Worstall on Wednesday The lads over at Business Insider seem to be getting a little over-excited about Xiaomi's latest fund raising exercise, claiming in their headline that it's the Apple of China. Well, no, not really, Apple is the Apple of China. Making cute kit and selling it in volume isn't the definitive point about Apple itself so a company that does merely that doesn't an Apple make.
The "Apple Of China" Raises Over $1 Billion, Valuation Skyrockets To More Than $45 Billion
That's the valuation being talked about, sure enough. Yet, as El Reg reported, there's not a great deal of profit rolling around. The corporate structure makes it very difficult to see what the actual profit margins are. But we do know that when they're all totted up, they're pretty small. We know this because we can go and look at their gross margins after the teardown guys have had a look. Admittedly, this is a little old but there's no sign of the current generation of models being any different:
Liu Hui, a Chinese semiconductor analyst concluded after a teardown analysis that the reasonable profit margin for Xiaomi phone would be 20%, or more than RMB 400 – 500 yuan, while the cost for Xiaomi phone is around 1500 yuan.
The problem here is that people are using a different meaning of profit margin. That teardown number is the gross profit margin: the difference between component costs and selling price. Apart from that one has to include the overheads of the business, design costs and so on.
Don't get me wrong, Xiaomi is getting some goodly part of the Apple model correct. They are aiming at adding value through services and design. They're certainly proving themselves pretty savvy in their Indian marketing, limiting themselves to flash sales at Flipkart, thus creating a feeling of scarcity and value. Reviews of the kit all tell us that they're pretty good pieces of electronics. But that's not enough to be considered an Apple.
To wander off a bit: anyone who has been in business will tell you that there're two basic strategies. There's the old Tesco one, pile it high and sell it cheap. This way you get low to non-existent margins but high sales volumes. There's also the sell very little specialist kit and then you can make a great margin on each sale, just not very many sales. In my own business world of metals the bloke selling steel hopes to make $1 a tonne on tens of thousands of tonnes at a time, me selling rare earths I look for 20 per cent margins on a handful of few-hundred-kg sales a year.
If really pressed everyone will agree that sometimes the stars align, perhaps as the result of some information asymmetry or something, and you get to sell, as a special deal, large volumes at high margins. But those times are rare indeed and they buy houses when they happen (for me, a weird Russian nuclear alloy in truckloads of scrap).
Finally, what everyone will tell you they want to be able to do is to sell high volumes at high margins by the bucketload each and every day. And while we all desire it, it's sadly - outside monopolies or government protection - as rare as rocking-horse shit. Perhaps the software business offers more opportunity than most other business arenas but in hardware it's really just Apple that we would hold up as the people who are currently managing it. Hundreds of millions of pieces of iKit a year and the margins are well over 20 per cent.
Which might make some think that Xiaomi is managing this: but we're back to talking about different sorts of margins again. That's Apple's net profit margin on turnover: not their gross margin on hardware. We know from the Apple teardowns that the gross margin (lower on iPads, lower again on Macs) on iPhones is well over 50 per cent. So, once they take off their design costs, overheads and so on they end up with a net profit margin that is larger than Xiaomi's gross profit margin.
We might think that Xiaomi might grow into being an Apple but that's going to be a very hard thing to do. Currently they make, for the price, very well spec'd phones. This is precisely and exactly because they have a low gross profit over component costs. It's feasible that they will be able to create enough brand loyalty that they will end up being able to sell such phones for premium prices and thus emulate Apple's gross margins: but it's something that's going to be damned difficult to do. Moving upmarket just ain't easy.
Another way to put this is that from a business point of view what matters is profit. And that's what makes Apple different. It's actually manufacturing that rocking horse shit: high gross and net margins on high volumes of iKit. High volume low margin, that's easy enough, as is low volume high margin. Outside very special times it's that fourth quadrant that is so hard to do. As that's what Apple is doing and Xiaomi ain't, we really shouldn't be going around shouting that the second is the next coming of the first.
Even a charismatic CEO just don't make it so. ®