Internet & Tech

Betting the ranch

Why Xiaomi’s founder may win a long-running wager with Gree’s boss


Lei Jun: ready to win his bet with Dong Mingzhu on surging sales?

The use of facial recognition technology is one of many ways that artificial intelligence (AI) is being deployed in China. But a malfunctioning system in the coastal city of Ningbo has demonstrated how the world of high-tech surveillance still has some way to go before George Orwell’s predictions of an all-seeing state come to pass.

Earlier this month cameras in Ningbo concluded that one of the country’s top tycoons was jaywalking and shamed her by flashing up her image on a big screen.

However, the artificial intelligence in the facial recognition system turned out to be flawed. Dong Mingzhu, the boss of Zhuhai-based Gree, was nowhere near the scene. But the cameras had captured a photo of her on the side of a bus and wrongly identified that she was there in person.

Dong is no stranger to the Big Data concept as she herself has spent the best part of the last five years attempting to transform one of the country’s largest makers of white goods into a smarter manufacturer. As we wrote in WiC433, Dong continues to plough Gree’s huge cash pile into areas like semiconductors (and her own money into battery technology) to create a company that will prosper in the Internet of Things (IoT) era.

She has also been locked in a long term bet with Xiaomi founder, Lei Jun. Back in 2013, she promised to pay him Rmb1 billion ($144 million) if Xiaomi topped Gree’s sales within five years. At the time, it seemed pretty unlikely given that Gree’s Rmb108 billion in revenues were roughly 10 times higher than Xiaomi’s.

But when Xiaomi released its third quarter figures last week, the numbers revealed that the two are now neck-and-neck. Xiaomi reported sales of Rmb50.8 billion, only Rmb7 billion or so behind Gree’s Rmb58 billion. Xiaomi recorded year-on-year growth of 49%, compared to Gree’s 38% so Lei may be in touching distance by the time fourth quarter results are out.

China’s social media commentators have been following the wager (the terms of which are disputed) since it was made. Yet the most popular comment on (by a wide margin) concluded that “it isn’t a real bet at all”.

“It’s just free advertising for Dong Mingzhu and Lei Jun. It shows what smart businesspeople they both are,” the contributor applauded.

The second most popular comment on Sohu was more revealing, perhaps, in arguing that “unlike Dong Mingzhu, Lei Jun doesn’t have a core technology and Xiaomi can easily be swept away”.

That feeds from a common view of Xiaomi as a manufacturer of well-made, low-cost smartphones but one which is in danger of losing steam as sales start to decline in the handset sector in general.

HSBC believes this perception is wrong, however. “Xiaomi is misunderstood,” warned Frank He, the bank’s head of A-share technology hardware research in early November. “Xiaomi has used its huge smartphone user base to build strong and data-related businesses in IoT and internet services.”

“We believe its achievements in these areas are not getting the attention they deserve,” he added.

It’s certainly true that the stock hasn’t performed well since its launch on the Hong Kong Stock Exchange in July. Although it was the world’s largest IPO in two years, the debut was also a disappointment to Xiaomi executives, who had been anticipating something much bigger only a few months before (see WiC415). The company raised HK$37.05 billion ($4.7 billion), but it was forced to price the IPO at the bottom of its indicative range at HK$17. Xiaomi ended up being valued at $53 billion, almost half the level that its more bullish backers had hoped.

Since then, the shares have fallen 15% to HK$14.5 at the November 28 close. However, they have been picking up from their HK11.66 low at the end of October and Xiaomi’s latest results may prove to have been a major turning point.

The company surpassed expectations across the board. Most importantly, it demonstrated that while IoT and internet services accounted for just 9.2% of overall revenues, the two now contribute more than 50% of gross profit (HSBC forecasts a 69% figure for 2018 as a whole).

Xiaomi keeps the prices of its handsets relatively low, which results in a low profit margin. But it does so to draw users into its ecosystem and then sell them internet services at a much higher return. The plan is to make most of its profits through a model that it has described in the past as “tipping”, or monetising its hardware base through the sales of software and services. “We sell our smartphones at affordable prices, but if you use our browser, watch streaming video on our phones, or use our online services, we earn a profit,” Lei told the South China Morning Post in the lead-up to the IPO as he tried to make the case for a higher valuation.

If that strategy sounds familiar, it is because Xiaomi is in many ways a wannabe Apple. And like Apple, it is also pushing its customers towards higher end phones, boosting its average selling price. During the third quarter, they spent more than Rmb1,000 per phone for the first time in the company’s history and 31% of Xiaomi’s total smartphone sales came from customers who spent more than Rmb2,000 per phone.

Then there is Xiaomi’s international push, which should be another driver for its share price. It now ranks among the top five vendors in 30 countries. It has been the top smartphone seller in India for four consecutive quarters and it is number two in Indonesia. And it is also making a push into Western Europe where sales growth has been strong (up 386% year-on-year during the third quarter).

As a result, international sales now account for 36% of the total. According to IDC figures, Xiaomi enjoys 9.4% global market share, up from 7.4% during the third quarter of 2017. Consequently, it has been one of the few smartphone vendors to buck declining global sales (they were down 6% year-on-year during the third quarter). Its overall unit sales were up 21%, although it couldn’t quite top Huawei’s, which were up a third over the same period.

The third prong of Xiaomi’s business model is its burgeoning presence offline, courtesy of its fast-expanding Mi retail network. This autumn it made waves when it opened 500 stores on a single day in India, for instance. It hopes to have 5,000 there by 2020, many of them targeting consumers in more rural regions.

Earlier this month it also opened its first store in the UK in London’s Westfield shopping centre, although its advertising blitz did not quite go to plan when customers discovered that a flash sale was not all that it seemed. Having been lured by the promise of a £1 phone, people were furious to discover there were only 10 smartphones in the promotion. Xiaomi was forced to apologise.

Elsewhere Xiaomi’s retail expansion appears to be paying dividends. According to iResearch, its Mi network generated Rmb270,000 per square metre in revenues last year, trailing only Apple in sales productivity.

Unlike Apple, Xiaomi’s Mi stores sell a lot more than smartphones and related equipment. One of the reasons why its shops are so busy is that Xiaomi has built up a huge ecosystem of IoT vendors, which also retail through its network. Customers are just as likely to walk out with a ‘smart TV’ as they are with a smartphone.

As HSBC writes, “Xiaomi is disrupting traditional home appliance manufacturers in multiple areas.”

In a move that may bother Gree’s Dong more than her Rmb1 billion bet, Xiaomi also launched its first smart air-conditioner this summer.

Of course, in terms of IoT, Xiaomi hardly has the field to itself. Huawei is a formidable competitor, selling 150 different types of smart devices. Lenovo has also unveiled IoT as a strategic pillar for its future. And Xiaomi is even in competition with some of the vendors that sell through its stores and is involved with several lawsuits relating to patent infringements.

But the core rationale is clear enough. In 2017, the IoT industry reached sales of $486 billion, overtaking smartphones ($458 billion) for the first time says HSBC.

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