Protocol | China

China is building the (cheap) smart homes of the future

Xiaomi might be blacklisted in the U.S. But in China, it makes over 1,000 smart home devices, creating a network nobody can match.

China is building the (cheap) smart homes of the future

A Xiaomi store in Hangzhou, China

Sun Xinhe is the kind of geek who goes out of his way to try new gadgets. With a graduate degree in automation and a government job, the resident of Tai'an, a third-tier city in Shandong province, has over 200 smart devices in his two homes. From the washing machine to clothing racks, from the ovens to the curtains, everything is connected to a mobile app owned by one Chinese company: smartphone giant Xiaomi.

China is hurtling into the smart-home era well ahead of the rest of the world, and it's mostly because of Xiaomi, which is marshaling its experience in hardware manufacturing and taking advantage of China's lax privacy protections to achieve what Amazon and Google can only dream of: a total takeover of the home. Home life in China increasingly offers a preview to the world of what's technically possible, although privacy concerns abroad may limit how far that model can spread.

Founded in 2010 and now worth $78 billion, the Beijing-based Xiaomi has not only built the world's third-largest smartphone brand in just a decade, it's also become the frontrunner in China's $26 billion smart-home devices market. The Beijing-based Xiaomi sells over 1,500 smart-home products on its website, most of which are cheaper than those available from major competitors. Crucially, all of them can be controlled with a single app.

By offering a wide selection of affordable and relatively reliable products, Xiaomi has made itself the IKEA of smart-home devices, a comparison its founder Lei Jun welcomes. In an open letter included in Xiaomi's 2019 annual report, Lei pledged to invest about $7.7 billion over the next five years "to ensure our absolute dominance over the new smart living era."

Other prominent Chinese smartphone brands, including Huawei, realized the importance of the smart-home market only after the growth of smartphone sales stagnated in 2018. By the time they resolved to make a similar plunge into smart devices, they were years behind Xiaomi.

Keys to success

Xiaomi has taken over the smart-home market using something of a pincer movement.

"The first [tactic] is to take an expensive, high-end product — for example, a Roomba — and make a cheaper version themselves," Flora Tang, a Hong Kong-based analyst at Counterpoint Research, told Protocol.

The other route is to take a generic, low-priced product and improve it. "Power banks, table lamps, electrical outlets ... there have always been companies manufacturing them, but you won't remember what brand is the power bank you use at home," Tang said. Xiaomi will add bells and whistles competitors lack, then produce its own version with a few improvements in its design or functions. During Xiaomi's 2015 main product launch event, founder Lei Jun spent nearly 20 minutes introducing its first electrical outlet, boasting the sleek design and high-velocity capacity. Xiaomi spent over 10 million RMB (about $1.5 million) in the R&D and manufacturing of this outlet alone, Lei claimed.

As a result, Xiaomi is doing exactly what IKEA did to the furniture industry: lowering the cost of expensive items while improving the quality of cheap goods. It's perfectly suited for China's hundreds of millions of new middle class, who want a taste of the good life at a reasonable price.

But low prices aren't unique to Xiaomi. What's more important is the network effect it creates among its many smart-home products.

It started in 2013 when Xiaomi launched an "ecosystem" strategy of investing in a slew of manufacturing companies. Today, it has stakes in over 300 companies making products from wearable gadgets to cables to kitchen appliances to cleaning tools. In most cases, Xiaomi doesn't control these companies but enjoys an extremely close relationship with them. In fact, many of these sub-brands have names that resemble Xiaomi, like "Green Mi," "Purple Mi," "Cloud Mi" and "Smart Mi." Customers often confuse these products as Xiaomi's own, which is fine with the tech giant.

This arrangement benefits both sides. Sub-brands save on sales and marketing by selling through Xiaomi's website and physical stores. They also benefit from Xiaomi's supply chain, according to Tang. As a low-cost smartphone company, Xiaomi has abundant experience negotiating low prices for its parts, an advantage it shares with the companies it invests in.

In return, the devices they produce often can only connect to Xiaomi's own home-kit platform, "Mi Home." Together, they formed a large and closed-circuit system. Once a customer steps in, he or she can get anything from it — and the costs of switching to another smart-home provider quickly become prohibitively high.

The network effect certainly worked on Sun, the Xiaomi product enthusiast. He fell for Xiaomi's devices around 2015 and gradually bought hundreds of the company's home products.

Sun finds pleasure in designing complex interactions among his devices. When he enters the room he uses as a walk-in closet, the motion sensor will trigger the light to switch on, the clothing rack to descend and the curtains to close. "All I need to do is to change my outfit and walk out," he said. After a while, everything automatically returns to its place.

Challenges emerge

But things are changing for Xiaomi's ecosystem. While many sub-brand companies have benefited significantly from Xiaomi's investment and supply chain in the early stage, they have grown into their own brand and are increasingly seeking independence.

The low pricing model that Xiaomi insists on has forced these companies to take narrow profit margins. Many of them are now developing different, higher-end products that work with other systems like Apple's HomeKit.

"Smart Mi will eventually have its own sales team and branding," the CEO of Smart Mi said in 2018, according to Chinese magazine Time Weekly. The company manufactures smart heaters, air conditioners and air purifiers for Xiaomi's ecosystem.

This is a longstanding problem that Xiaomi needs to solve. Since its early years, Xiaomi has branded itself an affordable option for the masses — customers rarely go to Xiaomi for high-end products. But the GDP per capita in China has almost doubled since Xiaomi's founding, and people are willing to pay more to improve their lives. It remains a question whether Xiaomi can appeal to these richer customers.

There's another challenge that Amazon and Google face regularly, one Xiaomi has dodged so far: data privacy concerns. When Amazon introduced an indoor drone last September, social media lit up with privacy concerns. In China, where surveillance has become a collaboration between the state and the private sector, such discussions remain unusual. Xiaomi is largely exempt from suspicion even though its products can literally reach every corner of a home.

Last October, China released its draft of the Personal Information Protection Law, but it made no specific mention of smart-home devices. Home data privacy made Chinese headlines in 2017 when some people found out security camera footage was being livestreamed publicly, but there's been little discussion around smart-home devices since then.

"Of course I worry about [privacy], but there's no good solution to this problem," Sun said. He considers it necessary for these products to learn more about his way of living. "It's just like having a housemaid. She has to know where you place everything in your home, how to use them, when you go to bed and what you like to eat. If she doesn't know that, she can't serve you."

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