2 Reasons Xiaomi's International Ambitions Aren't a Threat to Apple Inc.

By Markets Fool.com

As the expression goes, success breeds competition. So, it should come as no surprise that the world's largest publicly traded company -- tech giant Apple -- has attracted myriad challengers over the years.

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From IBM in PCs, to Microsoft and Google in software, to Nokia and Samsung in smartphones, Apple has locked horns with a laundry list of the world's largest technology companies. However, as Xiaomi eyes global expansion, many technology experts argue the Chinese smartphone upstart represents perhaps the most pertinent threat to Apple's billion-dollar iPhone empire.

They're wrong.

Xiaomi: Apple's next great threat?
Since being founded in 2010, Xiaomi's blistering expansion has granted it unique status among start-ups today. After only selling its first smartphones in 2011, Xiaomi says it expects global shipments to surpass 100 million units this year, establishing the company as one of the top smartphone vendors not just in China, but in the world.This breakneck growth has been like rocket fuel for Xiaomi's private market valuation. Indeed, Xiaomi received an astounding $46 billion valuation at its most recent round of fundraising. However, for all its nascent success, Xiaomi remains a power largely within its own borders.

Research firm IDC estimates international shipments comprised a mere 8.6% of Xiaomi's 2014 smartphone sales, a percentage the company appears determined to expand in coming years. Last year, Xiaomi launched its first smartphone in India, another high-growth market with tremendous long-term potential. Beyond India, Xiaomi only operates in a handful of smaller Southeast Asian markets at present, although it has expressed interest in entering larger markets such as Russia and Brazil. For a company with such obvious global ambitions, you can rest assured Xiaomi eventually intends on attacking the developed markets long dominated by the likes of Apple and Samsung. So why shouldn't Apple investors be worried?

Ready for the big leagues?
Replicating its undeniable success, particularly in lower-growth, smartphone-saturated developed markets, won't prove as easy for Xiaomi as it might initially seem. The key lies in Xiaomi's business model and the additional burdens international expansion will likely put on its unconventional operating model.

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According to company executives, Xiaomi sells its handsets at or near their cost of goods sold (COGS), the accounting term referring to the dollar value of the inventory Xiaomi uses to make its phones. Xiaomi can sell its phones for such relatively low amounts and still keep the lights on because of its unusually lean operating cost structure, which differs from other smartphone producers in two key ways.

First, Xiaomi spends effectively nothing on marketing. Instead, it has shrewdly cultivated a massive following though social media in China. This gives Xiaomi a low-cost channel to promote its products, especially compared to industry powers such as Apple, which consistently spends well over $1 billion annually on advertising. Second, Xiaomi primarily sells its handsets via its own online storefront, which enables it to maintain a lower overall cost structure by avoiding the retail markup brick-and-mortar distributors require.

While this recipe has worked seamlessly in China, many believe successfully reproducing the business model in its international expansion will prove difficult for Xiaomi.

Apples and oranges
To challenge the likes of Apple and Samsung on the global smartphone stage, Xiaomi will likely need to evolve its business model to some extent. Ostensibly, the largest shift will involve creating a wholesale pricing model in order to build out its distribution network in new markets.

For example, in India, the majority of buyers shop for smartphones in physical stores. It's unclear how, or to what degree, Xiaomi and its Indian retail partner share the added layer of cost. However, the key big picture implication is that Xiaomi's domestic online sales model won't hold as it expands globally, and the added expense that comes from developing physical, global sales channels could pressure its already paper-thin margins. Additionally, expanding into new markets will likely require Xiaomi to increase its advertising, particularly if it wants to truly challenge the likes of Apple and Samsung for global smartphone supremacy.

Xiaomi says it expects to generate an impressive $16 billionin sales in 2015. By comparison, Apple in the three months ended December 2014 producednet income of more than $13 billion. So while Xiaomi has achieved remarkable results thus far in its brief corporate history, it will need to overcome the critical challenges highlighted above before it can claim to belong in the same discussion as Apple.

The article 2 Reasons Xiaomi's International Ambitions Aren't a Threat to Apple Inc. originally appeared on Fool.com.

Andrew Tonner owns shares of Apple. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.