How Xiaomi Profits from Razor-Thin Hardware Margins
Xiaomi follows a unique business model of selling hardware at low profit margins to rapidly gain market share, then monetizing its user base through internet services. The company caps net profit margins on hardware at 5%, instead making money from online games, ads, and value-added services.
Xiaomi, the world’s third largest smartphone maker, is known for its high-quality devices sold at aggressively low prices. The company has publicly pledged to limit the net profit margins on its hardware business, which includes smartphones and IoT products, to a maximum of 5%. This prompts the question - how does Xiaomi actually make money?
The key lies in Xiaomi’s unique business model that prioritizes gaining massive scale through its hardware in order to monetize via internet services. Selling phones near cost allows Xiaomi to rapidly acquire users and build market share in the cut-throat smartphone industry. With a huge captive user base, Xiaomi then generates significant profits from its internet services division.
While hardware makes up the bulk of Xiaomi’s revenues, internet services are far more profitable for the company with gross margins around 75%. In Q1 2024, internet services brought in RMB 8 billion in revenue for Xiaomi, with RMB 6 billion in gross profits. 31% of internet revenue came from overseas markets. The main drivers are:
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Online games - Xiaomi operates a lucrative mobile gaming business, both developing games in-house and taking a cut of third-party games promoted on its app store. Hit titles like COK have over 10M DAU.
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Advertising - Xiaomi earns sizable income from ads placed throughout its custom Android interface MIUI and various apps. Its massive user base of over 500M MAU globally is highly valuable to advertisers.
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Value-added services - Paid subscriptions for digital content like music, video and books as well as Xiaomi’s fintech offerings contribute meaningful profits with low marginal costs.
Beyond the internet services, Xiaomi squeezes out profits despite thin hardware margins by pushing component costs down through large volume guarantees to suppliers, running an extremely lean direct sales operation, and upselling high-margin accessories. Making money on services allows Xiaomi to subsidize hardware to levels competitors cannot match.
This flywheel of using hardware as a low-margin user acquisition vehicle to feed high-margin internet profits has propelled Xiaomi to 3rd place globally with ambitions to challenge Samsung and Apple. As long as it continues adding millions of new device owners each quarter, Xiaomi can afford to live off the “digital services” rather than fat hardware margins. It’s a model uniquely adapted to the Internet age.