Phones weren't selling. So what was Xiaomi doing in 2016? | Top 15 Year-End Report

After a year of hustling on internet services and home appliances, Xiaomi came back to the most traditional business of all: selling phones.

Over the past year, Xiaomi had been busy telling new stories.

One of those stories traveled all the way to America. In early January, Xiaomi turned up at CES — the world's biggest consumer electronics show — for the first time in its seven-year history.

Rather than rent the priciest floor of the central hall, the way Sony, Samsung, and Huawei do, Xiaomi took a few hundred square meters on the second floor, up among the startups.

Across six or seven long tables, the smartphone — the product that made Xiaomi famous — was no longer the only star. Laptops, smart electric kettles, rice cookers, air purifiers, and more than a hundred other Xiaomi products filled the space.

Instead of hiring an events company, Xiaomi recruited 19 college students — mostly locals — from two West Coast universities, gave them two days of training, put them in red Xiaomi polo shirts, and stationed them in front of the booths.

For all four days of the show, crowds pressed around the Xiaomi stand.

"I knew Xiaomi made phones, but I had no idea they made so many other things," an American television-industry analyst told QDaily at the booth. He had bought Xiaomi's TV box when it went on sale in the US and thought it was flawless apart from the software — the US version of the Mi Box ran Google's stock Android.

"I'm pretty interested in the phones, but the little signs in front of every product all say 'China only,'" he complained.

On the first day of the show, VP Hugo Barra held a press briefing to introduce Xiaomi's new products: a white Mi MIX, a new TV, and a router. All of them were on display at the stand, but no timeline for entering the US market was announced.

"CES is, after all, a global show — distributors from all over the world come here. We wanted to show every Xiaomi product in one place, and we'd never had a chance to do that kind of outreach before," Wang Xiang, Xiaomi's VP of global sales, told QDaily from the show floor. He did not share the results of any talks with distributors.

To leave an impression on potential buyers and visitors, Xiaomi also produced a 24-page glossy catalog, packed with shots of models posing with its devices.

All this effort served one new story: Xiaomi is not just a phone company.

"You may all know Xiaomi as a smartphone company, but we are far more than that," Wang Xiang had told the assembled media at the briefing.

Behind that new story, the old story's main character — the smartphone — was not doing well.

Xiaomi cut its phone prices but couldn't sell more

From Lei Jun telling anyone who would listen in 2016 that Xiaomi wanted to be the Muji of tech, to two senior executives at CES insisting they were more than a phone company, Xiaomi kept painting a future beyond phones.

At Xiaomi's annual company meeting, Lei Jun gave his customary address to employees. This time, though, Xiaomi did not announce its full-year phone shipments.

By third-party research firms' count, Xiaomi sold only 40 million phones in the first three quarters of the year. Even with an optimistic fourth quarter, the final number could not beat the previous year's total.

It was the first time in Xiaomi's six-year history that handset sales had fallen.

In 2016, Xiaomi was beaten by the traditional retail channels that OPPO and vivo relied on.

The two companies' 200,000 franchise stores blanketed cities and towns across China, their names ran in the title-sponsor credits of nearly every popular variety show, and they reached far more people than Xiaomi could touch. In the first three quarters of 2016, OPPO had already shipped more than 52 million phones. By the third quarter, vivo — and even Huawei's sub-brand Honor — were outselling Xiaomi.

Against the gloom around phones, the story of "Mijia" and its hundreds of smart products sounded a lot livelier.

Xiaomi put more than a hundred home appliances on the shelves in a single year — but it all ran on the users its phones brought in

On March 29, 2016, Xiaomi introduced the "Mijia" brand, folding every product outside of phones, routers, TVs, and tablets under its umbrella.

Xiaomi had been investing in "ecosystem-chain companies" since 2014. The ecosystem chain is essentially a way of making products by investing in and incubating affiliated companies. For a project joining Mijia, Xiaomi steps into the product design, the supply chain, and the pricing, then puts its own name on the finished goods and sells them through mi.com.

After setting up the Mijia brand, Xiaomi visibly picked up the pace. By year-end, it had invested in 77 ecosystem-chain companies.

We counted: outside of phones and TVs, Xiaomi's online store carried 212 products, with new items going live several times a week on average.

• 72 smart-hardware items: air purifiers, water purifiers, fitness bands, and more;
• 23 earphone models;
• 36 lifestyle items: hoodies and T-shirts printed with Xiaomi slogans, 90Fun luggage, and more;
• 40 Mi Bunny dolls, toys, and other merchandise;
• 36 phone cables, power banks, AA batteries, and other accessories;
• 3 Mi Notebook laptops and related accessories;
• 1 Mi SIM card.

Most Mijia products lead with looks that beat the competition and prices pitched as outstanding value — and that is not necessarily a durable edge.

When we searched Taobao and JD.com for Xiaomi's most popular ecosystem-chain categories, the first results were often not Xiaomi at all, but products designed to look just like Xiaomi's.

