stratechery
stratechery

Dear Zoë Keating: Tell YouTube to Take a Hike

Cellist Zoë Keating is asking What Should I Do About YouTube?:

My Google Youtube rep contacted me the other day. They were nice and took time to explain everything clearly to me, but the message was firm: I have to decide. I need to sign on to the new Youtube music services agreement or I will have my Youtube channel blocked.

This new music service agreement covers my Content ID account and it includes mandatory participation in Youtube’s new subscription streaming service, called Music Key [a Spotify-like service that costs $9.99/month], along with all that participation entails.

Keating primarily focuses on the fact that YouTube is basically giving her no choice in the matter:

The catalog commitment is the biggest issue for me. All these years I’ve yet to participate fully in any streaming service although I’ve chosen to give a handful of recordings to a few of them. If anyone wants more and they balk at paying for it, they can always stream all my music for free on Bandcamp or Soundcloud or they can torrent it (I uploaded my music to Pirate Bay myself many years ago). I’ve heard all the arguments about why artists should make all their music available for streaming in every possible service. I also know the ecosystem of music delivery made a shift away from downloading last year. Streaming is no longer advertising for something else, it is the end product. It’s convenient. Convenience is king. Yup, got all that, thanks.

This is the important part: it is my decision to make.

Certainly, YouTube owns their service, and they get to choose the terms they offer. And it’s easy to look at Keating – who uploaded her entire catalog to The Pirate Bay – and dismiss her as some sort of radical. I get the impression from Keating’s article that that is exactly how she is perceived:

A year ago my Youtube rep let me know there was a new music service coming and she sent along a new agreement. I read it and raised my concerns and asked if I could return the contract with those particular terms struck out. Alas no but the product folks seemed genuinely curious about my concerns and I had a phone meeting with them. The meeting was similar to one I had with DA Wallach of Spotify a couple years ago. Similar in that I got the sense that no matter how I explained my hands-on fan-supported anti-corporate niche thing, I was an alien to them. I don’t think they understood me at all…

In fact, while Keating may be a radical, I think she’s also entirely rational: I’m increasingly of the opinion that all-you-can-eat subscription services like YouTube Music Key or Spotify are a downright bad idea for niche artists.

The Problem with Niche Artists and Subscription Services

Stepping back, in one of my favorite episodes of Exponent, James Allworth and I coined the idea of The Internet Rainforest (although, now that I think about it, we mostly refer to it as the Internet jungle). The idea is that the economics of the Internet work for two types of businesses:

  • Massive businesses that can take advantage of the Internet’s scale to reach a huge number of people very cheaply and efficiently
  • Niche businesses that can take advantage of the super low costs involved in running an Internet business to reach a very narrow niche of people all over the world very cheaply and efficiently

Think of any potential audience as following a power curve:

The two business models on the Internet

The two business models on the Internet

With this audience there are two ways to maximize revenue:

  • You can try to make a little bit of money from a lot of people – this entails getting a little bit of money from everyone on the curve
  • You can try to make a lot of money from a few people – this entails maximizing the gain from the people on the left side of the curve

Think about a company like Facebook: true, there may be some Facebook-aholics who live in the service and would love if Facebook would just go crazy on the features, but serving those customers would endanger the right side of the curve – the people who are more take-it-or-leave-it. Ultimately, because Facebook monetizes through advertising, more eyeballs are more important than more intensive ones, so their product decisions are made with an eye towards appealing to as many people as possible. Of course Facebook doesn’t stop here – you can think of targeting as a way for them to make more money from some consumers than from others. Still, the goal is more users, not fewer.

A site like mine, on the other hand, or any number of niche-focused sites and services, is much more concerned with people on the left-side of the curve. We don’t want pennies from millions, but tens or hundreds of dollars from thousands. This, though, means that our motivations when it comes to our product are far different: if we appeal to everyone, we are necessarily loved by no one.

True Differentiation

Tim Wu has a piece in The New Yorker about the rise of small businesses, with a particular focus on craft brewers:

Consider the story of craft beer. Large-scale breweries destroyed their smaller rivals in the twentieth century because they were able mass produce the stuff for cheaper (reaching wholesale prices of about fifty cents a beer or less) and because their fat margins allowed them to pay for things such as television advertising…

But the small breweries came back. Their beers were not better advertised and certainly not better priced. Rather, the crafts went after an enormous blind spot for the big breweries—namely, flavor. I don’t entirely mean to be snide; more precisely, craft beer succeeded by opting not to compete directly, instead pursuing what can be called a “true differentiation” strategy. That means they established a product that, in the mind of the consumer, is markedly and undeniably different…

