when Manu Jain, Xiaomi’s current India region head, first joined the company and spoke to one of the co-founders (we’re guessing this is either Lei Jun or his right hand man Lin Bin). Manu recalls:
“I remember one of the meetings…he asked me this question: How much was your marketing expense in your previous company? I gave him the answer. Then he asked: “Take a guess Manu. How much do we spend in marketing?” Because he asked that, I assumed the number was fairly low, so I said something like 5-6%. Guess again. I said maybe 2-3% because I assumed at least 2-3% of the revenue would be spent on marketing. Then he stood up and went to the board – and he drew a big zero.” (Times of India)
This is a peek into Xiaomi’s culture. It’s an entrepreneurial and resourceful company that knows it needs to be efficient and smart to win. This is Xiaomi’s approach to entering all of its overseas markets. In India, Manu Jain claims that Xiaomi spent zero marketing during its first three years, and yet still beat Samsung to the #1 spot.
[Author’s note: marketing expense is not actually a “zero”. Consider Xiaomi stores (just like Apple stores) which showcases its products. It is really a marketing expense, just not classified as such. But it is true in general that Xiaomi spends much less on actual ads (digital and traditional) than its competitors. Especially compared to competing Chinese brands like Oppo/Vivo which employs aggressive spending strategy focused on celebrities/influencers and store rebates]
Xiaomi took over the Chinese smartphone market by storm with its early product successes. However, success attracted competition. Competition in the Chinese market quickly intensified. The years from 2016-2017 saw the toughest period, and Xiaomi’s sales growth came to a halt as competing brands like Vivo, Oppo, and OnePlus spent aggressively to gain share. But as Xiaomi started to feel more pressure in China, its overseas sales took off in a massive way. Xiaomi became the #1 smartphone brand in India in the third quarter of 2017, overtaking Samsung – a position which Xiaomi has held for 16 quarters since then. At the same time, Xiaomi expanded into multiple overseas markets across all continents – becoming a truly global brand.
So it’s been quite the story – in just ten years, the company went from nothing to becoming the third largest smartphone maker globally (by shipments), closely behind Apple. Behind this is Lei Jun, the company’s founder and CEO. We need to talk about this key man.
Lei Jun
Lei Jun hardly gets the spotlight from Western media, although he is considered a legend within China’s tech circle. Even worse, when Western media mentions him, he has often been portrayed as sort of a “Fake Steve Jobs”. Again, this is harmful and English language coverage doesn’t do him justice at all (especially since Lei Jun doesn’t speak English well and has only given interviews in Chinese).
In the Chinese tech circle, Lei Jun is actually more often compared to Elon Musk, rather than Steve Jobs. Both Lei Jun and Musk are technical founders (engineers). Both have had a history of business successes already before founding their respective companies – Musk in Paypal and Lei Jun with Kingsoft and through subsequent experience as an angel investor. Like Musk, Lei Jun also has a sizable personal fan base (you could call it a cult). However, Lei Jun’s personality and image is quite the opposite of Musk – not flamboyant and polarizing at all. Lei Jun is known for being soft spoken, humble, down to earth, yet infinitely ambitious.
After graduating Wuhan University with a degree in software engineering, Lei Jun joined Kingsoft (software company) in 1992 as the company’s sixth employee. He worked his way up to becoming the CEO in 1998. After resigning as CEO of Kingsoft in 2007, he became an angel investor, investing in several notable companies including Vancl.com (online apparel), UCWeb (mobile company acquired by Alibaba), and YY (livestreaming), and had quite a successful investing career. Some may not realize this, but Lei Jun has always been a pure internet and software guy - he said himself that he hasn’t even touched hardware business until he started Xiaomi. Xiaomi calls itself an “internet company”, and while you may say this is just PR talk, there is actual truth to this. Lei Jun has always described his own management philosophy as being founded on an “internet and software way of doing things”.
Then, at the age of 40 Lei Jun became an entrepreneur and started Xiaomi. He was famous for saying:
“Liu Chuanzhi (founder of Lenovo) became an entrepreneur at 40, Ren Zhengfei (founder of Huawei) at 43, I don’t think much of myself starting a brand new journey at 40”
Indeed, the entrepreneurs that are the most relentless are ones like this. Lei Jun had made a lot of money from his successes early on, and could have just led a cushy life as a wealthy angel investor his whole life. Yet, he’s chosen a life of grinding himself down in one of the most competitive businesses in the world. He’s doing this to win, and this is one of the reasons why many investors and Mi-fans have a tremendous amount of respect for Lei Jun. Also, not many CEOs have his skill mix which consists of technical/engineering background combined with his understanding of the financial/business side from his investing career.
For anyone who is bullish on Xiaomi, Lei Jun must be a big reason why. At the end of the day, smartphones are a super competitive business, especially so for a young firm which is going up against the giants of the industry. There is no comparing Xiaomi to Apple – the latter can afford to run on autopilot for some time, while the former can’t. Therefore, it’s all the more important that investors select the right jockey. Lei Jun owns 55% of voting rights so investors are stuck with him. But in this case, it’s a blessing.
Business model
Now let’s dive into the Xiaomi business model. We believe there are three aspects which makes it unique, which are discussed below.