Chinese low-end phone champion Xiaomi has made quite a splash this year.
Concentrating on its home market and a few others (India, especially), it has surged to the #4 position in smartphone sales worldwide. Xiaomi shipped almost 16 million phones in the third quarter, five times what it shipped a year earlier and good for 5% of the global smartphone marketplace, Gartner reported on Monday.
A Wall Street Journal report last month even said Xiaomi was racking up big profits -- close to $600 million last year and over $1 billion this year. Supposedly, that was due to the brand’s smart social marketing efforts, which avoided TV ads and other expensive tactics used by Apple (AAPL) and Samsung.
But there are a few hiccups in the Xiaomi story coming out now that may have serious long-term implications.
First, Reuters over the weekend uncovered a public securities filing in which Xiaomi disclosed that its profit in 2013 was only $56 million. That means the operation may be running with a smaller margin for error than seemed the case after the Journal’s story, which was based on a private presentation Xiaomi made while seeking bank financing. Xiaomi told Reuters the numbers in the securities filing were accurate, but did not represent a complete picture of all of the company’s units.
Either way, Xiaomi's sales and profits lag far behind its bigger rivals, Apple and Samsung. Apple sold 39 million iPhones for $23.7 billion in the third quarter alone. Analysts estimate its profit margin at 30% to 40%. Samsung shipped an estimated 78 million smartphones in the quarter, though analysts estimate it has about half the profit margin of Apple.
A second problem for Xaiomi arose in India, where the company just lost a preliminary court ruling over patented Ericsson (ERIC) technology used in its phones. Sales have been suspended in India pending further court proceedings.
Patents, or a lack thereof, have long been considered Xiaomi’s Achilles' heel. The company was only founded in 2010 and doesn’t do much R&D, so it has few patents of its own. That's critical, because the way smartphone makers typically fend off patent attacks is by counter-attacking with their own patents. That’s largely why Google (GOOGL) went out and bought Motorola Mobility, for example (and even though it sold the Moto phone operation to Lenovo, it still kept almost all of Moto's huge patent portfolio).
Selling phones for as little as $114 requires absolute efficiency on the expense side. Substantial infringement penalties or royalty payments could ruin Xiaomi’s big advantage. It’s already limited the company’s market -- analysts say Xiaomi won’t dare enter developed markets like the United States and Western Europe due to its patent vulnerabilities.
To be sure, the company is not just about the lowest price. It's also seeking to grow on the Apple model, by building a loyal and devoted following. Already, flash sales of specialty models online sell out in minutes. It also has highly customized Google’s Android software to create a unique user experience and curates its own app and media stores.
And there are plenty willing to offer the company financial backing to expand. In August, Xiaomi said it had raised a round of venture capital at a $10 billion valuation, and rumors have it that another round will be forthcoming soon at three to five times that level.
Xiaomi seems stronger than ever in its home market and could grow quickly along with the increasing group of Chinese who can afford mobile service. But whether it can realize its global ambitions remains to be seen. VIDEO
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