Xiaomi vs. Ericsson – Bloody bandwagon.

Patent royalties will pressure margins further.

• Xiaomi has hit a road block in India as some of its products have been hit with a preliminary injunction following a complaint from Ericsson for infringement of Standard Essential Patents (SEPs).
• India is Xiaomi’s first major foray outside of its home market in China and this is likely to be the first of several royalty claims that are lodged against the company.
• The issue here is that most patent holders do not bother to pursue royalties in the Chinese market which is why this issue has only come to a head now.
• When it comes to pursuing royalties, an objective assessment is made as to whether it is worth the effort and expense.
• If unsuccessful, a patent claim can be very expensive for the plaintiff as the amount of research and the cost of legal services that are required are both very high.
• As a result, it is extremely difficult to make a return on pursuing patent infringement in China which is why no one bothers with it.
• However, the situation outside of China is very different and Xiaomi is now likely to end up having to pay SEP royalties on all of the products that it ships overseas.
• Xiaomi has sought an open dialog with Ericsson regarding its liability and I suspect that it will end up paying a royalty of around 1% of the wholesale price of its devices to Ericsson.
• This will open a floodgate and I suspect that Nokia, Google, Interdigital, Rockstar and some of the other industry consortia will also jump on the bandwagon.
• The end result is likely to be an increase in costs of 5-7% for Xiaomi on all products that ship outside of China.
• The one exception is Qualcomm.
• Qualcomm is an early investor in Xiaomi and I suspect that Xiaomi is already paying royalties to Qualcomm and will continue to do so on its products outside of China.
• This will have been already factored into Xiaomi’s planning and so does not represent an incremental negative for the company.
• This will meaningfully compound Xiaomi’s difficulties when it comes to profitably selling devices outside of its home market.
• This is because users in China buy the for their excellent Chinese-oriented media consumption services that the company offers in its devices.
• Outside of China, these do not matter meaning that Xiaomi will be just another Android manufacturer. (see here).
• Consequently, outside China Xiaomi is shipping a commodity meaning that’s it margins will be 2-4% in the best instance.
• This will particularly be the case as Xiaomi specialises in offering phones with great specifications for a very good price.
• The cost base is now likely to rise by 5-7% over the next few years which will pressure its margins even further.
• While, I think that Xiaomi has a shot in its home market, its outlook overseas remains very bleak.