Take power strips. Sort power strips by sales on JD.com and Xiaomi has fallen past 40th place. On the first page of results, Bull and Philips both sell designs that copy Xiaomi one-for-one. They are not necessarily cheaper than Xiaomi's, but they sell better.

Beyond power strips, search air purifiers on JD.com and Xiaomi comes in at No. 18. Even the IQAir model, priced at fifteen times what Xiaomi charges, outsells it.

The Mijia Rice Cooker — the most famous product in Xiaomi's ecosystem chain — was nowhere in JD.com's top 120 results. The best-reviewed low-end Mijia rice cooker had only 400 after-sale reviews.

"The Xiaomi power strip has driven progress across the entire power-strip industry. A year ago, right after we launched it, our peers followed at once — when I saw their products I was genuinely moved and excited, and I sincerely applaud them. We don't think people are obliged to buy our products… even when they look like Xiaomi, we should cheer every bit of progress our peers make."

That is what Lei Jun said in an interview.

The rivals' power strips did get better — but for a Xiaomi watching its core business slide, that is probably not good news. Xiaomi brought some changes to the market, and home-appliance makers with more experience and more complete distribution networks caught up fast.

At the end of 2016, Lei Jun revealed that the "smart-ecosystem hardware" companies Xiaomi had invested in had generated an estimated 15 billion yuan in revenue over the year. Of Xiaomi's 77 ecosystem-chain companies, 16 had annual revenues above 100 million yuan, and 3 had reached the 1-billion-yuan level.

The numbers look decent enough — but they rest on a heavy dependence on Xiaomi's own channels.

In July, Qingmi Technology, the Xiaomi-ecosystem company that makes power strips, disclosed one figure: more than 99% of its total sales came through channels owned by Xiaomi — mi.com plus Xiaomi's official stores on Tmall and JD.com. Xiaomi's e-commerce and exposure are Qingmi's main source of traffic.

When you get down to it, most people go to mi.com because of Xiaomi's phones. If phone sales stop growing, the support that Mijia products lean on disappears with them.

Whether the ecosystem-chain plan's 15-billion-yuan-a-year business can keep scaling comes down, in the end, to whether Xiaomi's phone business can grow.

Beneath all the fanfare of Mijia's constant stream of new gadgets, it was phones that gave Lei Jun real anxiety in 2016.

The "sell phones cheap, then make money on internet services" logic never panned out

Xiaomi had another headache: the internet-services business model it had counted on for five years had not come true.

By figures from The Wall Street Journal, only 6% of Xiaomi's total 2015 revenue came from software and internet services; the other 94% came from hardware. And Xiaomi was not alone. Even Apple — which sells a hundred or two hundred million iPhones a year and captures most of the high-end market — found that when iPhone sales fell 16% in a year, its software and internet services came nowhere near plugging the gap.

In 2015, Xiaomi launched seven phones, but four were sub-1,000-yuan Redmi handsets, an attempt to build a bigger user base to monetize through internet services.

By IDC's data, the average price of a Xiaomi phone in 2015 was just $141 — about 900-odd yuan at the time. Over the same period, Huawei's phones averaged $210. Huawei, of course, had once been a company that relied on carrier subsidies to sell low-end handsets.

After using low prices to move large volumes, Xiaomi tried in the spring of 2016 to make money by placing ads in the MIUI operating system. For a while, the MIUI calendar and even app folders were plastered with advertisements. The move only drew a fierce backlash from users, and in the end Xiaomi pulled most of the more intrusive ads.

There are simply too many Android phone brands to choose from. Unless every one of them stuffs its devices with ads, users will not put up with paying one or two thousand yuan for a phone and then staring at advertisements all day. And the three Chinese phone makers leading in annual sales — Huawei, OPPO, and vivo — all make their money by selling the phones themselves.

From 2013 to 2015, Xiaomi's phone strategy was to flood the market with cheap Redmi handsets and earn on internet services. That road has clearly hit a dead end.

In the end, it came back to selling phones properly

This year, Lei Jun put most of his own attention back on phones. The first thing he did was get a grip on the supply chain.

Suppliers of chips, screens, and memory have been through several rounds of consolidation and now hold more sway over the industry than the phone makers do. Smaller phone companies can no longer be sure of getting the parts they need.

In May 2016, Lei Jun sent an internal letter naming Zhou Guangping — formerly in charge of the supply chain — Chief Scientist, while the phone R&D and supply-chain teams would report directly to Lei Jun himself.

High-end smartphone parts were in severe short supply last year. In one interview, Lei Jun said the Mi Note 2, released in October, had originally been due in March, but a shortage of curved screens pushed the launch back six months. Lei Jun had to fly to Korea himself to negotiate with the screen-panel makers.

