The iPhone is losing China to Xiaomi and the new models won’t help

Over the past few years, we’ve seen Apple put increasing emphasis on China, opening new stores, integrating Chinese social media into iOS 6, etc. The new iPhones may be the company’s biggest move towards grabbing the China market yet, and it comes at a time when Apple has found its position in the Middle Kingdom slipping through its fingers. Although sales have increased, its tablet market share has dropped by more than 20% over the past year, and its smartphone market share is below five percent now. This quarter, for the first time ever, Chinese startup Xiaomi controlled a bigger piece of China’s smartphone market than Apple.

Xiaomi and Apple have been connected since the beginning. At first, that was just because Xiaomi founder Lei Jun seemed to have a bit of an obsession with Steve Jobs. Apple fans found it funny. Just a few months ago, no less a source than the New York Times said that Xiaomi — which had grown into an “empire” — had done so by “aping Apple”.

That’s a description that I took some issue with, but it doesn’t matter now. It’s clear who is following who in China: Xiaomi is paving the way, and Apple is running to catch up.

Apple’s initial lead, in China and elsewhere, was due to the fact that it offered the best product, period. When the iPhone came out, there was nothing on its level, and the fact that the phones’ prices were ludicrously, offensively inflated didn’t matter — people had the money, they wanted the best, and Apple’s product and design was simply a cut above what anyone else was offering.

Xiaomi came along a few years later, and while it may have aped some of Apple’s aesthetics (if “black rectangle” is a design concept we’re giving Apple credit for), its marketing has always been decidedly different. Apple’s phones were an US$800 luxury in China. Xiaomi’s were less than US$350, and the company’s CEO was running around telling people that he wasn’t even trying to make money on the hardware at all. In that sense, Xiaomi was the anti-Apple. Steve Jobs was many things, but he and his company have never been known for trying to spare consumers’ wallets.

The big problem for Apple is that Xiaomi’s product was good. Really good. Sure, none of Xiaomi’s handsets have the metal-and-glass heft of Apple’s $800 flagship phone. But they’ve got the silky-smooth user experience, the thoughtful and simple UI design, the broad selection of great apps (thanks to their Android compatibility), and even the hip-techie factor that Apple’s phones had in the early days. I was an iPhone 3G user who switched to Xiaomi shortly after the release of the Mi1, and to be honest, I didn’t notice that much of a difference between it and my friends’ iPhone 4s. Well, except for the price, of course. I bought two Xiaomi handsets — one for me and one for my wife — for significantly less than what a single iPhone would have cost in China.

Over the intervening two years, Apple has lost ground to Xiaomi and companies like it (Xiaomi may have led the charge, but cheap-and-powerful Android phones are available in droves in China these days). So when people ask why Apple is about to start offering a low-cost smartphone, I point to Xiaomi and China as the answer. After all, Apple still has nearly half of the US smartphone market, but less than five percent — and shrinking — of the market in China.

What to do? The answer Apple has chosen appears to be: follow Xiaomi into the cheap end of the market with a plastic iPhone that can be sold at a lower price. It’s an interesting approach, albeit one that’s coming a bit late, two full years after China’s cheap smartphone revolution kicked off. But it’s not going to work in the long run. Here’s why:

• Price: Being a foreign company, Apple can’t compete with Xiaomi on price and still profit. In fact, it may not be possible for it to compete on price at all. China levies heavy import duties on foreign tech products; that’s part of why the same unlocked 16 GB iPhone 5 that costs US$649 in the United States costs $866 in China. So to compete with Xiaomi on price, Apple would actually have to produce an equally powerful phone for significantly less than Xiaomi does, because Xiaomi’s price is not affected by import duties. I know Apple is great at finding cheap labor — probably too great — but I don’t think they’re good enough to beat Xiaomi by much, and I doubt the company’s shareholders will be interested in selling a phone that doesn’t make Apple a beefy profit once the initial thrill of a boosted market share wears off.
• Branding: Because of the high prices, iPhones are perceived as a luxury item in China. Offering a low-cost phone will probably be very popular in the short run because there will be lots of people who can’t afford an expensive iPhone but will rush to buy the cheap one for the luxury brand cachet that it comes with. The problem, of course, is that with a cheap option on the market, that cachet is going to wear off. After a year or two of offering a cheap phone, Apple isn’t going to be a “luxury” brand anymore. The iPhone is going to be just another smartphone. And if it’s just another smartphone, and other companies offer similar products for cheaper, what’s the point of paying a premium for the brand? There isn’t any point, and people aren’t going to do it.
• Ecosystem: The iOS/Android battle may be raging elsewhere in the world, but in China, it’s over, and Android won. Users prefer the open ecosystem that exists in China, with dozens of app stores to choose from and no one company in control of what you can and can’t see. They prefer the customizability of Android, especially given that Chinese users use their phones a little differently than Americans, and iOS is still designed primarily with the US in mind. China-developed Android ROMs (like Xiaomi’s MIUI or Meizu’s Flyme) give users China-specific features and tweaks that make using their phones a little easier. China’s iOS could certainly be adapted to include some of these features, but ultimately, it’s never going to be as open as Android because that’s not how Apple works.

The wild card here, of course, is iOS. We’ll be getting a new version of it very soon, and by all reports the differences are dramatic. If Apple is really offering something no one else in China has with iOS 7, then things might be different. But I’m not optimistic that it is, or that it’s particularly in tune with the kinds of changes Chinese users would want anyway.

So here’s what I think is going to happen: China is going to go nuts at the announcement of a cheap iPhone. Absolutely bonkers. Sales are going to spike, Cook will be hailed as a genius, and all will be right with the world for a while in Cupertino. Apple will probably even grab its top-five spot in China’s smartphone market back again for a little while. This effect will be even more pronounced if Apple finally announces a deal with China Mobile, which it might (and certainly ought to).

But after some time has passed and the 5c has had time to erode all of Apple’s branding as a high-end, luxury status symbol, all that will be left is the product itself, probably still at a higher price point than comparable domestic alternatives. In that market, can Apple beat Xiaomi? I could be wrong, but I really doubt it.

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This article by C.Custer originally appeared on Tech in Asia, a Burn Media publishing partner.