On May 31, 2016, Microsoft and Xiaomi announced that they are expanding their global partnership. One of the key details of the global partnership was patent cross licensing deal that included the transfer of 1,500 patents from Microsoft to Xiaomi. Also beginning in September 2016, Xiaomi’s Android devices will come pre-installed with Microsoft Office, Outlook, and Skype applications. Other terms of the deal were not released.
Xiaomi’s smartphone business has been experiencing turbulence for the past year. IHS estimates Xiaomi shipped 73.1 million units of Smartphone globally in 2015, which was well below its original target of 80-100 million units. In order to increase its smartphone shipments, Xiaomi has been putting efforts to diversify its sales regions for the past few years. Most notably, Xiaomi has been heavily promoting its smartphones in India. However, Xiaomi’s plan to expand into India hit a big stumbling block in late 2014, when its products received an injunction in India from a patent complaint filed by Ericsson. Getting an injunction in India not only slowed down Xiaomi’s sales momentum in India, but it also strongly discouraged its plan to expand into any other regions where patent enforcements are stronger than India. Since India has been known to be a jurisdiction with weak patent enforcement, Xiaomi had very few options to expand its sales regions.
Since receiving an injunction in India, Xiaomi has been working diligently to strengthen its intellectual property capabilities through hiring highly seasoned executives in the IP industry and steadily expanding its patent portfolio. In March of this year, we have seen Xiaomi receiving 322 US issued patents from Intel. Brand of a patent – the original issuer of the patent - is one of the factors when assessing the merits of a patent. Now with Microsoft brand added to its portfolio in addition to its existing Intel branded patents, Xiaomi has managed to add creditability to its patent portfolio within a short period of time.
After the announcement was made on Xiaomi’s acquisition of Microsoft’s patents, a lot of comments have been made regarding Xiaomi’s outlook to expand into the western market, particularly in the United States. Despite the urgency, if Xiaomi were to launch smartphones in the United States tomorrow, it would have to take on too much intellectual property associated risks. IHS has summarized three sets of intellectual property related tasks which Xiaomi can do that can minimize the patent related risks in the United States market.
First, Xiaomi will have to sign licensing agreements with its key suppliers in the industry. Thus far, Xiaomi has started to sign IP licensing deals with its key suppliers notably signing a China patent license agreement with Qualcomm in late 2015 and recently signing cross-licensing agreement with Microsoft. Although no official announcement has been made, looking from the patents transferred from Intel back in March, Xiaomi have been in talks with Intel. Based on the publically available information, it is clear Xiaomi is starting to gain traction in signing licensing agreements with key suppliers.
Secondly, Xiaomi will have to sign cross-licensing deals with major competitors in the United States smartphone market most notably Samsung and Apple. Due to its lack of patent portfolio, when a Chinese smartphone vendor enters the United States market, conventional wisdom would think it would agree to pay a certain sum of money to the incumbent market leaders. However, with the recent improvements to its patent portfolios, some of the well-known Chinese vendors are starting to aggressively position themselves during cross-licensing negotiations. The best example of this happened in May, when Huawei sued Samsung alleging patent infringement at the court for the Northern District of California. This case has a potential to set a precedent for Chinese smartphone vendors on patent licensing with Samsung before entering the US market. Regardless of the outcome from Huawei and Samsung litigation, the recent acquisition of Microsoft/Intel patents in their patent portfolio will help Xiaomi in signing the cross license deals with its future smartphone competitors in the United States.
Lastly, Xiaomi would have to find ways to minimize patent licensing costs associated with non-practicing entities (NPEs). NPE refers to someone or an organization who holds a patent for a product or process but has no intentions of developing. The reason that makes licensing with NPEs difficult is since they do not have a developed product, Xiaomi will not have an option to assert its newly acquired patents against the NPE’s products. Some of the aggressive NPEs often file a litigation even before a negotiation starts. Late last year, an NPE named Blue Spike LLC sued Xiaomi in Eastern District court of Texas even before Xiaomi launched a single smartphone in the United States. Since Xiaomi will not be able to assert its patents against NPEs, it would have to find creative ways to minimize its licensing cost. ZTE’s patent litigation with Vringo (one of the well-known NPEs) is a good example that show a patent license involving even one NPE could be costly. After fighting in patent cases for over 3 years, ZTE eventually settled with Vringo for a lump sum amount of $21.5million dollars in addition to incurring litigation costs on lawsuits in 12 different jurisdictions.
In addition to the intellectual property related risks described above, Xiaomi will be required to establish a working relationship with the local telecommunications carriers. United States is one of a few countries where telecommunication carriers have stronger channel power compared to the Smartphone vendors. Major portion of new smartphone buyers choose wireless plans before visiting the local store to select and activate new smartphones. For more than past two decades, Smartphone vendors have been collaborating closely with the United States carriers when marketing their smartphones. It is common in the United State where tens of millions of dollars are supplied by a vendor to a carrier to jointly conduct a marketing program on a newly launched smartphone. The smartphone marketing business structure in the United States is the mirror opposite of how Xiaomi has been marketing its smartphones in China since its inception where Xiaomi used online marketing campaigns to sell its product through the internet. In the United States, establishing a healthy business relationship with the top 4 carriers – AT&T, Verizon, T-Mobile and Sprint that owns 80% of the wireless subscribers - will be a must since online sales through third party retailers consists only minimal portion of the market.
As witnessed when Xiaomi received an injunction in India, patent related issues can pose a serious risk for product companies. After examining the number of key risks associated in the area of intellectual properties and in business structure in the United States, it is advised United States should be one of the last few regions where Xiaomi should be launching its smartphones. However, if Xiaomi decides to enter the United States market in near future, it would have to incur additional cost - reaching hundreds of million dollars - signing patent licensing deals and establishing relationships with the national carriers. As we all are aware, Xiaomi is a manufacturer that offers Apple iPhone-like products for a lower price. Entering the United States market will certainly increase Xiaomi’s cost structure that could effectively eliminate its cost advantage. With already a very thin margin, the only solution for Xiaomi to offset the rising cost issue would be to offer a differentiated product that will enable them to command higher price. There are a fair number of critics of the United States patent system that says the American patent system currently does not spur innovation as originally intended. In this case, hopefully the current Xiaomi’s dilemma which originated from the United State patent system will encourage them to further innovate its products.