This was not Xiaomi's problem alone. Richard Yu, head of Huawei's consumer business, said the supply chain was his biggest headache in 2016 too. In August 2016, the OPPO R9 had to switch suppliers mid-production because of OLED screen capacity limits; Japan's JDI ended up taking the order. That is why there is a special variant, the OPPO R9km, 0.35mm thicker than the standard model.

It was not just screens — processors for entry-level phones were badly short, too. MediaTek, the main chip supplier for mid- and low-end new phones from Xiaomi, Meizu, and others, issued a notice in November warning that the shortage would last into the third quarter of 2017.

Xiaomi was also trying to push its prices higher.

2016 was the year Xiaomi launched the most new phones ever — 11 in all, only 3 of them low-end Redmi. Other flagships, such as the Mi Note 2, broke through the symbolic 1,999-yuan ceiling of earlier years, with prices pushed up to 2,800–3,500 yuan.

At the same time, Xiaomi's phone marketing grew more conventional. Lei Jun, for one, finally stepped down as the face of his own phones.

In August, Redmi signed three brand ambassadors — Liu Shishi, Liu Haoran, and Wu Xiubo — each aimed at a different age group and gender. In October, the mid- and high-end "Mi series" signed Tony Leung Chiu-wai. Such heavy spending on celebrity endorsements was also a first for Xiaomi, six years after it had prided itself on "not spending a single cent on advertising."

Lei Jun also said he wanted to open 1,000 brick-and-mortar stores in China. Beyond its own outlets, Xiaomi announced a strategic partnership with Suning; in November, the unreleased Redmi 4 went on display in Suning stores ahead of launch so customers could pre-order it.

This online-offline shift carried over to overseas markets, too.

In the third quarter, Xiaomi had already sold 2 million phones in India, for cumulative sales above $1 billion, making it the country's third-largest handset brand. Half of those were the Redmi Note 3, sold through the Indian e-commerce platform Flipkart.

Beyond local e-commerce, Xiaomi was also working with India's offline channels. In May, Xiaomi signed an agreement with the Indian retailer The Mobile Store, a phone specialist with 1,000 outlets across 150 Indian cities. In August, Xiaomi announced partnerships in quick succession with two more offline retailers, Just Buy Live and Inncom, whose combined 5,000 stores began carrying Redmi phones.

But Xiaomi's rivals in India had also become OPPO and Huawei — the very companies that had beaten it in China.

On October 25, Xiaomi launched the Mi MIX in Beijing. The phone led with the idea of the "full-screen" design: no black "forehead" band at the top of the display, with the infrared proximity sensor and earpiece needed for everyday use replaced by an ultrasonic proximity sensor and a piezoelectric ceramic speaker.

Almost overnight, photos of people using the Mi MIX for X-ray-style see-through shots flooded social media.

Against the Huawei Mate 9 and the Smartisan M1, both of which also launched in October, the Mi MIX drew roughly two to three times the online attention — the most buzz any Xiaomi product had generated since the company shipped its first phone in 2011.

The Mi MIX really did get the whole distribution chain moving. On Taobao's gray-market channels, even the entry-level 3,499-yuan Mi MIX was fetching at least a 1,000-yuan premium. On Taobao, the ad slot right beside the Mi MIX search results had been bought by the OPPO R9s.

"We never meant to mass-produce it at first. It wasn't until July this year that my team told me we could make this phone for around 4,000 yuan. That's when we decided to bring it to market," Lei Jun said in an interview last year, adding that in the early prototyping stage nine out of ten units came out defective.

The MIX sold for a lot on Taobao, but volumes were never large — the top listing moved fewer than 300 units a month. It could not solve Xiaomi's shipment decline; it was more about arresting the decline in Xiaomi's brand image.

"Five years ago, when we launched our first Xiaomi phone, the venue was small — there were more than 800 people there in person, and even I, the presenter, could barely squeeze through the door. I had no idea then that a Xiaomi phone could cause such a sensation. After yesterday's [Mi MIX] launch, someone told me they felt the same awe they had when we launched our very first phone five years ago. The Xiaomi people had been waiting for is back — the company that can make cool products, the innovative, different Xiaomi — it's back." That is what Lei Jun said after the Mi MIX launch.

Having come full circle, Xiaomi was back to making good products and earning money by charging a slightly higher price for them — the traditional phone business.

The only question is whether it still has time.

About the Top 15 Year-End Report

2016 was a turbulent year around the world. Judging by how companies performed, the market leaders suffered more than those chasing them.

The Top 15 companies QDaily follows — the ones driving changes in the way we live — had a hard time as the year drew to a close, and they all shared exactly one problem: a ceiling.

Whether developing new products (Apple with its Watch and car) or new users and channels (IKEA moving into e-commerce), these industry leaders were all urgently — and perhaps bewilderedly — searching for the "next" growth engine.

Breaking through that ceiling has proven harder than anyone imagined. The Top 15 year-end report for 2016 is not all good news.