Here’s the thing: a lot of people dislike many of these craft beers, or at least some of the more unique and radical brews. But that’s a good thing! You can only succeed against a low-cost competitor by being different, and to be different is to be polarizing. More than that, though, you need a different business model: craft breweries make money by charging more; big breweries make money by reducing costs.1

The difference in business models is far more stark on the web; at scale, advertising is the obvious solution. For niches, though, I strongly believe that direct payment is superior. It’s simply easier to get a lot of money from your best fans than it is to get a little bit of money from many. This, though, is the problem with all-you-can-eat subscription services: they only afford the chance to make a little bit of money from any one customer, even as they increase the friction over free. And, I agree with Keating that the subscription services, including YouTube, don’t understand this:

The Youtube music service was introduced to me as a win win and they don’t understand why I don’t see it that way. “We are trying to create a new revenue stream on top of the platform that exists today.” A lot of people in the music industry talk about Google as evil. I don’t think they are evil. I think they, like other tech companies, are just idealistic in a way that works best for them. I think this because I used to be one of them. The people who work at Google, Facebook, etc can’t imagine how everything they make is not, like, totally awesome. If it’s not awesome for you it’s because you just don’t understand it yet and you’ll come around.

I think it’s more that nearly everyone at tech – and I’ve witnessed this first hand again and again – is deeply conditioned to think at scale. It is the first question out of anyone’s mouth when it comes to a new service or product – “Can it scale?” Niches, though, don’t scale; they go deep. More importantly, they go deep in a way that wasn’t possible previously. Note again this line:

We are trying to create a new revenue stream on top of the platform that exists today.

I suspect this was in reference to the monetization options already on YouTube, but I have a much more profound objection to this idea: the thing about craft brewers is that they didn’t even have the option to be different until 1978 when President Carter signed Senate Amendment 3534 which deregulated home brewing. Similarly, the vast majority of niches – particularly for rock-and-roll cello players – were economically unviable before the Internet drastically reduced the cost of both production and distribution. In other words, there is nothing to “build on top of.” Spotify and YouTube Music Key and other all-you-can-eat services are ultimately suited for music that is broadly appealing – the same sort of music that has ruled the radio for decades. For anything truly different, though, anything with a limited but intensely interested audience, they are nothing but a bad idea – a way to both limit your audience and limit the amount of money you can make from your best fans.

The Proof is in the Revenue

In fact, Keating is the best example of this: she revealed her revenue figures last year. From The Guardian:

Keating’s biggest source of income last year was Apple’s iTunes Store, where sales of 32,170 single tracks and 3,862 albums netted her just over $38,195. Meanwhile, 185 tracks and 2,899 albums sold through her profile on direct-to-fan site Bandcamp earned a further $25,575, while a mixture of physical and MP3 sales on Amazon earned her a further $11,571.

403,035 Spotify streams earned Keating $1,764, while more than 1.9m views of videos on YouTube – mostly those uploaded by other people featuring her music – earned her $1,248. US personal radio service Pandora generated $3,258 of royalties – but from an undisclosed number of streams.

To be sure, downloads are dying broadly, but that’s my entire point: the mistake YouTube and Spotify and nearly everyone else makes when considering media of all types is to put everyone in the same boat. In fact, it’s the middle that is doomed but things are looking up for the truly differentiated. There are more ways to reach more fans who really care and who will relish the opportunity to pay.2

So there’s your answer Zoë: tell YouTube to take a hike (but hey, keep it for marketing).

  1. As Joe Cieplinski noted on Twitter, “Your update today made me think of indie app devs. Most make craft beer and try to sell it at Bud Light prices.”
  2. Concerts are one way to make money, but they’re really expensive especially for niche artists (and they’re obviously not an option for non-musicians). I don’t believe they are a sustainable answer

Podcasts: Exponent 032 – Follow-up and Frustration; This Week in Tech; The Talk Show

On the newest episode of Exponent, the podcast I co-host with James Allworth:

We briefly follow-up on last week’s copyright discussion, discuss Ben’s article on what the technology adoption curve gets wrong about Apple and Xiaomi, and then react to Microsoft’s Windows 10 (and Project HoloLens) presentation

Links

  • Stratechery Forum Discussion about Episode 30: Flabbergasted – Stratechery Forums (members-only)
  • Ben Thompson: The End of Trickle-Down Technology – Stratechery
  • Ben Thompson: Part 1 of an Interview with Xiaomi VP of International Hugo Barra on India and Xiaomi’s Strategy and Target Customer – Stratechery (members-only)
  • Ben Thompson: Microsoft’s Windows 10 Event (and Project HoloLens) – Stratechery (members-only)
  • Ben Thompson: It’s Time to Split Up Microsoft – Stratechery
  • Ben Thompson: Face in not the Future – Stratechery
  • Ben Thompson: Christmas Gifts for Microsoft, Intel, Amazon – Stratechery

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback


This Week in Tech – The Adorable Kitten Show

Last Sunday I joined Leo Laporte, Serenity Caldwell, and Iain Thomson for a discussion about requiring backdoors, digital arms race, Xiaomi’s opportunity, and more.

