Why Xiaomi’s IPO Should Be a Wakeup Call to U.S. Tech

It has been reported that Chinese smartphone maker Xiaomi is exploring an initial public offering that could be valued at an eye-popping $50 billion or more. There are two important takeaways from this. First, China’s massive market gives an enormous leg up to Chinese tech firms. Second, Chinese government policies that unfairly favor domestic technology companies put that first advantage on steroids.

For those who say China can only copy and that tech companies in advanced economies have little to fear from Chinese competitors, this announcement should serve as a wakeup call. Xiaomi wants to join a growing list of companies—including Alibaba, Baidu, Huawei, Lenovo, and ZTE—that are gaining market share, not just in China, but globally.

Success in the technology industry requires two key factors: technology competence and access to a large market. With regard to tech competence, the slowing pace of development of many technologies—search, smart phones, PCs, Internet, etc.—compared to the torrid pace from the mid-1990s to 2010 or so, lets fast followers with much lower development costs, like Xiaomi, gain market share. The second factor, market size, is critically important because tech companies face high fixed costs but low marginal costs. The costs of developing an original software program or a phone prototype is high; the cost of producing subsequent supply for the marketplace is much less. This means that the massive Chinese market can give Chinese firms a sustainable advantage over rivals, because they can gain scale economies easier and faster than their foreign rivals.

Chinese firms, including Xiaomi, are using their position in the Chinese market as an “aircraft carrier” to launch attacks on other markets where the foothold of U.S., Korean, and other tech firms is less developed and where consumers are willing to spend less for slightly lower quality. For example, Xiaomi launched a $1 billion overseas expansion drive, including in Indonesia, Russia, and Vietnam. But Chinese firms are not content to stop there. As they gain more revenues and move further along the learning curve, they will increasingly challenge tech leaders in their richer home markets.

But Xiaomi and other Chinese firms would enjoy considerably less success if the Chinese government did not engage in a determined campaign of innovation mercantilism that supports “indigenous innovation” by sheltering Chinese companies from foreign competition. Under President Xi, China has doubled down on this unfair approach through new policy directives such as the “Made in China 2025 Strategy,” the “13th Five-Year Plan for Science and Technology,” and the “13th Five-Year Plan for National Informatization,” all designed to unfairly support domestic champions.

Moreover, over the last several years, virtually every leading American tech company has found itself in the dubious cross hairs of Chinese authorities. Apple CEO Tim Cook was forced to publicly apologize for purported problems with iPhone warranties. Next up were Qualcomm and Cisco, with the National Development and Reform Commission claiming that both were monopolists—and in Qualcomm’s case, the authorities imposed a massive fine and extracted concessionary licensing terms for Chinese smartphone companies.

And on top of that, the Chinese government encourages intellectual property violations, something that Chinese tech firms do with alarming frequency. For example, just this week Apple won an EU trademark case to prevent Xiaomi from registering its “Mi Pad” mobile tablet as an EU trademark, because the Court ruled that consumers were likely to be confused between it and Apple’s iPad, exactly what Xiaomi intended. And the name is not the only thing it copies from Apple; its designs are copied almost exactly, to the point where Apple design chief Jony Ive calls it “theft.” Likewise, Ericsson has sued Xiaomi in an Indian court for patent infringement. But prevailing in cases like this in China is virtually impossible, because Chinese courts are systemically biased in favor of Chinese companies.

So, absent a robust challenge by the world’s free-market democracies against Chinese innovation mercantilism, we can expect to see more Xiaomi-like IPOs.