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  • This video is sponsored by Skillshare.

  • You might have recently seen headlines like this, declaring Xiaomi some sort of communistic

  • charity club for voluntarily voluntarily giving up all of its profits above 5%.

  • And if anything in you went like wait a second, that's not how anything in capitalism works, then congratulations,

  • your bullshit detectors are working.

  • I'm Marton from TechAltar, you are watching the 34th episode of The Story Behind series

  • and let me untangle this fascinating PR campaign.

  • Because that's what this actually is.

  • Okay so the first question is: Why does Xiaomi voluntarily limit its profits to just 5%?

  • The answer is, to make more money.

  • Sounds confusing, but it isn't.

  • There are really three pillars of the Xiaomi business model.

  • 70% of their revenues come from phones, a bit over 20 % from the rest of their hardware

  • stuff, like air purifiers, power banks and internet routers, and the final 9% come from

  • what the company calls internet services.

  • These include things like a music subscription service, a cloud storage service, a Xiaomi

  • App store, advertisements on their phones, and so on.

  • Xiaomi's CEO only vowed to keep net profits of the first two categories below 5%, but

  • not the third one.

  • Now you might be saying that, given their weight, that's kind of the same thing, but

  • it's not.

  • See, Xiaomi calls itself primarily an internet company.

  • They said so in their IPO documents, in fact, they have consistently said so since their

  • launch, and they even claim that one of the meanings of their name is mobile internet.

  • So why would they choose to focus on this small part of their business?

  • Because they are a for-profit company, not a charity club.

  • See, here is a comparison between the gross margins of hardware and services in Xiaomi.

  • And gross margins don't even include things like marketing expenses, taxes, overhead costs,

  • and so on.

  • Xiaomi probably actively loses money on hardware, while margins on internet services are pretty

  • healthy.

  • Making smartphone hardware is a pretty lousy business, because still only

  • Apple or Samsung have figured out how to make a proper profit out of it.

  • But making internet services is a fantastic business, as Amazon, Facebook, Google, Microsoft, Alibaba,

  • Tencent, and a million other very profitable companies have proven.

  • So Xiaomi desperately wants investors to think that their main business is making internet services.

  • The difference is that traditional phone companies try to make their profits when the customer

  • buys the hardware, and then largely leave customers alone when they use their phone,

  • while Xiaomi accepts basically zero profits from the hardware purchase, but then tries

  • to make money from their customers during the usage period.

  • Now, this to me sounds like the hardware equivalent of freemium software.

  • We used to pay for software outright, but then companies figured out that giving it

  • away for free at first, and then making money from the users later, by making them pay for

  • a subscription, or loot boxes, or showing them ads, is great business.

  • Xiaomi making no profits on hardware is essentially the same as Facebook and Google making their

  • services free, or Amazon discounting phones that have lock screen ads on them.

  • It's not charity or communis. It's a business model.

  • Okay, question two, why do I think this was a brilliant PR campaign?

  • Well, I hope it's pretty clear by now that Xiaomi never really made or wanted to make

  • money from their hardware anyway, because higher phone profits means fewer users, less

  • money from services, and finally, lower profits overall.

  • So, the 5% limit is artificial and wouldn't have been meaningfully passed anyway.

  • This was just a statement, not a change to their business model.

  • But, with this statement, they convinced consumers, who never read past the flashy headline, that

  • Xiaomi is just a benign, trustworthy company that just doesn't want high profits, but also

  • investors, who totally get the business model, that Xiaomi is an internet company with much

  • better profit potential than simple hardware makers.

  • One statement that in reality didn't change anything makes consumers more likely to buy

  • Xiaomi phones and investors more likely to invest in Xiaomi.

  • Good PR can create value out of seemingly thin air.

  • And the third question then is how low hardware profits work in practice.

  • Well, internet services and freemium apps have kind of shown us the blueprint already.

  • This kind of business has two goals: acquiring as many new customers as possible, and then

  • making sure that those customers spend as much time and money on the platform as possible.