You can listen to the episode here


The Talk Show – Malaprops

I joined John Gruber for (another) marathon episode of The Talk Show, where we covered Apple’s hiring practices, Scott Forstall, Instagram, Box’s IPO, the Amazon Echo and Phone, and Microsoft’s Windows 10 event.

You can listen to the episode here.

As an aside, I noted in this show that Apple, at least in my experience, hires more broadly than many tech companies which I characterized as being very Stanford focused. I hope this is obvious, but one, I was using Stanford as a stand-in for a general focus on academic qualifications, and two, Stanford is awesome and lots of awesome people have gone there. My only point is that a diversity of backgrounds and experiences is a good thing. I think that was clear, but I apologize if it came across at all differently.

The End of Trickle-Down Technology

One normally wouldn’t expect farmer psychology and technology to have much in common, but drawing unexpected connections is the mark of truly innovative thinkers, and Geoffrey A. Moore’s Crossing the Chasm is a truly innovative book.

Building on the work of three Iowa State professors studying the spread of hybrid seed corn, Moore developed the technology adoption cycle, which breaks the market for new technologies into five parts:

image-26

  • Technology Enthusiasts love tech first and foremost, and are always looking to be on the cutting edge; they are the first to try a new product
  • Visionaries love new products as well, but they also have an eye on how those new products or technologies can be applied. They are the most price-insensitive part of the market
  • Pragmatists are a much larger segment of the market; they are open to new products, but they need evidence they will work and be worth the trouble, and they are much more price conscious
  • Conservatives are much more hesitant to accept change; they are inherently suspicious of any new technology and often only adopt new products when doing so is the only way to keep up. Because they don’t highly value technology, they aren’t willing to pay a lot
  • Skeptics are not just hesitant but actively hostile to technology

Moore was primarily concerned with “crossing the chasm” from the early market – enthusiasts and visionaries – to the mainstream market – pragmatists and conservatives, and if there is one product that clearly crossed the chasm, it is the smartphone. There are an estimated two billion smartphones in use around the world, and in developed countries penetration is reaching the 80% mark – only the skeptics are left. Surely this is a mature market.

That, though, makes the fates of the three biggest smartphone companies – Apple, Xiaomi, and Samsung – particularly interesting:

  • Apple offers by far the most expensive phones on the market, but even though the early price-insensitive market has presumably been saturated, the iPhone is actually growing
  • Samsung phones are widely available at multiple price points, making them an easy choice for low information customers on the right side of the cycle, yet the company is struggling
  • Xiaomi has very aggressive prices, but their brand proposition is very much tuned to the left side of the cycle

All of this seems to fly in the face of Moore’s assumption that late-stage adoption would be driven by price and pragmatism (or, in the case of conservatives, necessity). Price and pragmatism might as well be Samsung’s motto, while Apple is super expensive and Xiaomi is avowedly geeky.1

I suspect the problem is that while Moore has updated “Crossing the Chasm” (the third edition came out last January), the book is still a product of 1991 when nearly all technology buyers were businesses located in developed countries. Smartphones don’t have either qualification: people buy smartphones, not businesses, and developing countries are just as much a market as developed ones.

Apple and the Conservatives

According to Moore, high prices are only sustainable on the left side of the adoption curve:

The first perspective to set on pricing is the customers’, and, as we noted in the section on discovering the chasm, that varies dramatically with their psychographics. Visionaries – the customers dominating the early market’s development – are relatively price-insensitive. Seeking a strategic leap forward, with an order-of-magnitude return on investment, they are convinced that any immediate costs are insignificant when compared with the end result. Indeed, they want to make sure there is, if anything, extra money in the price, because they know they are going to need special service, and they want their vendors to have the funding to provide it. There is even a kind of prestige in buying the high-priced alternative. All this is pure value-based pricing. Because of the high value placed on the end result, the product price has a high umbrella under which it can unfold.

Certainly Apple has captured the visionaries, but how is it that the iPhone continues to grow? After all, Moore argues that conservatives will behave the exact opposite:

At the other end of the market are the conservatives. They want low pricing. They have waited a long time before buying the product – long enough for complete institutionalization of the whole product, and long enough for prices to have dropped to only a small margin above cost. This is their reward for buying late. They don’t get competitive advantage, but they do keep their out-of-pocket costs way down. This is cost-based pricing, something that will eventually emerge in any mainstream market, once all the other margin-justifying elements have been exhausted.

