SMARTPHONES: Thrifty Xiaomi in New Switcharoo Scandal

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Bottom line: Xiaomi will lower its profile after a recent spate of negative publicity and intensifying competition, but could still stand a 50-50 chance of becoming a major smartphone brand if it executes well in its globalization strategy.

Xiaomi in new switcharoo scandal

Former smartphone high-flyer Xiaomi is quickly learning that a high profile is a double-edged sword, with word that it’s landed in the middle of a fresh new false advertising scandal. Xiaomi certainly isn’t the only company learning this lesson, as its recent downfall tracks a much louder crash at former e-commerce high-flyer Alibaba (NYSE: BABA).

No one is predicting Xiaomi’s demise just yet, and I’ve often said that co-founder Lei Jun is largely to blame for the recent fall due to the huge expectations he set for his company. But this latest news involving false claims for one of the newest models from Xiaomi’s low-end Redmi smartphone line will certainly bring the company down yet another notch in the eyes of investors and consumers.

According to the latest headlines, the increasingly embattled Xiaomi is coming under assault for using a domestically produced screen in its new Redmi 2A model. (Chinese article) The company had earlier promised the phones would contain screens from Japan’s Sharp (Tokyo: 3128) and Taiwan’s AU Optronics (Taipei: 2409), but ultimately ended up using parts from the Beijing-based BOE Technology (Shenzhen: 000725).

The reports contain numerous photos of Xiaomi’s earlier materials that claimed the 2A would contain the imported screens, as well as pictures of phones whose actual screens come from BOE. Anyone feeling like they’ve seen this story before would be partly correct, since Xiaomi was caught up in a similar scandal earlier this month involving switcharoo claims for another model, the Redmi Note 2. (previous post)

At the time of that scandal, Xiaomi attributed the issue to mistaken labeling in some of its earlier marketing materials. It seems the company must have mislabeled many  of its materials, since there are quite a wide range of advertisements containing the Sharp and AU Optronics claims for the Redmi 2A.

Cost Cutting in Focus

All this does seem to indicate that Xiaomi at one point planned to use those higher-quality imported screens for the new Redmi models, but ultimately changed its mind and decided to go with domestically produced ones. The switcharoo is already embarrassing enough and could even lead to massive calls for refunds. But equally bad is all the negative publicity, as well as the new image Xiaomi is gaining as a penny-pinching company using inferior made-in-China parts as it struggles to control costs.

That perception is far from the trendy image that Xiaomi carefully created through last year, when it soared on the near nonstop publicity generated through a savvy combination of an online-only sales model and artificial product shortages it created. But the charismatic Lei Jun has had trouble maintaining his momentum, and is also learning that media love to see former superstars crash and burn.

China tech watchers will know that Xiaomi isn’t the only company now experiencing this kind of sudden reversal, and that e-commerce titan Alibaba is now going through a similarly painful cycle. Alibaba was once a darling of consumers and investors, and briefly saw its market value surpass that of Amazon (Nasdaq: AMZN) last year after making the world’s biggest IPO of all time in New York.

But since then its fortunes have plunged on a string of scandals and negative reporting. That has wiped out more than $100 billion in market value from Alibaba’s stock, and forced the company’s talkative founder Jack Ma into an awkward and relatively unusual defensive posture.

The fact that Xiaomi’s switcharoo issue surfaced as 2 separate scandals shows just how much the media love to feast on this kind of stumbling company as it experiences its own Alibaba-style fall from grace. Like Alibaba, I do expect Xiaomi and Lei Jun will assume a quieter posture over the next year and instead focus on running the businesses, which is really what they should have been doing all along.

It’s quite possible Xiaomi will ultimately still emerge as a major global smartphone brand, as it lays the groundwork for a global expansion that will take it into most major developing markets by year-end. But I would now put its chances of success at only 50-50 following the recent spate of setbacks, negative publicity and intensifying competition from surging domestic rivals like Huawei and ZTE (HKEx: 763; Shenzhen: 000063).

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