Xiaomi – Hardware heaven?

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Right strategy but where is the money?

• Xiaomi has exactly the right strategy to develop a thriving ecosystem of its own but whether it can make money from it is another thing entirely.
• There are three ways to monetise an ecosystem: selling hardware, selling advertising or selling subscriptions to one’s Digital Life services.
• Xiaomi has chosen the hardware route and seems to be developing that by investing in many different device companies.
• RFM research indicates that hardware is by far the best monetisation mechanism but it is also the riskiest.
• Not only is organic growth in hardware grinding to a halt, but if one misjudges a product cycle, market share and margins can collapse in a matter of months.
• RFM research has also identified that offering an ecosystem consistently across a range of devices is becoming an important factor when it comes to having a successful ecosystem.
• Most ecosystem contenders and hardware makers have approached this problem by making all of the devices themselves, but Xiaomi’s approach is very different.
• Xiaomi does this by investing in a range of start-ups whose products should then become part of the Xiaomi ecosystem.
• So far Xiaomi has invested in around 20 start-ups but it plans to invest in a hundred more.
• The latest addition to the family is Segway which has just been acquired by one of its hardware partners Ninebot.
• Assuming that 4/5 start-ups never amount to anything, this would leave Xiaomi with around 20 different device types within its ecosystem with Xiaomi phones at the centre.
• Assuming that Xiaomi’s ecosystem drives device preference, then these devices should all be able to command a price premium over competition, allowing them to generate higher margins.
• However, Xiaomi will only be a minority owner in these companies meaning that it will not reap the full benefit from the ecosystem that it has created.
• I suspect that there will be a revenue or profit share payable back to Xiaomi as the creator of the ecosystem which will help, but this will not take it into Apple’s league when it comes to revenue and profit generation.
• However, other devices could be a meaningful factor in driving device preference for Xiaomi smartphones which would help it to increase pricing and earn a better return on its own smartphones.
• Unfortunately, all of this is predicated on developing a thriving ecosystem.
• Xiaomi is off to an excellent start with its media consumption offering and its app store.
• However, it still only has 17% of Digital Life covered meaning that it has an awful lot more services to develop.
• Furthermore, in its home market it is up against Baidu, Tencent, Alibaba and China Mobile all of whom have big ecosystem ambitions of their own as well as much greater resources.
• Xiaomi has the first mover advantage but will have to invest heavily to stay ahead of its competitors meaning that margins are likely to stay low for some time to come.
• Xiaomi has by far the greatest understanding of what is required to create a thriving ecosystem, but it is still uncertain whether it will be able to fully monetise it.
• This is why when valuations of $45bn or even $100bn get waved around, I get concerned that an awful lot of success is already being priced into the equity of the company.
• I would prefer to consider Lenovo’s potential IPO of its mobility division which may come at a fraction of the valuation despite its higher global market share and greater scale.