In this Moore’s thinking is not unlike Clayton Christensen’s: low-end disruption theory is also focused on performance and price. In a new market – the visionary market – when no product is good enough, the integrated provider can sell superior performance with a margin to match, but over time, as the technology becomes “good enough,” lower-priced modular competitors will take over the market.

However, as I argued in Best, in consumer markets the user experience is just as important.

The primary flaw in this conclusion, as I detailed last year, is that the Christensen evaluation of “good enough” only considers technical capabilities. Christensen did later add the idea of emotional jobs-to-be-done – this covers things like luxury bags, for example, which confer status – but that doesn’t fully explain Apple in particular. Instead, my position is there is a third component of product capability: the user experience. Moreover, the user experience is unique in that, like emotional jobs-to-be-done, a product can never be “too good,” and, like technical jobs-to-be-done, it is always possible to improve – or to fall behind.

Moreover, if user experience matters generally, it matters the most to conservatives. Moore notes:

The truth is, conservatives often fear high tech a little bit. Therefore, they tend to invest only at the end of a technology life cycle, when products are extremely mature, market-share competition is driving low prices, and the products themselves can be treated as commodities. Often their real goal in buying high-tech products is simply not to get stung. Unfortunately, because they are engaging with the low-margin end of the market, where there is little motive for the seller to build a high-integrity relationship with the buyer, they often do get stung. This only reinforces their disillusion with high tech and resets the buying cycle at an even more cynical level.

If high-tech businesses are going to be successful over the long term, they must learn to break this vicious circle and establish a reasonable basis for conservatives to want to do business with them. They must understand that conservatives do not have high aspirations about their high-tech investments and hence will not support high price margins. Nonetheless, through sheer volume, they can offer great rewards to the companies that serve them appropriately.

I think Moore was spot-on on the psychology of conservatives, but completely underestimated their willingness to pay for a solution that allays their fear. These customers don’t want leftover technology that barely works. They want technology that works better. Specifically, Apple’s focus on the user experience ought to be even more attractive to conservatives than it is to visionaries, and this very sizable group is potentially more willing to pay for a solution that is easier to use.

If indeed Apple has broken through with conservatives, this has powerful implications for all kinds of companies: smartphones are the tip of the spear when it comes to the spread of technology into every part of society, and what Apple may be demonstrating is that there is real money to be made amongst late adopters if the user experience is demonstrably superior. To be sure, Apple’s powerful brand and reputation is hard to replicate,2 but the iPhone’s continued success offers hope that customers will pay for true differentiation, not trickle-down technology.

Xiaomi and the Visionaries

If Apple is doing surprisingly well on the right side of the adoption cycle, I think the best way to think about Xiaomi is that they are competing in a different market entirely. For much of China and especially India, price matters not because people don’t care, but simply because many don’t have very much money.

This is a critical distinction: in Moore’s telling, pragmatists and conservatives pay attention to price simply because they aren’t willing to pay a premium. They have the capability, but not the desire. This, though, does not describe the typical Xiaomi customer. From an interview I conducted with Xiaomi Vice President of International Hugo Barra (members only):

BT: Who is your target customer in China?

HB: Our target customer in China are the 18 to 30 year olds, reasonably well educated, reasonably geeky, and value-orientated [i.e. not rich] and who appreciate the high spec. They are the ones who become the ambassadors for the brand to other audiences…

BT: What about internationally?

HB: Largely the same thing. I think we what we’re learning in India in particular is that the IT-educated is extremely large. I think a lot of that is a result of India’s tradition of being the IT back office of the world. In India, even the Red Mi product line attracts the IT-educated customer who just doesn’t have the money to buy one of our high-end products. But we find ourselves having a conversation about features and specs with a customer who bought Red Mi 1S that in other markets I would only have with someone who is buying a high end product. We’ve never experienced a level of scrutiny at a spec and performance level on a Red Mi product that we have in India.

These customers are not conservative, or even pragmatists: they are enthusiasts and visionaries who simply don’t have very much money. The proper way to reach them, then, is not to sell them trickle-down technology: they will see right through that, and dismiss it out of hand. Rather, the solution to is develop new business models – indeed, in the case of Xiaomi, a new company – that is built from the ground-up to serve their specific needs.

This, too, is a powerful opportunity: there are far, far more potential customers in developing countries than there are in developed ones, but just because they don’t have much money does not mean they are technological laggards. Indeed, many of these customers are even more advanced when it comes to being mobile first because of the lack of a PC legacy, and they will embrace a brand that lets them live on the cutting edge.


