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China's Xiaomi caps hardware profit margin at 5% indefinitely

Any extra money will be passed to users via 'reasonable' means, says CEO

HONG KONG -- Chinese smartphone maker Xiaomi on Wednesday announced that it will forever limit its net profit margin of hardware sales to a maximum of 5% in the lead up to a multi-billion dollar IPO later this year.

Xiaomi, now the world's fifth largest phone maker, said it will distribute the extra profits to users by "reasonable" means if the margin exceeds the ceiling, as it restated its philosophy of making innovation affordable for everyone.

While it is a rare practice for any business, analysts see the move more as a marketing gimmick, as smartphone makers nowadays typically do not have a profit margin higher than that, except for premium brands such as Apple and Samsung.

"We do so with the firm belief that our strategy of enabling users to access the power of the mobile internet will enable us to build on our remarkable track record as we expand further in Asia, Europe and around the world," said Lei Jun, Xiaomi's founder and CEO. The company's hardware line-up includes smartphones, wearables and AI speakers, as well as smart home appliances.

The company, founded in April 2010, reaped more than 100 billion yuan ($15.9 billion) in sales for the first time last year and shipments approached 100 million units.

Several Hong Kong media outlets reported that the Chinese company will apply to go public on the Hong Kong stock exchange as early as next month, with an estimated valuation of $100 billion.

"It is remarkable for phone makers to achieve a profit margin higher than 5%" on hardware sales, said Richard Ko, analyst at China Merchants Securities, as the sector has a relatively low profitability ratio.

"Xiaomi announced the goal because it is very manageable," Ko said, adding that the cap will not have a real impact on the company's business or profitability in the future.

While hardware sales still contribute the bulk of Xiaomi's revenue, the segment is not likely to be a key profit generator for the group, as the company is developing more internet services-based products.

Through its self-developed MIUI operating system, the company also generates revenue from advertising, video streaming and other paid content from subscribers.

"I don't think capping the profit margin for hardware will affect Xiaomi's IPO valuation," said an analyst with a Chinese securities company who asked not to be named for compliance reasons. "Investors know that the growth of its other services will be higher than hardware," he said.

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