How will China’s fast-growing smartphone brands ever make real money?

Never settle… for revenue.
Never settle… for revenue.
Image: OnePlus
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Two Chinese brands are emerging fast in the global smartphone game.

OnePlus, from Shenzhen, is just a year old, but recently launched its latest smartphone in the US and UK to great excitement among gadget lovers. China’s biggest homemade smartphone brand is Xiaomi—now the world’s third largest smartphone vendor behind Samsung and Apple. But amidst growing fandom for both companies lies a greater question—how will they actually make money?

OnePlus and Xiaomi are betting on an untested business model. They both aim to sell handsets for almost no profit, to gain market share and edge out competitors like Samsung. After that, they hope to earn the bulk of their profits off of other things they sell to these smartphone users.

On OnePlus’s online forum, co-founder Carl Pei outlined three possible avenues for making real money:

  • Accessories—it sells goods besides smartphones.
  • Services—it sells software that people pay for, or that companies pay to get pre-installed.
  • Scale—it sells enough phones so the company can buy components on the cheap, and maintain a low-but-healthy price point.

This closely mirrors Xiaomi’s plan, which has been in place for about three years longer. Xiaomi started out by selling top-of-the-line Android phones at near-production cost, online only, with an eye towards targeting gadget nerds who want cutting edge features. It explained its low prices by promising it would earn money by selling other accessories or services.

Last year, Xiaomi just barely reached profitability through phone sales (the “scale” part), first and foremost, judging by company documents obtained by Reuters and the Wall Street Journal, as well comments from VP Hugo Barra. But for the company, valued at $45 billion, to actually make real money, it needs to push more hardware and services to its phone users.

OnePlus is a few steps behind Xiaomi on this front—the company told Quartz it aims to sell 3 to 5 million phones by the end of this year (Xiaomi is targeting 80 to 100 million phones). OnePlus CEO Pete Lau said last year the company unexpectedly turned a profit, but didn’t discuss specifics.

To Xiaomi’s credit, it has made significant inroads in China beyond selling commoditized smartphones. The company expects to earn $1 billion in services this year, from things like in-app purchases, media downloads, and virtual goods (the company will not state which specific services brought in how much money). It also has built a broad e-commerce business selling internet-of-things devices like smart scales, smart lightbulbs, and smart wristbands.

Still, it’s too early to assess whether or not building out a profitable software or e-commerce business can justify the costs of building a marginally-profitable smartphone business.

The most successful phone company in the world right now is run by Apple, which makes both the software and hardware. But its revenues from software like iTunes and iCloud amounts to about $5 billion—only 10% of the company’s overall revenue.

A $5 billion market may sound big, but OnePlus and Xiaomi don’t have exclusivity on an operating system like Apple does. They both rely on Google’s Android software, and Android users, who on average have lower incomes, spend about a quarter as much as Apple users do on app-store purchases.

Selling good phones at low prices might guarantee lightning growth, but building a viable business from that remains a long-haul bet.