To be sure, there is still innovation happening among rich consumers in the developed world – Uber is evidence of that! However, I suspect it is these two markets – conservatives in developed countries, and enthusiasts and visionaries in developing ones – that will provide some of the biggest opportunities over the next few years. The smartphone has opened the door: which companies will walk through it?

  1. Xiaomi Vice-President of International Hugo Barra told me in an interview (members-only) that Xiaomi is “a geeky lifestyle brand
  2. Even if, as many fret, it is being damaged

Mobile First

Last Friday was the eight-year anniversary of the announcement of the iPhone, the event that began the mobile epoch. It was, though, an Apple rumor that to my mind illustrated just how much the world has changed.

Mark Gurman is reporting at 9to5Mac that the next MacBook Air will have a radical redesign. The biggest surprise was about the ports, or lack thereof:

The upcoming 12-inch Air has the fewest amount of ports ever on an Apple computer…On the right side is a standard headphone jack and dual-microphones for input and noise-canceling. On the left side is solely the new USB Type-C port. Yes, Apple is currently planning to ditch standard USB ports, the SD Card slot, and even its Thunderbolt and MagSafe charging standards on this new notebook…As we’ve reported on multiple occasions, the new USB Type-C connector is smaller, faster, and more capable than the standard USB 2.0 and 3.0 ports on existing computers. The connector is able to replace the Thunderbolt Display port on the current Apple laptops as USB Type-C actually has the technology to drive displays. Additionally, the latest specifications from the USB foundation indicate that USB Type-C can actually be used to power computers, which makes the standard MagSafe plugs unnecessary on this new device.

The obvious caveat here is that this is a rumor; Gurman may have a great track record, but he could be wrong and the next MacBook Air could have more than one port. But I rather suspect he’s right, because the MacBook Air he describes is the first Apple PC1 that is Mobile First.

The Origin of Mobile First

As best I can tell, “Mobile First” was first used by Marc Davis, then Yahoo’s Chief Scientist and VP of Early Stage Products of Yahoo! Mobile.2 From ReadWriteWeb, reporting on the Web 2.0 Expo in April 2009:

Yahoo’s Marc Davis spoke about the mobile internet and the future of the mobile industry. As the mobile web evolves, he said, it’s no longer good enough to simply port the PC experience to the phone’s small screen – it’s time to start building “mobile-first” products instead. What are “mobile-first” products? They’re services designed to take advantage of the strengths and abilities of the mobile devices themselves, leading to entirely unique creations that can only be found on the mobile web.

Though it’s taken a few years, Mobile First is now gospel for most consumer tech companies in particular. Perhaps the most famous example is Facebook; in a shift akin to Microsoft’s 1995 embrace of the Internet, Facebook went from having a mere 20 people on its mobile team in 2012 to several hundred mobile-focused developers embedded in every team in the company. The results – both in product and to the top and bottom lines – have been stunning.

A better example is Instagram: the photo-sharing social network launched as an iPhone app only, and for a long time its only web presence was direct photo links. Today there is a website, but it’s little more than a scaled up version of the app, and there is no tablet app at all. This should not be a surprise: while tablets mostly run mobile operating systems, they are not mobile devices; they do not go with you everywhere.

This distinction is critical: what is essential to understand about Mobile First is that everything flows from, well, mobility. The relative importance of implementation details and even the underlying OS fade relative to the significance of nearly every person on earth having an Internet communicator with them at every single moment. Every single product and service must start with this fundamental assumption.

The Implications of Mobile First

In this reading of Mobile First – that it’s about presupposing that every potential consumer of your product or service has a smartphone – the implications apply far more broadly than social networks or app makers.

Consider CES: over the last several years the show has seemed to fade as smartphones have subsumed all types of gadgets from cameras to music players to video recorders. This year, though, was all about the “Internet of Things,” and as annoying as that catchphrase may be, it’s something that only makes sense in a Mobile First world: now, instead of those old gadgets that make PC functions mobile, “Internet of Things” products assume the presence of a mobile smartphone. Thus the most interesting innovation is in things that don’t move: locks, light bulbs, garage door openers, and more, because they are designed with the assumption that the smartphone – and associated individual – comes to them.

Even more interesting was Sling TV, the first service that, with its focus on sports, has the potential to actually make cord-cutting palatable for far more people than any service before it.3 Just as interesting, though, is that while the service is provided by Dish Network – a company that has invested millions in launching satellites – the service is provided through an app. In other words, while the old Dish Service – and every other pay-TV service – was delivered to an address, Sling TV is delivered to a person. It is Mobile First.

