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A Second Power Transfer in the Mobile Phone Industry: Will Xiaomi Succeed in the End?

Is it an irreversible trend or just a flash in the pan for Internet heavyweights in China to enter the mobile phone industry? Will they succeed as the new protagonists of the industry chain as they are trying to reshape the mobile phone ecosystem?

The first revolution in the mobile phone industry occurred with the arrival of 3G. Telecom operators succeeded in this revolution by shifting from old-fashioned telecommunication network providers to fashionable, entertainment-oriented information service providers. The data service methods of Japanese telecom operator NTT DoCoMo and SK Telecom from Korea were taken as models for Chinese telecom operators. On the NTT DocoMo platform i-mode for mobile phones, service providers and content providers were marginalized while operators made a lot of profit. Operators took profit shares at high proportions and paid the service and content providers separately, making the telecom operators dominant in the mobile phone industry chain.

Now the second power revolution has come. Internet companies are trying to reshape the telecom ecosystem and become the new dominators. With a large user-base at hand, can they really make money with software and applications?

“I think Internet companies will beat telecom operators and mobile phone manufacturers,” says Zhou HongYi, Chairman of Qihoo 360, while speaking at the China Telecom Mobile Internet Conference in June in Guangzhou.

What worries operators is applications like Weixin and Miliao, which may gradually replace traditional text messages and even voice services with the services of newfound phone manufacturers and Internet companies. Last year, KIK Messenger in America gave operators a fatal blow by letting users of KIK Messenger send messages to contacts in their address books for free. Xi GuoHua, Chairman of China Mobile,  recently said that traditional telecom operations are now confronted with a severe challenge provoked by Internet services.

Will the Xiaomi Model Succeed?

The so-called “Xiaomi model” develops mobile phone operating systems using the Internet, emphasizing software over hardware. Its business model is to outsource the hardware development and manufacture to a third party, while focusing on the development of mobile application software as well as on third-party developer communities. In other words, Xiaomi dominates the market through “e-commerce” and “customized service”.

Apart from the Xiaomi mobile phone itself, Xiaomi also provides users with services like the MIUI-based Android operating system, as well as Miliao, a voice chatting software. Lei Jun, Xiaomi’s CEO, described its business model in this way: ”Xiaomi doesn’t make money by selling phone or hardware, and it’s not yet clear whether one can make profit through applications.”

However, compared with Apple, which has many years of experience with consumer electronics development and manufacturing, Xiaomi Technology faces many challenges. Last October, Xiaomi was about to sell off 2000 phones. However, because floods were sweeping through Thailand at the time, where providers of the battery cells were located, they were threatened with supply problems. Thus, Xiaomi understood then the huge risks in its supply chain management.

Nevertheless, Xiaomi has an advantage in cost. It saves 40% of its channel cost by using social media for advertisements. “Xiaomi still relies on hardware to make money, and it is unclear when it can make a profit on software,” an insider from Xiaomi Technology said.

Competition Through Occupying the Mobile Phone Desktop

Different from the Xiaomi model, many Internet companies now threaten telecom operators by entering the phone industry with applications that occupy users’ phone desktops. They make profit through flows, for example, through advertisements and information retrieval.

Zhou HongYi has said that Weixin will replace text messages and MMS, VOIP will end voice services, and Internet accounts will replace phone numbers. Furthermore, he says the Internet has control of all kinds of applications. He believes that smart phones will be free of charge for hardware in the future. Internet companies will establish their business models by built-in value-added services.

Right now there are two ways for users to obtain apps: built-in apps or those downloaded from app stores. More than half of the apps used are built-in. So, built-in will be the best channel for companies to occupy. Of course, users will be the final judges.

However, Zhang Kai, GM of Zhidao Consulting, believes that the purpose of Internet companies is not built-in applications, but to make a profit by establishing the mobile phone ecosystem and imitating the business model of Apple.

Can Internet Companies Replace Operators?

Although Internet companies have entered the mobile phone industry with different business models, they have all concentrated on mobile Internet applications. Can they really replace operators and gain dominance?

“For operators, the spread of instant communication software like Miliao, Weixin of Tencent and Talkbox will cause a reduction of income from text messages,” said an industry insider. Indeed, the increase of traditional telecom services has lowered the pace of messaging globally. New technology and applications are replacing communication services at a growing speed. For example, Finland wireless operator Sonera found that people sent 8.5 million text messages on Christmas Eve in 2011, 10.9 million less than in 2010.

Sue Ruud of Strategy Analytics points out that, with the obvious increase of income from OTT information platforms, such as Messenger, WhatsApp and iMessage, the income from text messages has reduced rapidly.

Operators try to defend their profit by launching applications like China Unicom’s Woyou and China Mobile’s Feiliao. But will traditional telecom operators rally? No one is sure.

“The replacement of phone calls and text messages is an irreversible trend,” says Zhang Kai. Still, it is not easy to make money by software and applications and reshape the ecosystem of the telecom industry. In Zhang’s view, only Tencent has the possibility to replace operators. The reason is simple: QQ has 700 million users.

Translated from the Chinese original by Stella Wang (Sina Tech)

Edited by Matt Johnson

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