The embarrassment of Apple and Xiaomi’s “softening”: Internet service revenue has been slow to rise

The embarrassment of Apple and Xiaomi’s “softening”: Internet service revenue has been slow to rise

Can the Internet business be the savior of mobile phone manufacturers after the decline in hardware sales?

Apple's answer is affirmative. Since the second half of last year, Apple has frequently released signals of "transforming to services". Even at this year's spring conference, it completely abandoned hardware and focused on promoting its streaming media and financial services.

However, less than half a year after Apple launched its “softening” slogan, reality dealt it a heavy blow.

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Recently, the eight-year-long antitrust case against the Apple App Store finally came to an end, with Apple losing the case with a 5:4 vote ratio. This also means that users can continue to sue the App Store for its monopolistic behavior, and Apple may be required to reduce the 30% commission it collects on the platform.

For Apple, this is no small matter. Apple's commission on the App Store has always been an important part of Apple's service revenue, and is also called the "Apple tax" by many dissatisfied people. According to estimates by analysts familiar with Apple, this part of revenue accounts for about 35% of Apple's service revenue. Taking 2018 as an example, the total amount was about 15 billion US dollars.

This is also Apple's fastest-growing service segment. In a report estimated by Sensor Tower, the App Store is expected to reach $96 billion in revenue in 2023; proportionally, Apple will earn $33.6 billion from it, which is close to all of its service revenue in 2018.

Today, the growth potential of this revenue is being questioned. The antitrust case is only part of the problem of Apple's App Store. In the industry, due to dissatisfaction with the "Apple tax", high-traffic apps such as Netflix and Spotify have closed Apple's payment channels since the end of last year and transferred paid subscriptions to their own payment channels to bypass the "Apple tax". If the implementation effect is good, it may lead to more apps following suit, further reducing Apple's revenue source.

The reason why Apple's service transformation has attracted so much attention is not only because of the attention paid to this star giant itself, but also because its success or failure to a certain extent represents whether the "Internet model" of the mobile phone industry can work, and after the mobile phone market enters the saturation period, the future of mobile phone giants will be "softening" or "hardening".

The Internet model that once “worked”

"Many people asked me whether I should give Xiaomi the same valuation as Tencent or Apple. I said I wanted Tencent's valuation multiplied by Apple's." Lei Jun made this statement on the eve of Xiaomi's listing. In his definition, Xiaomi is an Internet company.

This positioning has been constantly questioned since it was proposed. One of the most direct reasons is that among Xiaomi's revenue proportions, revenue from the Internet accounts for only 9%, which cannot be compared with hardware revenue.

Although positioning is related to the market value of the company and should be judged according to the financial situation, if we judge purely by the business model, Xiaomi's self-proclaimed "Internet company" is not blindly following the trend. Going back to 10 years ago, when Xiaomi was first founded, it relied on the Android customized ROM MIUI system software to obtain its first batch of seed users.

"MIUI, MiTalk and mobile phones" are the three pillars that made up Xiaomi's early revenue. In fact, the first internal test of MIUI was in August 2010, one year earlier than the first generation of Xiaomi mobile phones.

This is a story made by the times. In the early days of smartphones, Android phones were unstable, so flashing became the choice of many mobile phone enthusiasts; custom ROMs also became a hot topic for entrepreneurship, and Xiaomi MIUI and Meizu Flyme came into being, becoming the leaders among domestic ROMs. Different from today's understanding, MIUI at that time did not only provide services for Xiaomi phones, but covered all brands of mobile phones on the market. On the official MIUI forum, you can see exclusive pages for major brands such as HTC, Motorola, and Samsung, and provide exclusive ROMs for each major model.

Customized ROMs made Xiaomi and Meizu successful. MIUI gained its first 1 million users only one year after its launch. When these two brands launched their first two or three generations of mobile phones, they were not only attractive because of their low prices, but also because of their high popularity in the "flash circle". A large number of "mobile phone enthusiasts" attracted by MIUI heard the news and became the earliest Xiaomi users, which echoed Xiaomi's slogan "Born for enthusiasts".

Until 2016, MIUI was regarded as one of the core competitive advantages of Xiaomi mobile phones.

The success of ROMs such as MIUI has spread rapidly in the technology industry. Since 2012, leading companies such as Tencent, Baidu, Alibaba, and Shanda have successively launched customized ROMs and regarded them as the "next mobile gold mine." According to the idea at the time, the imagination space of ROMs is indeed quite large. Take Baidu as an example. In its ROM, Baidu Input Method, Baidu Maps, Baidu Cloud Disk and search engine are built-in, becoming an ideal entrance for attracting traffic.

Luo Yonghao, the founder of Smartisan, was also a believer in the ROM model. In 2013, before starting his business, he invited Zhu Xiaomu and three designers he was going to recruit to dinner at a restaurant near Zhongguancun. During his endless persuasion, he repeatedly emphasized that Xiaomi had created a business model for transitioning from ROM to mobile phones. Following this path, finding some excellent designers and getting investment, "everything will be fine."

The Imagination of the Internet

ROM, or system software, is not only an added value for enterprises in improving the smoothness of mobile phones, but also means multiple "Internet service incomes" including theme stores, push ads, multimedia, pre-installed software, paid downloads, etc. Take Xiaomi's theme store as an example. As early as 2014, this category could reach millions of monthly turnover. According to Xiaomi, some top designers can earn 70,000 to 80,000 yuan per month by selling themes.

In addition to Android phones, Apple has also added services to its revenue categories since 2012, accounting for about 10% of its revenue that year. According to Philip Elmer-DeWitt, a senior Apple analyst, as of now, more than half of its service revenue comes from multimedia and App Store paid commissions, totaling nearly $20 billion per year.

