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Business

Commodification of electronics doomed LeEco's ambitions

Conglomerate-building strategy of Sony, Samsung no longer an option

| China

Chinese technology group LeEco has been in the spotlight recently, both for its expansion plans and its cash woes. It has launched a new phone in India and is laying off employees. It is investing in Faraday Future, an ambitious U.S. electric vehicle company, and it is being pursued by Chinese and Taiwanese suppliers for unpaid bills.

It is also purchasing U.S. television brand Vizio, has invested in Chinese gadget maker Coolpad Group and begun selling phones in the U.S. Meanwhile, founder and chief executive Jia Yueting has slashed his salary to 1 yuan to support cost-cutting measures. Jia has likened 2016 to "being in ice and fire simultaneously."

The story of a company growing faster than its cash flow allows is a familiar one. Depending on the ratio of income to expenses, it can lead to anything from postponed purchases to financial catastrophe. But LeEco's time in ice and fire illustrates more than just a corporate stumble.

LeEco copied an old strategy, becoming a branded electronics conglomerate, but this model isn't working so well anymore. The conglomerate strategy has been around seemingly forever; it's what put the word "general" in General Electric. As manufacturing moved from Europe and the U.S. to East Asia after World War II, the model was adopted most famously by Tokyo Telecommunications Engineering, better known by its later name, Sony.

Sony started out manufacturing tape recorders, then portable radios, and then the Walkman. That portable cassette player was the iPod of its day, cheap enough to be a mass product, desirable enough to command a premium price, and very, very profitable.

The Walkman brought Sony a global reputation for innovation and transformed the phrase "Made in Japan" from an epithet to a boast. It also brought Sony enough cash to expand through growth, partnerships and acquisitions.

This approach remained viable as it moved from country to country. Samsung Sanghoe transformed itself from a purveyor of dried fish to a huge, high-tech multinational with the critical pivot being a shift to electronics in the late 1960s. Xiaomi, LeEco's closest competitor in China, went from eight guys in a room to a multi-billion dollar business in less than five years.

Jia wanted to create the next version of the branded electronics conglomerate using profits from LeTV, a streaming service under Leshi Internet Information & Technology, the group's Shenzhen-listed unit, to expand into TVs, smart bikes and of course mobile phones. The problem LeEco faced with this expansion is that the company, with its origins in handling licensed content, had no special expertise in electronics; TVs and phones are now products lots of companies can offer, the very definition of a commodity.

With electronics, the combination of "good for the price" and "cheap for the quality" used to create a competitive advantage. It's now become the minimum requirement, largely because Xiaomi showed the world how to design on a budget, driving device margins close to zero in the process. LeEco entered the market after those margins had already been compressed.

Beginning of the end?

Ten years ago, the only company in the world with all the skills and competence needed to make a smartphone was Apple. Now there are dozens, with vendors in Shenzhen and factories in Dongguan ready to turn a white-label product into a branded one. LeEco's problem is circular: All the markets it has entered are now open to companies like itself. When producing electronics is this easy, profits become much harder to defend.

This has also happened to Xiaomi, which went from being a small group of engineers with a better smartphone operating system to become in early 2015 the No. 1 vendor in China, the largest market in the world. The bad news for LeEco is that even Xiaomi, who pioneered the combination of beautiful design sensibility and aggressive cost control, has since seen rising competition and falling sales.

Most notably, Xiaomi has been displaced in its home market by other local companies, Huawei Technologies as well as Oppo Electronics and Vivo, both owned by BBK Electronics. Like Jia, Xiaomi CEO Lei Jun recently acknowledged publicly that the company had grown too fast.

Also ominously for LeEco, Xiaomi's other well-regarded products, ranging from the Yi sports camera to the MiTV, have not generated the sales its smartphones did. Meanwhile, the two flagship products of the electronics world -- phones and TVs -- no longer command the prices, volumes, or margins that used to make those markets so attractive.

With LeEco's restructuring, something is ending. Chinese developer Sunac China Holdings threw LeEco a lifeline on Jan. 13, offering 15 billion yuan ($2.19 billion) for stakes in Leshi and two other group companies. But smartphone sales in emerging markets can no longer be the driver of growth; Chinese companies have already split most of the domestic market between themselves and grabbed 40% of the Indian market. Those are the only markets with a billion consumers and both are now competitive battlegrounds, with no hypergrowth foreseeable. All the Nigerias and Indonesias in the world do not add up to one China.

Meanwhile, the next big hardware challenges -- solar homes, self-driving cars -- are big-ticket items with long lives. Consumers won't replace their cars every two years, unlike their phones, while the hoped-for internet service economy is mostly controlled by software companies like Alibaba Group Holding and Tencent Holdings, not hardware makers.

Sony's iconic Walkman, Samsung's smartphones and TVs and Xiaomi's mid-market "design at scale" strategy are all examples of companies using the popularity of select products to fund growth in other areas. With the commodification of smartphones and TVs, the last two of the "high cost, frequent purchase" devices around, it may no longer be possible to create a clear competitive advantage with a single, innovative piece of electronics. With LeEco's retrenchment, we may be seeing the end of half a century in which ambitious East Asian companies could use personal electronics to bootstrap global expansion.

Clay Shirky

Clay Shirky is an associate professor in both the interactive telecommunications program and the Carter Journalism Institute of New York University, and the author of "Little Rice: Smartphones, Xiaomi and the Chinese Dream."

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