As I noted in The State of Consumer Technology at the End of 2014, individual as service endpoint is an essential characteristic of one of the most important categories of emerging services, the so-called “sharing economy”. Uber is the easy example – the service quite literally goes to an individual’s exact location and picks them up – but it also applies to services like Instacart: without a smartphone coordinating shopping trips would be a logistical nightmare. The service is absolutely Mobile First.

Mobile First is also upsetting lots of assumptions around the transition to digital: consider the surprising news that the prospects for bookstores are looking up. From the Financial Times:

The plot has now twisted sharply, with publishers and book chains in the US, UK and Australia celebrating sales figures showing the resilience of physical editions and of bricks-and-mortar stores.

Waterstones said its sales had risen 5 per cent in December compared to the previous year…The optimism was echoed in the US. Barnes & Noble appears to have ended a run of declining sales, and expects sales to be flat in 2014 and 2015. Its shares rose 5 per cent on the news.

Fundamental shifts in consumer behaviour may also be helping the high street bookstore. “People are moving back to more frequent local shops. That’s when you can start popping in and buying books,” said Paul Lee, an analyst at Deloitte.

That fundamental shift in behavior is mobile: the most interesting place to be is no longer in front of a computer, it’s to go out into the world with a computer in your hand. And in that view, it’s no surprise that “3rd-places” like bookstores are experiencing a renaissance – or that physical goods, a welcome break from that ever-present screen, are more desirable than ever.

The impact will likely be felt far more broadly than bookstores: a decade ago, every small business thought they needed a website. Now many more businesses are simply focusing on their Facebook page, which is easier to find and use on mobile. Here China is light-years ahead: nearly every business has a WeChat account (you follow by scanning a QR code – they are ubiquitous) that includes not only the basics like addresses and hours but even ordering with delivery to wherever you’re sitting when you press the ‘Order’ button.

Ordering dumplings in WeChat

Ordering dumplings in WeChat

Even dumplings are Mobile First.

Why the Rumored MacBook Air is Mobile First

And so, the story of the (rumored) MacBook Air starts not with the Mac, but rather with the iPhone. By virtue of its omnipresence it is the most important device in most consumers’ lives. It is the first choice for getting information, for communicating, for taking pictures. It is a device that a huge majority of people could live on exclusively, and it very much stands alone: all of its essential functions have cloud counterparts, but none assume a PC.4

True, it would be nice to have a keyboard to type longer emails, reports or papers, or a larger screen to watch movies, but those capabilities – again, for most people, not all – are nice to have, not essential.5 Moreover, all of those capabilities depend on the same cloud services as the phone: email, social networking, photos, all of it comes over the (wireless) network, not a cable.

In this world, a Mobile First world, what exactly is the point of a port?6

  1. Chromebooks were first
  2. Seriously, that’s the title, according to this TechCrunch article reporting Davis’ exit a mere three months after coining the term “Mobile First”. I suspect there is a lot about Yahoo’s fate that can be gleaned from this footnote
  3. I wrote about this extensively in the Daily Update here and here) (members-only links)
  4. Microsoft’s “Mobile First Cloud First” strategy makes much more sense now, no?
  5. To put it another way, a MacBook Air is in the same class as an iPad
  6. If you need ports, buy a MacBook Pro. But if you care about rumors of unreleased products, you’re probably not a normal consumer!

Podcast: Exponent Episode 030 – Xiaomi

On the newest episode of Exponent, the podcast I co-host with James Allworth:

We discuss Xiaomi’s ambition to own the home, why we’re frustrated with patents, why the West is unfair to the developing world, and what makes China unique.

Links

  • Jordan Lewis: Exponent Bingo – Twitter
  • Ben Thompson: Xiaomi’s Ambition – Stratechery
  • Ben Thompson: Handicapping the Internet of Things – Stratechery
  • When Charles Dickens fell out with America – BBC
  • To Live (The film about the Cultural Revolution) – Wikipedia

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

Xiaomi’s Ambition

Xiaomi, the Chinese smart phone company that late last month raised $1.1 billion at a $45 billion valuation, sells way more than smartphones: Mi.com boasts over a thousand items, and it’s the third-largest e-commerce site in China. One item it doesn’t sell, though, is a AA battery charger. Only Apple:

applebattery

I clearly remember when this rather oddball product came out, not because it was particularly magical or revolutionary, but because a co-worker had one in his hand the very next day. He regaled us with tales of power efficiency and “vampire draw” (or the lack thereof), curiously neglecting to mention why it was he actually needed a battery charger. He bought it because it was made by Apple, and that was enough.

What is Xiaomi?

There’s come to be a bit of a cliché when it comes to writing about Xiaomi. The author declares that Xiaomi is known as the “Apple of China”, but actually, said author explains, they’re something very different: more like Amazon, or maybe a bit of Google, to use the words of Xiaomi CEO Lei Jun. They sell smartphones at cost, or close to it, and will make money through services.