Compared with hardware, the profit margin of Internet revenue is more attractive. When Lei Jun emphasized that the profit margin of mobile phone hardware should not exceed 5%, he pinned his profits on Internet services, which have a profit margin of more than 40%. In the recent financial report, Internet services accounted for about 10% of Xiaomi's revenue, but contributed nearly 50% of its gross profit margin; even Apple, whose hardware profit is the best in the industry, has a gross profit margin of 20 percentage points higher than that of the iPhone alone.

"Internet revenue" has become the next development goal for mobile phone hardware manufacturers, especially when hardware growth encounters a bottleneck. Since last year, Apple has repeatedly emphasized that it will use services as a growth driver in the future and has launched a number of Internet service content.

During the new product launch season in March 2019, a notable phenomenon was that although Apple updated several new products such as the iPad Air on its official website a few days before the launch, it did not mention the hardware at the official launch conference, and gave all the publicity to Apple News+, Apple Card, Apple Arcade, and Apple TV+, which was called "Apple going soft."

Some analysts have affirmed the idea of ​​transforming to services. Dan Ives, an analyst at Wedbush Securities, a US investment bank that has always been optimistic about Apple, even said that in the coming year, Apple's service business will have annual revenue of $50 billion. Because services are the key to Apple's future growth, Apple's market value outlook will be $1.5 trillion.

Apple's choice is not an isolated case. As early as 2015, when Xiaomi 5 faced a shipment crisis due to supply chain problems, Xiaomi had already transferred the "monetization" pressure to MIUI. According to Xiaomi employees, at that time, every MIUI product manager had to shoulder the performance task of monetization. The two MIUI versions released in August 2015 and June 2016 were both called ADUI, which means that this is an "advertising system" rather than a user interaction system.

Another company that hopes to save hardware with software is Meizu. Several Meizu employees revealed that after Meizu's shipments fell sharply, the Flyme department took on the main profit-making task. In the entire system, "every place where an advertisement can be placed, even calendars, notebooks and other locations, have advertisements implanted."

In trouble

In 2016, it was not MIUI advertising that ultimately helped Xiaomi overcome the crisis, but Lei Jun's readjustment of the supply chain system; and after the increased pressure on monetization, Flyme was not optimistic either. First, users criticized that "Flyme had changed." Shortly thereafter, the Flyme team experienced major changes, with more than half of the employees leaving within a year.

A Meizu employee explained that as a mobile phone ROM, the number of Flyme users depends on the number of Meizu mobile phones owned. As mobile phone sales continued to decline, the number of Flyme active users fell to less than 30 million. The products that can be developed based on this user base are becoming increasingly limited, "even not as good as a larger App."

MIUI is also facing a growth bottleneck. According to estimates by the Jianzhi Research Institute, in 2015, Xiaomi had achieved 110-120 million monthly active MIUI mobile phone devices in China. Since then, this number has not shown any significant growth, and the growth of advertising value per user has also slowed down.

An increasingly obvious trend is that mobile phone Internet services will ultimately be limited by the size of their hardware.

In the "flashing era" when third-party ROMs emerged, the industry once believed that ROM development could surpass mobile phone hardware. For example, even if Xiaomi's mobile phone users were only 10 million, the number of MIUI users could reach 15 million, 20 million or even more.

However, the high threshold for user ability to "flash the phone" means that ROM is destined to be a transitional product as an independent product. With the increasing maturity of the Android system and mobile phone ROMs, this product category is destined to exit the market. Since 2015 and 2016, leading third-party ROMs such as LeWa and Baidu Cloud have gradually withdrawn from the market, and MIUI has gradually stopped adapting to other brands. Now, in the MIyou community, there are only ROM packages that support Xiaomi phones.

If Xiaomi and Meizu represent the development of Internet services that is hindered by a small number of users, the antitrust experience of Apple's App Store represents another dilemma of Internet development after a sufficient user base. Of course, if Apple's sales continue to decline, it may also fall into the former dilemma.

In the past two years, as the growth of the smartphone market has stagnated and slowly declined, competition in the mobile phone industry has become increasingly fierce. Under such circumstances, it is not surprising that the revenue and profits are pinned on software services. However, all signs show that the road to "softening" is not easy to follow.

At the beginning of its listing, Xiaomi, which positioned itself as an "Internet company", defined its three revenue drivers as "hardware + new retail + Internet", but six months later, its key strategy has shifted to "mobile phones + AIoT", placing new growth engines on the various hardware included in IoT. According to estimates by the Wall Street Journal's Jianzhi Research Institute, the recent rapid growth in MIUI's monthly active users is mainly due to the increase in shipments of Xiaomi TVs.

In contrast to the "softening" strategy, at the other end of the competition in the mobile phone market, hardware "black technology" is becoming the mainstream competition object recently. Technologies such as chips, under-screen fingerprints, photography and video, and face recognition are rapidly developing and iterating, becoming the core capabilities of mobile phone competition. Not only has Huawei's HiSilicon chips entered the mature stage, even OPPO and VIVO, which were known for their high prices and low configurations in the past, have rushed to launch highlight technologies such as TOF, under-screen fingerprints, and 10x zoom in the past two years.

So far, it is still difficult to determine which of the two mobile phone manufacturers who have chosen the "softening" and "hardening" paths will be the winner. An interesting data is that in IDC's statistics on shipments in Q1 2019, when the overall market shrank by 6.6%, Huawei grew by 50.3% year-on-year, while Apple fell by 30.2%.

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