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Will Xiaomi’s Disruptive Force Move Around The World?

During the past four years Xiaomi has taken China by storm, with explosive growth that has challenged the incumbent smartphone manufacturers. During the last year-and-a-half it has set its sights on Southeast Asia and India, pushing hard to expand into both.

But for all the success that Xiaomi has had, creating the market segment of low-cost high-feature phone which many — including ASUS (TPE: 2357) with its Zenfone have rushed to emulate — the company does have limits to its success.

The world’s most lucrative smartphone market is the United States. As a whole American consumers are the world’s wealthiest, and the world’s largest economy has a strong taste for consumer goods. While the taste of China’s newly wealthy for gadgets such as Apple’s (NASDAQ: APPL) iPhone and Apple Watch might make headlines, the regular and constant demand of US consumers for the same things do not — unless it’s launch day for a new Apple product.

Herein lies the problem for Xiaomi: it’s a product without a market outside of Asia. Xiaomi can sell its phones with razor-thin margins because the handsets effectively serve as a loss leader for its MIUI services. MIUI, a heavily forked version of Android, replaces Google’s (NASDAQ: GOOG) services and connects the handset into the broader Chinese e commerce ecosystem.

This works well in for Xiaomi in China. Any purchases the user makes with his Xiaomi device, Xiaomi gets a cut. But in the US, this simply won’t work. Google’s ecosystem is far too entrenched as a competitor to Apple for a third party to enter. Amazon (NASDAQ: AMZN) tried to in many ways emulate Xiaomi’s business model with its Fire Phone, but this foray failed miserably costing the company $170 million.

Xiaomi does have an advantage unlike other major smartphone companies: it doesn’t have a hefty patent portfolio. While giants in the smartphone business such as Apple, Samsung and Qualcomm (NASDAQ: QCOM) are always seemingly at war over patents, Xiaomi doesn’t have this baggage. In fact, Xiaomi can now take advantage of an unfavorable ruling against Qualcomm to have access to its patents at a competitive price.

In an interview with CKGSB Magazine, Teng Bingsheng, Associate Professor of Strategic Management at CKGSB and a Xiaomi analyst explained why this would be an advantage.

“Some people have been criticizing Xiaomi for the lack of intellectual property, but the reality was that Xiaomi could access technologies by paying for them. For example, Qualcomm has been providing this package of patents to various phone makers by charging a lump sum fee,” he said.  “But, of course, Qualcomm has some [anti-trust] problems in China and beyond [for having this arrangement]—it was just fined RMB 6 billion and the model doesn’t exist anymore. The implication is that companies with more patents will be better off, but for companies like Xiaomi, their patent payments will be somewhat higher.”

Mistrust of China

But the elephant in the room for any Chinese brand expanding into the United States is dealing with its Chineseness. Consumers in the US have an institutional mistrust of Chinese made goods over perceptions of poor build quality, or in the case of telecommunications equipment cyberwarfare. Regardless of whether these issues are real or perceived with Xiaomi, both will be an uphill battle for Xiaomi to fight these in the marketplace.

Asia’s a big market

While Xiaomi has ambitions to expand to become a global brand, the reality is it will be extremely difficult for the company to make it in the West.

But there’s plenty of market in the East for Xiaomi to sell to. There’s a whole generation of consumers in third and fourth tier cities in China and Southeast Asia that haven’t been sold their first smartphone yet.