The trouble with a lot of this commentary surrounding Xiaomi1 comes in determining exactly what those “services” are. The easy assumption are traditional Internet services like those offered by Google, including an app store, online portals, so on and so forth. That, though, hardly validates a $45 billion valuation, particularly when most of the money to be made on mobile services in China is being vacuumed up by Tencent through their dominant WeChat app, with Baidu (search), Alibaba (e-commerce), Apple (the App Store), and the various Chinese App Stores’ capturing the rest (Xiaomi has their own app store, but it’s only the 5th most popular).

Instead, the way to understand Xiaomi and why exactly they are so valuable is to more deeply understand what Lei Jun means by “services”, and, in the end, why Xiaomi actually is a lot like Apple after all.

Horizontal versus Vertical

Early in this blog’s life, I spent quite a bit of time discussing the differences between vertical business models – like Apple – as compared to horizontal business models – like Google. Apple provides services as a means of differentiating their hardware, which they sell for a profit; they are exclusive. Google, on the other hand, wants to reach everyone with their services, whether they be on iOS or Android.2

It’s not immediately obvious where Xiaomi fits though. After all, MiUI, Xiaomi’s freely available Android ROM, itself a service that enables access to all of Xiaomi’s other services, is available for other manufacturers’ Android devices. That seems like a horizontal offering. On the other hand, the vast majority of Xiaomi’s revenue comes from handset sales, which suggests a vertical business model. Are they stuck in the messy middle?

I don’t think so, and the answer comes back to my co-worker’s battery charger.

Xiaomi’s Fans

In 2013, Xiaomi shocked a lot of observers when they announced the MiTV. It was less surprising when Xiaomi released internet routers, but the shock returned with last fall’s announcement of an air purifier, and apparently a water purifier is on the way; all tie in to MiUI. At the time of the MiTV announcement, Lei Jun said something very interesting: “We want to build the first TV our fans will use.”

Understanding Xiaomi’s fans is critical to understanding the company. The New York Times captured the fervor well in a profile of the company last month:

Li Nan, vice president of the rival Meizu, which began in the early 2000s by making digital music players and aims at customers slightly older and wealthier than Xiaomi’s, likens the devotion of Xiaomi supporters to a religion.

“Xiaomi fans have a high level of organization,” he said. “They love Xiaomi. It’s a form of idolatry.”

Han Yu, a 24-year-old studying for his master’s degree, is one of those idolaters. He, with tens of thousands of others, helps Xiaomi test its user interface by looking for bugs and offering suggestions. Mr. Han moderates several pages on the company’s online forum, which averages 200,000 posts a day and is where fans interact with the company.

Much of his personal life revolves around Xiaomi, and he says he has met many friends that way. He said he was honored when his suggestion to create a private photo folder was adopted on phones by Xiaomi.

“I really enjoy the sense of participation,” Mr. Han said.

Note Han’s age: 24. That fits with the data captured by Flurry last summer:

Xiaomi consumers over-index on the 13-17, 18-24 and 25-34 segments and under-index on the 35-54 and 55+ segments. This data shows that the Xiaomi devices are very popular among the young population of China, especially college students and young adults who just entered the workforce.

xiaomi_users_hires_v1

The article doesn’t say where Han lives, but it’s highly likely he still lives with his parents. That’s the norm in China (and much of Asia): children will live with their parents until they are able to afford to buy a place of their own (renting is frowned upon). This actually makes these customers quite valuable: they tend to have more disposable cash than if they were paying for all of their own housing, utilities, food, etc, and certainly Xiaomi’s extensive accessory offerings take advantage of this.

What is more interesting, though, is what will happen when Han and his peers finally do get places of their own. They will need to buy TVs, and air purifiers, and all kinds of (relatively) high renminbi goods. And which brand do you think they will choose? If Apple can sell a battery charger to my coworker, I’m pretty certain Xiaomi can sell an air purifier to Mr. Han, and, sooner rather than later, just about everything he needs for his new house (many of these products will be built by 3rd parties that Xiaomi invests in).

Selling the Xiaomi Lifestyle

This, then, is the key to understanding Xiaomi: they’re not so much selling smartphones as they are selling a lifestyle, and the key to that lifestyle is MiUI, Xiaomi’s software layer that ties all of these things together.

