One common narrative is that the profits in tech are not in hardware nor even in software, but in services. The poster example for this trend is Xiaomi, a company that is supposedly subsidising the cost of its smartphones, and making it up with profits from services.
I have always had a problem with this logic. My problem resides in the fact that not all services, even the very successful ones, are profitable. Another problem is that the most profitable tech company in the world, Apple, is making its money, not because it has the best services in the world, but because it has the best devices (which are a combination of hardware, software and services). It doesn’t seem to be as simple as services = high profits, hardware = low profits.
In this light, I think it’s important to look at exactly what kind of services Xiaomi is offering. This Wall Street Journal article is a good place to start.
Mr. Lei expects big growth in services built around the smartphone ecosystem. Each day, Xiaomi’s 130 million users use their phones 115 times for a total of 4.5 hours on average, he said. The company has set up a marketplace for online commerce and services, including things as diverse as video, news, financial services, television sets, air purifiers and luggage. “We’re a huge content platform,” he said. “All our [traffic] numbers are astronomical.”
The services described here are all quite commonplace. There are many companies doing video and online commerce, and technically it is very straightforward to do. Online financial services are also provided by many companies, and there is little reason to believe that Xiaomi’s offerings are significantly better than average. The selling of branded television sets, air purifiers and luggage is really low-tech, and in many ways what we would consider a commodity. If these are the services that are profitable for Xiaomi, then we have to rethink what it means to be profitable in services.
It would seem that profitability in services is not directly tied to the innovation provided. At least Xiaomi doesn’t believe so. Instead, Xiaomi seems to be selling mediocre services and products to its loyal fan-base, and it appears to believe that this is how to make profits.
The way I see it is this;
Android smartphones are unprofitable because of hyper-competition. The promise of high-growth lures companies into this market, despite very low short-term profits. On the other hand, commodities like air purifiers. luggage, online financial services etc. have a proven business model that is at the very least, more profitable than smartphones, partially because competition is less fierce. Therefore, one business model is to gain the trust and loyalty of customers by selling good smartphones at cheap prices, to the extent that you become a lifestyle brand. Then sell mediocre but profitable lifestyle products with your branding to these customers.
In a nutshell, gain customer loyalty through high-tech, but earn profits from low-tech.
And “services” is the low-tech part. Which also means that it’s relatively easy to copy.
Update
Just to extend this argument and make it more interesting.
Imagine if Google decided that it needed another business model outside of advertising. Imagine if they adopted the Xiaomi model. What might we see?
I could imagine;
- Google branded bicycles, apparel, furniture.
- Google banking and insurance services.
- Google virtual shopping malls.
Mind you, none of these need innovative tech inside them. Just do what everybody else is doing but leverage the power of your brand to earn higher-than-average margins.
Naofumi Kagami 