  • Obviously low hardware prices do the magic for step 1, but step 2 is all about software.

  • Namely MIUI, the company's own version of Android, and it's no wonder that Xiaomi takes

  • its software so seriously.

  • People must love this UI, become loyal to it, and spend as much time with it as possible

  • for Xiaomi to be able to sell them their services, or serve them ads.

  • And this business model has good and bad sides for consumers.

  • The good stuff means that Xiaomi, unlike most Android phone makers, actually has financial

  • incentives to frequently update their phones and give them relatively long software support.

  • Xiaomi has also built a large, engaged online community around MIUI, where people can do

  • things like vote on features to be put into MIUI.

  • On the bad side though, Xiaomi is also incentivized to push its own software even if it means

  • duplicating apps or creating bloatware, and like any other freemium software player, Xiaomi

  • has incentives to invade your privacy and to lock you into their ecosystem.

  • Cause you have to keep paying those subscription fees and seeing those ads for as long as possible

  • for this model to work.

  • Aaand last question is: will this work?

  • And while I find Xiaomi's business model new and genuinely exciting, I also think that

  • from a purely business perspective, there are a few weaknesses here.

  • First of all, at 9%, the profitable part of Xiaomi is very small, which means that right

  • now, Xiaomi's strategy isn't really working.

  • People are happy to buy cheap Xiaomi hardware, but most of them don't want to pay for Xiaomi

  • services.

  • Even the company itself admitted that they have to increase this rate, but last quarter

  • the opposite happened, where hardware grew significantly faster than services at Xiaomi.

  • Not a good sign.

  • The services business is also relatively small.

  • Just for scale, Xiaomi made 1.5 billion dollars from services last year, while Apple made

  • over 9 billion in just the last quarter.

  • And that's on top of the massive revenue and profits Apple has made from hardware!

  • So, Xiaomi has to grow their services business significantly to reach a truly global scale.

  • Second, Xiaomi's business model has only been proven in China.

  • It sort of works there, because Google services, including the Google Play store are blocked

  • in China, so people are often happy to use services form their smartphone maker, even

  • alternative app stores.

  • But as Xiaomi is becoming increasingly international, it will have to compete against Google.

  • Google Apps are installed on nearly all international phones, which instantly makes Xiaomi apps

  • less useful, so there will be lower engagement and lower income per user, and customers might

  • even be annoyed by duplicate apps, instead preferring a phone with clean, stock Android.

  • It's kind of enough to have Google spying on you and filling your phone with crap apps

  • you've never asked to use, but getting this treatment from two companies at once is not

  • a great experience.

  • In fact, Xiaomi did ask their users in a poll what they preferred, and embarrassingly enough,

  • their own fans voted for stock Android.

  • Aaaand then Xiaomi deleted the poll.

  • Ouch.

  • And the third problem is that people who buy cheap phones, also tend to use cheap, or even

  • free software, which is not what Xiaomi needs.

  • So in order for Xiaomi's business model to work, Xiaomi will need to invest a lot more

  • into making really premium phones like the MiMix, and attract more wealthy consumers, and then

  • also make internet services that truly outclass those of Google.

  • Not an easy task for a company on such tight margins as Xiaomi.

  • But none of that makes Xiaomi's fantastic PR move any less impressive.

  • Tech enthusiasts often see PR and marketing as mysterious or magical forces, but the concepts

  • that make it all work are fairly easy to understand if you know where to look.

  • Like this excellent course on branding from Skillshare that I can personally recommend

  • to my viewers.

  • Skillshare is an awesome online learning community with more than 20,000 classes on basically

  • any topic you can think of.

  • From marketing and business to graphic design and photography, and much more.

  • With 2 months of free premium access for TechAltar viewers, you can get unlimited access to all

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This video is sponsored by Skillshare.

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Why does Xiaomi limit its profits to 5%?

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    Johnny Tsai posted on 2018/05/22
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