In fact, you could argue that Xiaomi is actually the first “Internet of Things” company: unlike Google (Nest), Apple (HomeKit), or even Samsung (SmartThings), all of whom are offering some sort of open SDK to tie everything together (a necessity given that most of their customers already have appliances that won’t be replaced anytime soon) Xiaomi is integrating everything itself and selling everything one needs on Mi.com to a fan base primed to outfit their homes for the very first time. It’s absolutely a vertical strategy – the company is like Apple after all – it’s just that the product offering is far broader than anything even Gene Munster could imagine.3 The services Lei Jun talks about – MiUI and Mi.com especially – sell the products and tie them all together, but they are all Xiaomi products in the end.

And, of course, that fan base is concentrated in the most populous country in the world.

This strategy also explains Xiaomi’s international expansion strategy: India – the world’s 2nd largest population – is already well underway, and Indonesia – the 4th largest – just kicked off. Brazil (5th) is coming soon. True, the United States (3rd) isn’t coming any time soon, but why bother? Apple has the fans, everyone has appliances, and yes, there is a bit of an IP problem.

Xiaomi’s Challenges

Xiaomi’s ambitions are, I think, far more audacious than most realize. The company doesn’t just want to be a dominant player in smartphones, one of the largest and most lucrative product categories ever. They want the entire house, and I wouldn’t be surprised if even that is too limiting a description of Lei Jun’s ambition. There are significant challenges though, and many of them come back to product design.

In the short run, it’s not actually a huge market problem if Xiaomi’s products too closely “compliment” other products on the market;4 the solemnity of intellectual property is rather unique to Western culture. In China, as in much of Asia, inventions and even pure acts of creation were thought to belong to the community; visit any Chinese museum and you can calculate the value of a scroll or painting by the number of seals applied by important people showing their appreciation:

From Art-Virtue.com

From Art-Virtue.com

And, I might add, from my perspective it’s not a big moral problem either: the truth is the United States ran just as roughshod over intellectual property during its rise to power as China does today, and I’m more than sympathetic to the developing world’s position that the West is attempting to pull up the ladder behind it: no one was holding Europe or American to task for pollution or intellectual property or workers’ rights the way the West does the rest of the world. That doesn’t make it “right,” it just makes “right” a whole lot more gray than “Xiaomi-are-copycats” complainers are apt to admit.

The problem with Xiaomi’s originality – or lack thereof – becomes more pronounced when you consider the company’s international prospects. The further you get from China, the less impactful are intangibles like Lei Jun’s celebrity, the rock-concert product announcements,5 Xiaomi’s powerful social media presence, etc. Moreover, the costs start to rise as well, as Xiaomi is increasingly forced to rely on 3rd-party retailers (although, even then, Xiaomi is going the online-only route). If Xiaomi wants to create the same sort of fans they have in China – the sort of fans that will make their house a Xiaomi house – they need to rely on their products. And copycat isn’t going to cut it.

What is certain, though, is that Xiaomi isn’t going to the West anytime soon. Not only would the licensing fees be prohibitive,6 but the West already has fully furnished houses and powerhouse brands. The opportunity is simply so much greater elsewhere. It’s absolutely the truth that a company can be worth $45 billion – and, in the long run, probably a lot more – without ever targeting the United States or Western Europe.

Xiaomi and China

In the long run, though, the impact of Xiaomi may prove to be more intangible yet more significant than how much money the company ends up making its investors. There have been a lot of big Chinese companies, even some that have gone international, but there has never been a big Chinese consumer brand that has resonated beyond China, in part because few have resonated within China.

In fact, there is more than what meets the eye when it comes to the age of Xiaomi’s fans. Older Chinese – the over-30s that under-index on Xiaomi ownership – have traditionally looked down on their own country’s brands, assuming them cheap and second-rate. This is the population to which Apple – and all of the Western luxury companies – are selling to with great success. There is a younger generation, though, the Xiaomi generation, that has grown up in a country that has been growing by near double digits every year they have been alive. To their minds of course China is a global power, and why wouldn’t they embrace Chinese brands? Xiaomi is tapping into that nationalistic bent, and the red star on their mascot’s hat couldn’t be less subtle:

MIUIEs-Logo

Make no mistake: it is the Chinese themselves that were always Xiaomi’s biggest challenge, and they’ve won and won handily. Don’t underestimate their potential – and China’s broadly – in the rest of the developing world, a world that is far, far bigger than the West.

  1. A notable exception is this excellent piece by Michael Vakulenko
  2. As I laid out in The Android Detour, the entire reason Android exists is to preserve access to Google’s services
  3. Munster is famous for predicting – for years now – that Apple will make an actual TV set
  4. It’s not just Apple fans that gripe; even the air purifier faces charges of copying
  5. There will be another one next week; I will be attending and documenting it for Daily Update subscribers
  6. And again, many of these licensing fees go to companies that aren’t even competing in the smartphone space anyway; are these patents really making the world a better and more innovative place?