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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A user posing with an iPhone showing an installed New York Times app on Jan. 5 in Beijing. (Fred Dufour/AFP/Getty Images)A user posing with an iPhone showing an installed New York Times app on Jan. 5 in Beijing. (Fred Dufour/AFP/Getty Images)

China’s “Great Firewall” has been central to the Communist Party’s strategy of controlling what residents can and cannot browse online. Websites ranging from search engines, discussion forums, to online media are closely monitored and censored.

Up until now however, mobile apps occupied a corner that has largely been under the radar of the “Great Firewall.” Alphabet Inc’s Google Play Store isn’t available in China and Apple Inc.’s App Store has a severely limited selection of apps in China. Outside of a few major domestic players, Chinese mobile app stores haven’t been heavily regulated.

Last week, new regulations were passed aimed at reining in the hundreds of unregulated mobile app stores in China. The exact number of app stores are unknown, but marketing firm AppInChina estimates that over 200 exist currently. Most of these stores have little to no established process to vet apps before their release.

The announcement was released by the Cyberspace Administration of China (CAC). Since Jan. 16, mobile app stores must register with the CAC to continue to operate legally. Such registration will make it visible to authorities who owns the app store and how many apps are present, allowing regulators to shut down stores as necessary.

Fragmented Market

Despite Beijing’s stance on regulating mobile app stores, the environment and fragmentation of the market makes it almost impossible to enforce the new measures.

The biggest smartphone platform in China—a country with more than 700 million smartphone users—is Google Android. But Google Play, the default app platform of the operating system, is disabled in China. This gave rise to a proliferation of third-party app stores, the biggest ones are those run by the nation’s large technology companies such as Tencent, Baidu, Xiaomi, and Alibaba. App stores run by these large companies are self-regulated.

Content that would be strictly blocked on a Chinese website sometimes could be found inside mobile apps.

But hundreds of other smaller third-party app stores have also sprouted, many with low security and vetting standards. Content that would be strictly blocked on a Chinese website can sometimes now be found inside mobile apps downloaded from these platforms.

Like many Chinese regulations, the guidelines are vague and open-ended. “It’s almost impossible for the regulators to register and supervise all the millions of apps there one by one,” Zhu Wei of the China University of Political Science and Law told the Wall Street Journal.

Hard to Enforce

Judging by the CAC’s language, the enforcement, monitoring, and censorship of content within these apps seems to fall on those operating the mobile app stores. The model CAC has adopted is to police the app stores, with the hope that the app stores will police the apps within.

But that’s a strategy that has proven faulty.

Earlier this month, the New York Times app was taken down by Apple after Chinese government censors demanded Apple remove it. Apple told the Times that its app violated local laws, without elaborating on which laws it violated.

This is hardly a surprise, until one realizes that the New York Times’ website has been blocked by China since 2012. This means that while Chinese censors intended to fully block access to New York Times’ content since 2012, Chinese residents were still able to access New York Times content through its mobile app for the last five years.

And this example involves Apple and New York Times, two of the most visible targets of Chinese censors. There are millions of Chinese mobile apps across hundreds of app platforms, most of which are small, private, and lack the resources to self-censor all of the apps and their content. 

How long will it take to cull all of them?

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A driver uses Alipay on his smartphone to pay a highway toll, on the Hangzhou-Ningbo Expressway in Hangzhou, Zhejiang province Sept. 21. (STR/AFP/Getty Images)A driver uses Alipay on his smartphone to pay a highway toll, on the Hangzhou-Ningbo Expressway in Hangzhou, Zhejiang province Sept. 21. (STR/AFP/Getty Images)

China is the world’s largest and fastest-growing market for mobile payments, and its most popular service is planning to parlay its success abroad.

Alipay, China’s biggest mobile payment service, unveiled several new partnerships to accept payments in the U.S. last week. Alipay is a service of Ant Financial Services, a spin-off of Chinese internet giant Alibaba.com.

Its foray into the United States commenced with deals struck with Verifone Holdings and credit card processor First Data Corp. Alipay has aggressively expanded into foreign markets in recent months, signing up local merchants in the U.K., Germany, Thailand, and Australia.

Western media has explained the move as a desire to service China’s 150 million tourists who travel abroad each year. Alipay looks to join the ranks of Visa, MasterCard, and China UnionPay as their preferred payment methods.

But the company’s ambitions clearly extend beyond Chinese tourists. “We are targeting 2 billion users in the next 10 years,” Alipay’s international president Sabrina Peng recently told Reuters. The company expects 60 percent of its transactions to come from outside of China by then, and that kind of volume can only be achieved by mainstream global adoption.

China’s Mobile Wallet

Last year, China overtook the United States as the world’s largest mobile payments market by total value spent.

