The Xiaomi shock

“FROM the beginning, Xiaomi has considered the mobile phone to be a converged gadget of software, internet services and hardware, not just a simple device.” So declared Lei Jun, the charismatic founder of Xiaomi, a Chinese smartphone-maker with global aspirations, during a recent meeting at his firm’s headquarters in Beijing with Choi Yang-hee, South Korea’s telecoms minister.

Bland as Mr Lei’s comments may sound, the meeting revealed something important about Xiaomi. That a South Korean minister would deign to visit a Chinese tech firm which until recently was barely known outside its home country, let alone sit through such a lecture, is telling. Such has been the Korean hubris over the prowess of its chaebol—most notably Samsung, the world’s leading mobile-phone firm—that the scene would have been unimaginable just a few years ago. It shows how worried Samsung is of being upended by what another South Korean minister has called the “Xiaomi shock”.

To see what he means, consider what the firm has accomplished since its first phone was launched four years ago. Its worldwide sales were 61m handsets last year, a rise of 227% on the year earlier, making it the sixth-biggest mobile-phone firm in the world. In China, Xiaomi had leapt ahead of all its rivals, foreign and local, by the final quarter of last year, to become the top-selling brand of smartphones (see charts). This year Mr Lei wants to sell 100m units worldwide.

The company has already started a big push towards achieving this. Last year it began selling phones in a few South-East Asian markets, including Singapore. It also struck a deal with Flipkart, India’s leading e-commerce firm, to sell handsets in that market. Earlier this month it unveiled plans to sell headphones and other accessories (though not yet phones) in America.

Conquering the world will be harder than dominating the home market. Google and its Android app store are unavailable in China, making it easier for Xiaomi’s flavour of the Android operating system, and its app store, to flourish there. Few consumers in other emerging markets are as plugged into e-commerce as the Chinese are. Entering such markets may require Xiaomi, which has thus far relied mostly on internet sales and word-of-mouth buzz, to make expensive investments in advertising and in bricks-and-mortar retailing.

Profitability is also a big concern. Xiaomi, still private, releases few details of its finances. But Mark Li of Sanford C. Bernstein, a research firm, suspects that its handsets do not make the sort of double-digit margins earned by Apple. Even the firm admits it has enjoyed higher margins from selling millions of fluffy promotional toys—in the form of a bunny called “Mitu”—than it has from handsets.

Another snag is its lack of intellectual property. Smartphone companies are highly litigious. Unlike its more experienced local rivals, Lenovo (which has bought Motorola’s smartphone division from Google) and Huawei, Xiaomi does not have a huge patent portfolio. Lin Bin, its president, says it has been filing thousands of patents in preparation for a legal onslaught: “This is something we expect to happen.” Indeed, an Indian court is investigating claims that Xiaomi has disobeyed its order to halt sales of some of its phones in the country, over a patent dispute.

Given these obstacles, why is Samsung still worried? One reason is that Xiaomi has positioned itself perfectly to be a disrupter of firms offering overpriced, over-elaborate devices. Its best handsets are not quite as good as Apple’s or Samsung’s best, but they are far better than those from other, cut-rate rivals—and they cost half what an unsubsidised new iPhone does.

Consider again the sweeping assertion made by Mr Lei to the Korean minister. From the start he has understood the awesome power of the connected mobile device. That has led to a business model that blends Apple’s walled garden, which encourages users to stay loyal to its “ecosystem” of apps, with Amazon’s use of the Kindle as a loss-leader to sell lucrative content, software and services. Xiaomi started off peddling handsets without profit, but it is creating a bunch of apps, “smart home” gadgetry, online video and peripheral devices to make a return on its investment.

The other reason incumbents should worry about Xiaomi is its financial firepower. Some 29 banks tripped over themselves to offer it a $1 billion loan in October. In December several respected venture capitalists including GIC, Singapore’s sovereign-wealth fund, and DST of Russia, an early investor in Facebook, provided another $1.1 billion. Some reckon that this latest investment, which values it at $45 billion, makes the Chinese upstart the world’s most valuable startup. Xiaomi’s shock-and-awe campaign rolls on.