China's Fitbit – Huami and Its 'Prisoner's Dilemma' [1/3]

Technology Author: Beier Kan, Ivan Platonov Editor: Luke Sheehan Jul 16, 2020 10:49 PM (GMT+8)

The short-term and long-term interest conflict is intensified in Huami's case due to Xiaomi's deep involvement. As the global smartwatch market grew by a staggering 10%, will the Huami thrive under this trend?

What's the best out of frenemy-ship? Image credit: Huami

► Huami is in the middle ground of being Xiaomi’s original design manufacturer (ODM) and a self-owned brand.
► The company has an unbalanced revenue structure: 70% of the total comes from one single customer. 
► Xiaomi’s success in smart wearables is a double-edged sword for Huami. 
► Building a stronger ‘Huami’ brand is one of the concrete ways out of its current dilemma.
► The smart wearables market is at the growth stage, and the competition is intense with a multitude of participants.

In the previous article, we discussed the smartwatch trends around the world and in China, one of the hottest consumer electronics markets. Here, we continue the analysis of this trendy product category with a supply-focused perspective by looking at the financial performance and strategic choices of the smartwatch-specialized Chinese vendor, Huami technology (HMI:NYSE).

It used to be a tricky situation if someone who wore a fancy Huami Amazfit (HMI:NYSE) smartwatch got asked what brand his/her gadget was before 2018, when the company went public. The name 'Hua mi' always reminds people of two Chinese tech giants, Huawei and Xiaomi (01810:HKEX), among which the former does not have any link to the company, while the latter has been nurturing Huami since its inception.

'2+1>3' ?

 – the cooperation model with Xiaomi

Even though the early stage of Huami's product promotion was deeply bonded with Xiaomi in sales channels and branding as a part of the so-called 'Xiaomi ecosystem', the wearable producer is not Xiaomi’s subsidiary. The strategic cooperation reached by the two is neither a purely ODM model which would not empower Huami’s self-branded products, nor an M&A that would entirely bond the two's strategies and risks.

Huami shoulders the design and manufacturing of Xiaomi's wearable products, including smart bands, smart watches (excluding children watches and quartz watches) and smart scales products, as the most-preferred-partner. Xiaomi, in return, is responsible for the distribution and sales of Xiaomi wearable products and Huami’s self-branded products through its established networks and sales channels around the world.

As for the transactions between the two, Xiaomi will purchase Xiaomi-branded products that are designed and developed by Huami at a price that covers all of the related costs and expenses in connection with the manufacturing and shipment. After products sold through Xiaomi's marketing and sales channels, the two companies will share all profits, normally on a 50:50 basis as mentioned in Huami’s prospectus. The retail price is jointly set by both sides.

The comprehensive corporation model from production to sales, led Xiaomi to cast a deep influence on Huami’s revenue structure and product lines.

Tracing back to 2015, revenue generated from Xiaomi wearable products was as high as 97.1% of the total, indicating a risky strong buyer situation, especially when the agreement can be terminated earlier by Xiaomi under certain circumstances. As Huami’s self-branded product, Amazfit smartwatch kept growing, the proportion of Xiaomi's contribution has been declining for the following years to 67% in 2018 and a slight rise in 2019 with 72%. Though the endeavor in driving self-branded products is apparent, Xiaomi still represents an abnormally high proportion of the firm’s revenue structure.

The risk of Xiaomi breaking strategic cooperation with Huami and consequently taking 70% of the revenue away under the current status is not at a high possibility since Xiaomi Corporation is the second largest shareholder with 14.5% of Huami’s total outstanding shares. After all, the company's positive long-term development trend stands in the same line with its shareholders. However, besides the worst scenario (Xiaomi ceasing to buy Mi band series from the company), the other two challenges that Huami is facing can be fatal as well.

'Perfect' coopetition?

Huami’s smartwatch shipments saw a sharp decline in the first quarter of 2020 from 17% to 5% market share in China. The downslope is largely caused by the competition from Xiaomi as it released its own smartwatches, Mi Watch and Mi Watch Color in the last quarter of 2019. The positive market feedback to Mi Watch is good news for Huami to some extent, as the Mi Watch is designed and developed by Huami and sold to Xiaomi, sharing 50% of the final profit – the same model as the Mi band series.

The dilemma for Huami is in the peculiar ‘coopetition’ relationship with Xiaomi. The products, especially for smartwatches, are not expected to show a technology-based difference, because they basically came from the same lab. When Xiaomi, with stronger customer recognition, releases a similar product with Huami, there is almost no doubt that the sales of Xiaomi-branded products will outperform the ones of Huami.

Though the short-term revenue, driven by the aggressive performance of Xiaomi products, may present an encouraging growth, the poor brand recognition will be an obstacle for the company’s long-term development, as an independent, technology-driven international corporation. Only if Huami could climb out the shadow of Xiaomi’s shining wearable reputation, will the company find a solid foothold in the smart wearable area.

Besieged from all sides?

Besides Xiaomi, the products offered by Huami compete with a variety of competitors as the smart wearables market has a multitude of participants. The most similar competitors are companies specializing in smart wearable technology, such as Fitbit and Garmin. Others may include large, broad-based consumer electronics companies that either compete with Huami in the US or Chinese market, such as Huawei, Apple (AAPL:NASDAQ), Samsung (005930:KS) and Xiaomi. As Huami is seemingly set to bet on the healthcare track to further distinguish its products from Xiaomi and Fitbit, the traditional health and fitness instruments companies are strong competitors for the company as well.

Huami’s future success largely depends on the company’s ability to promote its self-branded products with unique market positioning and strong technology support.