Low-Margin Smartphone Business: How Long Will Business Be Sustainable?

Smartphone maker Xiaomi was caught in the middle of a spat between the Stock Exchange of Hong Kong Limited and mainland counterparts when its IPO fell flat on opening day (it has since recovered). However, there are other reasons why investors may be shy.

The low-cost, feature-rich smartphones selling in high volumes in emerging markets such as China and India come with slim profit margins—and that may make investors nervous. Xiaomi is an interesting case study. A closer look at its publicly available 2017 financials reveals that 52% of its profit came from only 29% of the company’s revenue, which was generated by the IoT/lifestyle products and internet services categories. Meanwhile, Xiaomi’s smartphone segment accounted for more than 70% of revenue, but represented less profit (nearly 47%) than the two other combined segments. Even starker is a look at the internet services category, which produced 8.6% of revenue but generated nearly 40% of the company’s profit. Not surprisingly, the internet services category revenue includes ads and media.

Although it’s still too early to say how the future will look for Xiaomi, its peers such as Oppo and Vivo may be rethinking following Xiaomi’s business strategy. These two Chinese suppliers followed Xiaomi into the Indian market and adopted many of Xiaomi’s practices, including selling advanced smartphones at low prices (and low margins), as well as starting up initial sales through online flash selling.

In today’s competitive smartphone market, smartphone suppliers that focus mainly on lower-profit hardware could be easily be replaced by big giants such as Huawei. These larger providers are positions to offset low margins with its robust telecommunication equipment manufacturing business. As a result, it may be time for low-margin smartphone suppliers to tweak strategies by growing their services and media sales units, or raising prices little by little, like Netflix.

There are many paths that might be taken to build more profit into the smartphone business.  But one thing is clear: the Chinese smartphone suppliers have to make some change in their strategy.