Xiaomi and the future of IoT

Smartphones vs. mobile OS — the value is in platforms

Outside of China, Xiaomi is mostly known for manufacturing smartphones.

They started with affordable smartphones and tablets (mostly in the large-screen “niche” initially dominated by Android phones) but then quickly expanded their range to higher-end devices.

Besides the intrinsic value of their hardware — a fraction of the price of Apple or Samsung flagship devices for a very similar quality — a significant factor in their success was in the spread their own mobile OS: MiUI. In building this proprietory version of Android, they undeniably copied the best of Apple’s iOS UX principles (any patent infringement debate is outside the scope and topic of this article). MiUI was the foundation of Xiaomi’s own mobile ecosystem from which they derived classic platform dominance and network effects.

This partial dominance was made possible by the fact that iOS and Android do not enjoy those classic platform/network effects in China as much as in the rest of the world. This is due to the coexisting Android versions which compete for the Chinese smartphone user’s preference. As brilliantly described in 2017 by Ben Thomson in his Stratechery article Apple’s China Problem, this is at least partially due to the existence of the intermediate WeChat layer. This layer, unavoidable and omnipresent, makes mobile OS ecosystems far less relevant to the Chinese market (the monopoly and network effects are instead enjoyed by Tencent, WeChat’s parent company).

Chinese entrepreneurs and business executives are well aware of the extra value, network effects, and long-term moat that can be enjoyed by companies who manage to control a platform. Probably with Blackberry’s story in mind, Xiaomi did not focus on hardware to ensure their success. They needed good quality and reputable hardware as a base (same as Apple did with its first iPhone models), but they thereafter justly focused their efforts on where the true value resides: mobile as a platform. (for a more detailed read on this subject, I recommend Modern Monopolies by Alex Moazed and Nicholas Johnson) Tencent, Alibaba, and to a lesser extent Baidu don’t have much to envy from Google, Amazon, Apple and Facebook. I argue that Xiaomi’s strategic momentum puts the company in an amazing position to become one of the top platform global players in the next decade or so.

Smartphone margins are dead, long live the digital economy

It is very difficult to maintain long-term dominance as a hardware manufacturing company. Hardware does not enjoy the same near-zero-marginal-cost economy of scale as software or digital content does. This makes manufacturing a cost-driven economy.

Driven by ever-lower labour costs, the shipbuilding industry was taken away from Europe by Japan, then from Japan by China, then from China by South East Asia. Nowadays, only very niche shipbuilding remains in Europe (mostly luxury and state-sponsored military), while Japan still holds high-tech LNG carriers. But most bulk carriers and cargo ships are built in China and South-East Asia. The automotive industry has been experiencing a similar fate, to some extent. Aircraft manufacturing is slowly following suit. Automation can curve or even reverse this labour-cost-driven phenomenon, but we are not there yet.

Smartphones are also hardware, and they are getting commoditised at an impressive speed: European smartphone OEMs are out of the game. US ones… are not smartphone manufacturers: Apple and Google are software/IP/advertising companies who subsidise their smartphone-hardware branch to protect their respective ecosystems and push the competition into markets that are secondary to their core business — if not read already, I strongly recommend the now-classic Laws of Tech: Commoditize Your Complement. Samsung is still there, but substantial margins are gone. And the battle is fierce between Chinese manufacturers.

Clearly, the future growth of Chinese tech companies does not lie in controlling an ever commoditising smartphone manufacturing markets.

Tencent is building its future around social networking and advertising.

Alibaba around distribution and marketplace.

I argue that Xiaomi’s future is IoT.

Well-executed IoT is the next frontier

IoT has been there for quite some time. So has AI. And so had “smartphones” before the iPhone revolution.

What made smartphones a mass-market reality was Apple’s impeccable execution. Execution is also key with AI — it is well and good to have AI models running asynchronously, but delivering them to our daily life in a brilliant way is what currently makes the AI market what it is. Operationalised, near-real-team ML models are the foundation of autonomous driving, chatbots, credit-check/mortgage-application/insurance-claim-approval a real-life thing. 5G should also boost delivery quality.

IoT follows a similar rule. Bill Gates enjoying what is probably the first-ever “smart home” was a reality in 1997! But there was no mass market for this at the time. This was simply not commercially viable for retail. It is viable today, but the user experience is still suboptimal. Great IoT execution is changing the game — and Xiaomi is a pioneer in it.

Google and Amazon (and Baidu) are well aware of that new market. Most recently, at their September 2019 “Amazon Devices Event”, Amazon announced the release of several smart devices. One would imagine that the opportunity has to be huge for such companies to focus so much effort on it. And it is: the global IoT market should reach $1.6 trillion in 2025. As a comparison, the mobile application market — largely monopolised by Google and Apple — is worth around $0.5 trillion today and should be worth circa $1 trillion in 2023. IoT is a very large market opportunity indeed.

But again, building a linear hardware business around IoT is not durable for the same reasons as described above about smartphones. But controlling the ecosystem as a platform should prove to be a very profitable position. Besides their growing entertainment division, one could argue that Apple’s valuation today is mostly based on them controlling a sizeable share of the mobile application ecosystem (and getting a 30% cut out of its overall turnover!). A company that would achieve a similar dominance over the IoT ecosystem would enjoy a comfortable long-term valuation. Even if that dominance is partial and/or mostly Asian-based: the Asian market is big enough, and quickly getting much bigger than the US and Europe together.

So, when you compare Huawei, a brilliant hardware manufacturer… with only 8 “Smart Home” products as an IoT product line, to Xiaomi’s vast IoT offering (from smart lamps to smart alarms, going through smart vacuum cleaners and air purifiers), the long-term bet is striking.

On top of its diversified IoT product line, Xiaomi’s seems to have a clear understanding of the opportunity and to have accordingly aligned its strategy in order to seize it. The proof is that Xiaomi is already semi-mature as an IoT platform: many of its IoT devices are no longer manufactured by the company itself… but each and every one of them creates network effect value to Xiaomi’s “Mi Home” platform.

How did Xiaomi manage to get there? By starting with great IoT hardware as a linear business. Good recipes do not have to be complex, only well-executed.

There is certainly still a long road ahead, and the competition for a market this large will be fierce. But I do believe Xiaomi stands out with a solid head start even versus the US tech hegemony, and that their strategy is bearing promising fruits already.

Disclaimer: Considering my conviction in Xiaomi’s long-term value prospect, I am a Xiaomi shareholder (although not in a concentrated position).

This article was originally published on Medium as Xiaomi and the future of IoT