A Xiaomi store is seen in Beijing Jan. 12, 2015.(Wang Zhao/AFP/Getty Images)A Xiaomi store is seen in Beijing Jan. 12, 2015.(Wang Zhao/AFP/Getty Images)

Recent years haven’t been kind to Chinese smartphone maker Xiaomi, China’s biggest company in the industry three years ago.

The company’s market share has steadily eroded since 2014. In fourth quarter 2016, Xiaomi’s smartphone shipment volume and market share was 7.4 percent, less than half of its 2015 market share and a distant fifth behind current leaders OPPO, Huawei, and Vivo, according to data from market research firm IDC.

OPPO and Vivo—who share the same parent—came out of nowhere to displace Xiaomi and dominate the middle range of the Chinese smartphone market—a segment filled with commodity-like Android devices sold at lower price points than devices from Apple and Samsung.

Beyond Xiaomi’s sluggish sales, its fortunes were further dented by the January departure of Hugo Barra, head of the company’s international business and arguably its most well-known figure. Barra joined the company in 2013 as a VP from Google, and has been instrumental in building Xiaomi’s business abroad most notably in India where Xiaomi maintains a 6.6 percent market share.

Despite declining sales, Xiaomi still has higher ambitions. Its Chairman Lei Jun styled himself as China’s homegrown Steve Jobs, and the company recently joined Apple as one of the few global smartphone makers to design and manufacturer its own processor chips.

Xiaomi_China_IDCQ416

(Source: IDC)

Homegrown Chip

Xiaomi announced its own chip, called Pinecone Surge S1, on Feb. 28 at an event at the China National Convention Center. The chip—which has eight cores running at up to 2.2 GHz—is used in the company’s new midrange Mi 5c smartphone. With this, the company joins Apple, Samsung, and domestic rival Huawei as the only smartphone makers in the world with their own processor manufacturing capabilities.

Xiaomi’s introduction of a self-made chip is interesting on a few fronts.

The private startup has not raised capital since 2014, when Xiaomi was valued at $45 billion by investors. Today, given slowing sales, its valuation is presumably lower. But during the launch event to unveil its new smartphone chip, Xiaomi deviated from its usual script of thanking investors for their ongoing support. Instead, Lei Jun flashed a slide that read, “Thanks for the government’s support,” according to the Wall Street Journal.

While few details about Xiaomi’s funding from Beijing are known, the support seems to be broad-based. According to Lei, financial backing came from a semiconductor development fund set up by Beijing, China’s Ministry of Science and Technology, and Beijing’s municipal government.

Beijing has identified semiconductors as a nationally important sector and last year, numerous funds were set up at the national, provincial, and local levels to support sector R&D. China’s desire to be self-sufficient in the sector was driven by foreign government opposition to acquisitions of semiconductor companies by Chinese firms due to security concerns.

Xiaomi’s new chip is also a shot across the bow of leading global chipmaker Qualcomm by the Chinese communist regime. China has long eyed Qualcomm’s dominance among high-end smartphone chips with disdain. Beijing fined Qualcomm in 2015 for almost $1 billion after a years-long investigation into supposed “anti-competitive practices.” As part of the fine, Qualcomm was forced to lower the royalty rates it charged Chinese smartphone makers using the company’s chips. Qualcomm’s royalty calculation basis was lowered from 100 percent of selling price as was the norm globally, to 65 percent of the selling price for Chinese phones.

Broadening Product Range

Politics aside, Xiaomi’s introduction of its own chip shouldn’t have a material impact on Qualcomm’s business. All of China’s leading phone brands use Qualcomm chips in some of their smartphones, especially the higher end ones. And Xiaomi’s meager global market share isn’t likely to have a meaningful impact to Qualcomm, even if it ceases using Qualcomm chips entirely.

But given Xiaomi’s current struggles—the company last year decided to stop releasing quarterly smartphone shipment figures—the chip is all about its future. Having a first-party chip allows Xiaomi to cut production costs and obtain control over a vertically integrated process from design to hardware to software (Xiaomi has its own MIUI Android custom OS).

This is the model Apple has built and perfected over two decades. And Xiaomi is among the earliest first movers to tackle the “internet of things” and smart home ecosystem products in China. The new chip allows Xiaomi to more effectively connect and integrate its wide range of product offerings.

For example, Xiaomi has been an aggressive player in the wearables segment. Its Mi Band wrist monitor has a 15.2 percent global market share right behind Fitbit, according to IDC. It’s the fastest growing major brand in the wearables sector, with year-over-year growth of 96 percent compared to Fitbit’s decline of 22.7 percent.

Xiaomi has a broad range of connected home and personal products spanning action cameras, routers, smart coffee machines, and smart scales. Its most recent product is a smart guitar with accompanying app to facilitate learning.

