Xiaomi, the second-largest smartphone brand in China, recently developed a ROM with Microsoft (MSFT +0.66%) that lets users install Windows 10 Mobile on its Mi4 flagship device.
Xiaomi's Mi4. Source: Xiaomi.
Only members of the beta testing program in Beijing can install the ROM on the Mi4, but it's an unusual move for both companies. Why would Xiaomi -- which integrated its own ecosystem apps into its version of Android, MIUI -- help Microsoft take over its hardware? And does Microsoft actually believe that Android OEMs and users would voluntarily install Windows 10 on their devices?
What's Xiaomi up to?
Xiaomi controlled 13.7% of the smartphone market in China during the first quarter, compared to 14.7% for Apple (AAPL +1.18%), according to IDC. Since most Google (GOOG +2.92%) (GOOGL +2.53%) services are blocked in mainland China, Xiaomi offers users its own comparable apps, including Mi Cloud, Mi Fit, and the Mi App Store.
Last November, the Mi App Store topped 10 billion cumulative downloads with a run rate of 50 million daily downloads, generating about $59 million in revenue from January to October 2014. By comparison, Microsoft reported that about 200 million Windows Phone apps were being downloaded daily in 2013. In foreign markets, Xiaomi devices are sold with Google services pre-installed.
Xiaomi international Vice President Hugo Barra explained in a Google+ post that there aren't any plans to offer Windows 10 Mobile or dual-boot systems to all users. Instead, Barra said Xiaomi is merely testing it as an "option" for "power users."
Windows 10. Source: Microsoft.
More than meets the eye
Barra played down the significance of Xiaomi working with Microsoft, but I suspect that there's more going on than meets the eye.
Investors should remember that Google doesn't make money by licensing Android to handset manufacturers. Instead, it relies on search, advertising, and Google Play revenue to monetize the OS. However, Android handset manufacturers must pay Microsoft about $5 per device for patent fees on the OS.
Five dollars matters a lot to Android handset manufacturers that are struggling with shrinking margins. That's why Samsung stopped paying Microsoft patent fees last year, igniting a legal battle between the two companies.
Samsung and Microsoft settled the dispute with confidential terms, and the South Korean electronics company subsequently started launching smartphones and tablets with Microsoft apps pre-installed. Over 30 Android OEMs have now agreed to do the same thing.
In my opinion, Microsoft might be dropping or reducing patent fees for Android manufacturers that agree to pre-install its apps. That lines up with its strategy of making Windows free for phones and small tablets to compete against Android. Therefore, Xiaomi might be mulling a similar deal with Microsoft to pre-install its apps or dual boot Windows 10 to reduce patent fees. If Microsoft is willing to subsidize Xiaomi for launching Windows 10 handsets, the OS might actually gain ground in China, where (per Kantar Worldpanel) it controls just 1% of the market.
How to disrupt Android
Cozying up with Google's partners is only one part of Microsoft's attack plan against Android. Microsoft is also making it easier for developers to port Android and iOS apps to Windows 10.
Microsoft currently has more than 385,000 Windows Phone apps and 585,000 apps in the combined Windows Store. By contrast, Apple's App Store and Google Play both have over 1.4 million apps. By breaking down the walls between Windows, iOS, and Android, Microsoft could close the "app gap" with those market leaders.
Windows Store. Source: Microsoft.
Yet this isn't really a new idea -- BlackBerry started making its BB10 OS compatible with Android apps in 2013, and Windows can already run Android apps through third-party emulation.
Microsoft could help Xiaomi enter the U.S. market
Xiaomi might sound like just another pawn in Microsoft's grand plan to disrupt Android, but the Chinese company might have its own reasons for this partnership.
Xiaomi recently launched its online store in the U.S. and Europe, but it's not selling any phones yet. Instead, it's selling cheap fitness bands, headphones, and other mobile accessories to gain a foothold in those markets. Barra said Xiaomi intends to eventually sell smartphones through these stores, but no timeline has been set yet.
As I mentioned in a previous article, Xiaomi faces two main barriers in the U.S. market: brand recognition and patents. Bringing its online store stateside might improve brand recognition, while partnering with Microsoft might help it avoid litigation from Apple, Samsung, and other handset makers.
Xiaomi already faced a partial ban in India last December due to violations of wireless patents held by Ericsson. Ericsson, BlackBerry, Sony, EMC, Apple, and Microsoft co-purchased a vast trove of patents from Nortel Networks in 2011. Microsoft could grant Xiaomi access to those patents, but Xiaomi might have to make Windows Phones in return.
The key takeaway
Investors should follow Microsoft's partnerships with Xiaomi and other Android manufacturers carefully. If all goes well, Microsoft could hijack Google's operating system and undermine its influence over device makers.
If it can subsequently convince more OEMs to install Windows 10 Mobile instead, it could tether those mobile users to its "One Windows" ecosystem across multiple platforms.
