Lei Jun, the creator of the Xiaomi smartphone, in Taipei. (Photo/Chen Man-nung)
The meteoric rise of Xiaomi smartphones in China was hailed by many as a stunning success in the country's burgeoning market. But the company has not been untouched by controversy and other problems even as sales of its budget smartphones continue to soar from their competitive pricing.
Lei Jun, founder and CEO of Xiaomi Technology Co, made a major announcement in Beijing on Aug. 16 to launch both an upgraded version of the company's first-generation phone called the Xiaomi 1S and also a second-generation model.
Just one day earlier, the company slashed the price for the first-generation smartphones from 1,999 yuan (US$315) to 1,299 yuan (US$205). The declaration not only shocked the industry but also drew protests from customers who had bought their phones at the higher price tag.
Nonetheless, all 90,000 G1 handsets in stock sold out in just three hours, according to Innovative Finance Observation, a daily based in Tianjin.
People with a suspicious view about Xiaomi's business and marketing operations have raised a number of points.
Zhou Hongwei, chairman of antivirus software producer of Qihoo 360, which is also investing in its own line of budget phones, is one of them. He said the new deal presented people who purchased Xiaomi phones in the past six months an immediate financial loss of 700 yuan (US$110) and the company should give each of them a compensatory refund.
One blogger said on his microblog that Xiaomi struck a deal with China Unicom, one of the top telecom service groups, at the end of 2011 to supply one million Xiaomi handsets, of which there are now still about 400,000 or 500,000 to be delivered. But the unilateral price cut by Xiaomi could mean a financial loss exceeding 300 million yuan (US$47.3 million) for China Unicom.
The blogger said the telecom carrier has been seeking price protection from Xiaomi to avoid losses. He also quoted from other sources saying that China Unicom has the ability to sue Xiaomi. His comments inevitably drew attention and the blogger was forced to make an apology and discontinue his comments for fear of legal action.
An executive at Xiaomi clarified that the company has reached a deal with China Unicom on the supply of the upgraded Xiaomi 1S model. But market doubts concerning the costs, profit, quality, marketing tactics, and after-sales services involving Xiaomi phones have persisted.
Zhou of Qihoo 360 noted that based on Xiaomi's financing data, the company stands to reap profit of 700 to 800 yuan (US$110-$125) per unit for a huge gross profit of 2.5 billion yuan (US$394 million) on the projected sale of three million to five million sets in 2012.
Industry experts said that the production of the Xiaomi handset carries a cost of only 900 yuan (US$142).
However, Lei Jun has stressed that his company is an internet service enterprise that does not rely on hardware for profits. He also insisted that handsets garners a thin profit of about 100 to 200 yuan (US$16-$32) per set.
Xiaomi has already unveiled its cost structure, including materials, manufacturing, patent right payments to chip supplier Qualcomm, and taxes. But analysts said there are various ways to list costs, including lumping corporate operating costs into the costs for the mobile phone sector, reporting only net earnings but not pre-tax gross profit, offsetting customs duties with VAT tax, and other measures to create data that shows a gross profit of 800 yuan and net profit of 600 yuan (US$94) for each phone.
Lei had explained that Xiaomi set price tags based on the minimum sales volume of 300,000 units to break even and the profit will come from sales exceeding tise level. He said the profit rate reached the normal business rate of more than a dozen percent starting in the second quarter of the year because of high sales volume.
In order to dispel market doubts in advance, Lei said the average cost of the second-generation handsets is 2,350 yuan (US$370) and there will be profit only when sales top three million sets.
Available data show that Xiaomi procures handset cases from a company based in Shenzhen, touch panels from TPK, batteries from a firm in Huizhou, plus other costs like a one-time payment of 200,000 to 250,000 yuan (US$31,500-$39,400) as a certification fee for each model, mold cost of 700,000 yuan (US$110,300), and about 1,000 (US$157) yuan in BOM costs (including packaging materials, batteries, rechargers, earphones and so on) to reach about 1,180 yuan (US$186) when including 17% in VAT, 6.63 million yuan (US$993,000) to Qualcomm, IPR costs and an assembling cost of no more than 50 yuan (US$7.90) per set by retaining Inventec and Foxconn Technology for contract manufacturing.
There are other costs like logistics and delivery, averaging 20 yuan (US$3.15) per set and after-sales service of 3.5% or 41 yuan (US$6.45) each set.
The above figures show that Xiaomi could have a profit of about 641 yuan (US$100) per set by deducting the total cost of 1,358 yuan (US$214) from sale price of 1,999 yuan (US$314).
Li Wanqiang, one of the 56 original co-founders who jointly raised US$11 million to set up Xiaomi Technology, said the company succeeded in combining internet know-how to reform the mobile phone business by integrating the strengths of Dell Computer with zero inventory, the Amazon marketing style to slash distribution costs, and the online social network media to get promotion and publicity free of advertising budgets.
But some critics noted that Xiaomi had speedily rushed out smartphones by compromising on quality. Major Chinese mobile phone manufacturers that adopted microchips similar to the ones used in Xiaomi products normally test for a longer period of time to prevent troubles and disputes later.
Xiaomi has already shown defects in the functions of its handsets and strains in after-sale services, said some industry observers. The company has stated that the malfunction rate generally reaches 4% to 5% due to the different yield rates of materials and components, but less than 2% of Xiaomi customers actually took their handsets back for repairs.
Yet many industry analysts have doubts on the low proportions as reported by Xiaomi itself.
Many have been more tolerant with the company. But some more critical voices said Xiaomi actually thrived on the "shanzhai 2.0 mobile phone" concept in the Chinese market, meaning an upgraded version of "counterfeit handsets."
On Aug. 23, Xiaomi started accepting online orders for its 1S phones with the old practice of limiting the supply volume to only 200,000 handsets. The second round of sales and the debut of the telecom version of the 1S will start on Sept. 6, while sales of the second-generation Xiaomi handsets will begin in October.
Company executives denied that Xiaomi has been using "hunger marketing" schemes to deliberately limit supply in order to spur high anticipation and widespread hype from potential customers.
Some analysts said it remains to be seen how the sales for the new products will go. But they pointed out that such artificial controls in marketing volumes have already backfired since the company is confident of high volume demand as sales of the first-generation product have amounted to 3.52 million sets.
Some customers who already placed orders for Xiaomi handsets have decided to resell them on the internet.
Lei Jun 雷軍
Zhou Hongwei 周鴻禕
Li Wanqiang 黎萬強