Taking another page from Apple and Samsung’s playbook, Xiaomi has been quietly amassing a portfolio of patents.

Xiaomi recently bought intellectual property (IP) assets from Intel, Broadcom, Microsoft, and most recently Casio, according to IAM, a leading IP industry journal. The lack of IP portfolio has long been an Achilles’ heel for Xiaomi; it’s a chief reason for the company’s limited scope outside of China. Amassing IP assets should further equip Xiaomi for future growth.

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Oppo's OnePlus 3 smartphone is seen at a launch event in New Delhi June 15, 2016. (Money Sharma/AFP/Getty Images)Oppo's OnePlus 3 smartphone is seen at a launch event in New Delhi June 15, 2016. (Money Sharma/AFP/Getty Images)

It’s the end of 2016, and the most popular smartphones in China—a nation of 700 million smartphone users—aren’t made by Apple, Samsung, or even Chinese cult brand Xiaomi.

Oppo and Vivo, two little-known companies in the West, have come to dominate the Chinese smartphone market using seemingly antiquated marketing strategies.

As of the third quarter 2016, Oppo held the biggest smartphone market share at 16.6 percent, with Vivo closely behind with 16.2 percent. Huawei and Xiaomi came in third and fourth, with 15 percent and 10.6 percent respectively, according to market research firm Counterpoint. Apple was a distant fifth with 8.4 percent market share.

The two companies came out of seemingly nowhere to sell millions of smartphones. Oppo’s sales were 84 percent higher than last year, mainly on the popularity of OnePlus, a line of smartphones with edgy designs, high-end specs, and low prices. Vivo relies on simple but solid designs and rock-bottom prices, a formula that propelled its sales 114 percent higher than prior year’s.

A Vulnerable Xiaomi

The phone market in China is fairly simple to enter, but difficult to dominate.

At the high end of the market, Apple still reigns. Around $60 billion of Apple’s total sales were generated from China alone last year, and it wasn’t too long ago that Apple vied with Xiaomi—which hailed itself as China’s own Apple—for top smartphone market share. While Apple still has a stranglehold on the top end of the market, its position has eroded over the last year due to Beijing’s blockage of iTunes, a slowing Chinese economy, Xi Jinping’s anti-graft measures, and a flood of cheaper but high-quality alternatives.

China_smartphone_CP

(Source: Counterpoint Research)

It’s the middle range of the market that’s more interesting, and it’s where Oppo and Vivo have recently excelled. This is a market that has seen numerous winners emerge over the years such as Lenovo, Huawei, and most famously, Xiaomi. Xiaomi CEO Lei Jun styled himself as a China version of Steve Jobs, focusing on design, high-end specs, but at a lower price point than Apple. Xiaomi—popular with urban millennials—was known for its high-profile launch parties and until recently, an internet-only sales model.

But Xiaomi runs a version of Google’s Android operating system. And without an app ecosystem to lock in users, companies found that customer loyalty was almost non-existent amongst commodity-like smartphones that run Android. Even a brand with cult status like Xiaomi was susceptible to newer entrants.

Going Brick-and-Mortar

Oppo and Vivo are both owned by Guangzhou-based BBK Electronics, a company started by billionaire investors and entrepreneur Duan Yongping. Both brands have similar approaches to selling phones.

They observed that Xiaomi was a favorite of urban millenials—at least those who want a cheaper or Android-based alternative to the Apple iPhone. Xiaomi until recently only sold phones directly via its website, and promoted each phone release via hip launch parties.

Oppo and Vivo saw an opening in working with retail stores, where two out of three phones are still sold in China. The companies especially targeted stores outside of large cities and in rural areas, where consumers are more price-sensitive, have less access to the internet, and place more reliance on local technical and customer support. Oppo and Vivo partnered with retail sales professionals in small vendors and offered sizable affiliate sales commissions and subsidies to sales reps.

“Oppo and Vivo are willing to share their profit with local sales,” Jin Di, an analyst at market research firm IDC, told Bloomberg.

“The reward was an extremely active and loyal nationwide sales network. They’re doing something different—they do local marketing.”

It’s an antiquated strategy, but it’s a fit with Chinese consumers outside of major cities. The small vendors serve as the companies’ local salesmen, technical support, and customer support. With the added incentives, they help promote the products to friends and consumers on WeChat, and steer sales away from competitors toward Oppo and Vivo phones.

Their other killer app? Oppo and Vivo phones often carry powerful, zoom-enabled front cameras for selfies.

Xiaomi, meanwhile, has moved up market in recent years. It now manufactures a variety of other products such as video cameras and “Internet of Things” home devices in an effort to position itself as China’s homegrown Apple.

Through the success of Oppo and Vivo, Xiaomi also realized the value of having a retail presence. It now runs a few hundred stores in China.

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