Smartphones are the key pieces of hardware in the hard-fought battle for Chinese consumers. How do the local-grown manufacturers compete against foreign stalwarts? What competitive advantages can they develop?

In this second instalment of our three-part series on China’s Mobile Economy, by Winston Ma, we look at the hard-fought scene for smartphone handsets in China. With over 600 million smartphone owners, yet a market potential of about 1.15 billion people above the age of 15 (often the entry age for smartphone usage), China is the world’s largest smartphone market, yet it is quickly approaching saturation. To thrive, or simply survive, handset manufacturers will increasingly have to rely on replacement purchasers or upgraders.

Because of its juicy prospects, the Chinese handset market quickly attracted foreign players, with Apple and Samsung being the current co-leaders. Yet, to China’s credit, home-grown alternatives quickly sprouted up, usually relying on low-cost manufacturing to help penetration of the entry level market segments. For Apple and Samsung, survival has meant clear positioning in the premium segment, relying mostly on carrier sales (whereby the handset is provided free or at a discount to customers who sign long-term contracts).

On the other hand, domestic Chinese manufacturers Lenovo, ZTE, Huawei, and Xiaomi initially competed on a low-cost positioning. Yet, increasingly these manufacturers are expanding their product lines and moving into the premium segment with newer handset models. The deep pockets of Lenovo (with the support of its cash cow Personal Computer division) or Huawei (with its established telecoms router equipment profits) have helped finance the substantial upfront investments.

Battle of the operating systems
As is the case worldwide, Google’s Android system confronts Apple’s IOS, with a smattering of smaller independent competitors trying to capture crumbs of the operating system pie. One example is Xiaomi, with its self-developed MIUI operating system, a cornerstone of the company’s success, namely in attracting local app development.

Yet the specificities of the huge Chinese market are not to be underestimated, and go beyond the technicalities of operating systems. The Chinese psychology is different. Who at Apple could have guessed that its gold color option for the iPhone 5S would be the runaway success, beating out the silver and black options handily? Which handset manufacturer would have devined that large screens would be more popular in China, since they made surfing the Net easier?

Xiaomi’s runaway success
For author Winston Ma, Chinese handset manufacturer Xiaomi offers revealing aspects of the hardware side of the mobile economy. For starters, at the end of 2014, the company landed a financing round that valued the company at $45 billion, making it the most valuable start-up at the time, even exceeding the valuation of ride-sharing company Uber, floated the same month. How had Xiaomi founder Lei Jun pulled off this magic barely four years after the 2010 company launch?  Despite being a latecomer to the smartphone game, Xiaomi (meaning millet or little rice in Chinese) honed a development strategy based on low-cost production, on a base of tech fans, and on direct sales via the Net without intermediaries. Another interesting tactic in Xiaomi’s initial years? The use of hunger marketing for its handset models from 2011 to 2013, meaning production runs purposefully too small to satisfy full demand. The happy few owners were particularly proud of their purchase.

The end result? Leadership position for Xiaomi in the Chinese market among domestic brands, although rankings are contested due to the lack of full transparency in the market; and number 3 market position overall, behind Apple and Samsung.

Hold your breath
Yet the mobile hardware wars aren’t over until the fat lady sings, and that is not scheduled for soon, according to Winston Ma: “Amid ever higher smartphone penetration, the Chinese consumers’ tastes are shifting away from low-end smartphones” (page 74), yet as established Chinese manufacturers move into the more lucrative up-market postions, hungry new entrants such as Meizu or LeTV are eroding the vast bottom of the pyramid. Perhaps it is the fear of looming hardware saturation that prompts Xiaomi to insist it is an “Internet company”, not a smartphone maker. Establishing an ecosystem of internet services is one way to face the threat of phone agnostics.

Stay tuned for more
The first part of Winston Ma’s book (Casium issue 51, published July 27) provided some background information on how the mobile explosion occurred in China, and some hints on the reasons why.

In the forthcoming third part (Casium issue 53, to be published on August 24), we’ll examine the extensive software implications of the mobile boom across various sectors: gaming, social media, finance, e-commerce, and more.

Related Case Studies
Case no. 9B16A046 on Samsung smartphones
Case no. 116-0065-1 on Alibaba
Case no. 315-133-1 on Tencent 

Book Data

Title: China’s Mobile Economy; Opportunities in the Largest and Fastest Information Consumption Boom
Author: Winston Ma
Pages: 340
Publisher: Wiley
Price: $34.95

Author Bio
Winston Wenyan Ma is a managing director of China Investment Corporation (CIC), the sovereign wealth fund of China, with a focus on long-term investments in large-scale concentrated positions. Since joining CIC in 2008, he has held leadership roles in major direct transactions involving natural resources, financial services and high-tech sectors.

Prior to joining CIC, Winston Ma served as the deputy head of Equity Capital Markets at Barclays Capital. Previously, he was a vice-president at J.P. Morgan investment banking, and a corporate lawyer at Davis Polk & Wardwell LLP and Freshfields.

He is the author of the bestselling book Investing in China: New Opportunities in a Transforming Stock Market (Risk Books, 2006) and has been widely quoted in global financial media.

Winston was selected as a 2013 Young Global Leader at the World Economic Forum (WEF) and in 2014 he received the Distinguished Alumni Award from NYU.