China has around 200 million people using their smartphones as wallets, according to eMarketer estimates. That’s an almost 40 percent adoption ratio of mobile payment users to total smartphone users. Together, more than $1 trillion worth of mobile transactions were made in 2015 on mobile, according to iResearch data.

Alipay, with 450 million accounts, is the largest mobile payment platform in China with a 68 percent market share. Together with WeChat Pay (Tenpay), operated by rival Tencent Holdings, the two platforms have an 89 percent market share. The most recent entrant into the Chinese market is Apple Inc.’s Apple Pay, which recently signed a deal with China UnionPay in hopes of a quick market capture.

Payment via mobile is fairly straightforward. After pushing a “pay” button in the Alipay or WeChat app, the app generates a QR code which can be scanned by merchants and keeps a copy of the digital receipt. NFC (near field communication) compatible hardware also allows making payments without opening the app.

Mobile payments—and the broader internet banking market—has always been a two-horse race between Alibaba and Tencent, which operates WeChat, China’s biggest social-networking and instant messaging app.

Two years ago, Alibaba and Tencent were locked in bitter competition on multiple fronts, including internet banking, mobile payments, and even taxi services. Their competition in mobile banking intensified during the 2015 lunar new year period when both services used “red envelop” cash promotions and other subsidies to attract new users.

Since mid-2015, Tencent has scaled back its competition with Alibaba after a few minor setbacks. The Tencent-backed taxi service Didi was acquired by Alibaba-backed taxi service Kuaidi to form Didi Kuaidi. The company is known today as Didi Chuxing, the largest ride-sharing company in China which recently agreed to acquire Uber’s China business.

Tencent’s online bank—WeBank—also got off to a slower start compared to Alibaba affiliate Ant Financial in loan origination activity. Ant is also better funded; its Series B funding round earlier this year pegged the company at a $60 billion valuation, making it one of the most valuable startups in the world. Alipay and Ant’s recent wins drove Tencent’s decision earlier this year to eliminate fee subsidies when customers transfer cash from their bank to WeChat, in an effort to stem losses. The action further ceded market share to Alipay. 

No Quick Global Adoption

Alipay will face stiff challenges it never encountered in China.

The biggest concern for Alipay is fragmentation of global payment infrastructure. Developed markets in the United States and Europe have entrenched ways of securely making purchases online, something China lacks.

The World Bank estimated that only 16 percent of Chinese consumers have a credit card. Many smaller businesses, especially those outside the more advanced cities, do not accept credit or debit cards.

This made the transition from cash to cashless payments a far more open competition, one which mobile payment services have captured handily due to the penetration of smartphone usage in China. In other words, Chinese consumers were happy to sign up for mobile payments due to a lack of reliable alternatives.

Nielsen-payments

Digital payment systems are the number one online payment method in China (Source: Nielsen Media)

In developed markets, the prevalence of credit and debit cards presents a stiff challenge to mobile payment solutions. Alipay only needs to look at the slow adoption of Apple Pay, almost two years after its introduction, for evidence. Apple has run into a slew of issues, both technical and environmental—where banking giants and rivals such as Samsung have invested huge sums into their own mobile payment solutions. Until mobile payments can demonstrate clear advantages over credit cards, adoption will be slow.

The other challenge facing Alipay—if it wants to gain international trust—is concerns over data security.

Only 16 percent of Chinese consumers have a credit card.

Earlier this year Apple and its CEO Tim Cook sparred with U.S. Department of Justice over government access to private customer data stored on Apple’s devices. This month, Alibaba founder Jack Ma did the complete opposite by essentially pitching customer data to the Chinese communist regime.

In an October presentation to the Chinese Central Political and Legal Affairs Commission, which runs the Party’s security forces, Ma suggested to authorities and police officers present on using digital data for rooting out illicit activities. “Police used to follow a pickpocket thief day by day,” Ma told the group, according to a transcript obtained by Sohu.com. “In the future, if the man uses electronic payment, and the police finds him riding 50 different buses in one day, this person may be very suspicious.”

“I believe that public security, courts, the People’s Procuratorate [the Chinese agency responsible for investigation and prosecution], security departments, including anti-terrorism departments, should use this data,” Ma said.

The technology industry’s relationship with law enforcement will be a hot topic as the digital economy expands. And that’s especially true for the Chinese market where “illicit activity” can carry any definition ascribed by the Chinese communist regime leadership. 

For now, the foreign partnerships should give Alipay more business from traveling Chinese nationals. But it remains to be seen whether global consumers will entrust their financial data to a company affiliated with Ma—China’s second-richest man, a proponent of China’s internet censorship policies, and a defender of counterfeit goods.

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