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Apple, Xiaomi feel pressure in China by upstarts using bricks and mortar

Two years ago, Xiaomi had stormed on to the smartphone scene, overtaking Samsung as the biggest smartphone vendor in China and becoming one of the top five players in the world.

Fast forward 24 months, and major shifts have taken place. Xiaomi, the world's second-most valuable private tech start-up which made its name by selling online through flash sales and creating social media buzz, is getting attacked by upstarts using traditional bricks and mortar stores to sell smartphones. Meanwhile, Apple, which had been doing steady business in China, is facing intense competition from nimbler players.

Oppo and Vivo – two Chinese handset makers owned by BBK Electronics Corporation – are making a big impact, attracting young buyers wanting low-cost but high-spec smartphones, the audience that Xiaomi once had a hold on.

Xiaomi had a 13.3 percent market share in China in the second quarter of 2014. That now stands at 11.2 percent, according to data from Counterpoint Research. Meanwhile, Oppo's market share grew from 2.7 percent to 18 percent in the same period, while Vivo's increased from 2.2 percent to 14.9 percent.

"We tried the online thing, but it wasn't getting the traction we wanted, so we had to look back at strategy and we took a chance and we invested into point of sales presence. We localized everything and from there it really helped us build a stronger brand presence," Michael Tran, director of global strategy at Oppo, told CNBC in a phone interview last week.

"Consumers want to touch and play with the device, they want to know there will be someone there if there are issues."

Both Oppo and Vivo focus their products around high-performance cameras and audio. Oppo's flagship R9 smartphone is marketed as the "selfie expert" with a 16 megapixel front facing camera, fingerprint sensor, and a design very similar to Apple's iPhone 6. But the handset retails at 2,799 yuan ($420), much more cheaper than the $800-plus price tag for Apple's flagship device.

Tran explains that Oppo has over 320,000 physical points of sale in the markets it operates in which includes China, Australia, India and a number of other South-East Asian countries. Oppo and Vivo have both stepped up their marketing efforts. The brands have partnered with major fashion companies, celebrities and sporting tournaments to help boost their name among millennials.

'Muddled' strategy

Oppo and Vivo's growth has come at the expense of Xiaomi and even Apple, with the U.S. technology giant suffering declining revenues in China in recent quarters. Analysts said that Apple has suffered from the fact that operators have been reducing their subsidies, making the iPhone less attractive from a price perspective, as well as the likes of Oppo and Vivo producing affordable premium handsets.

Xiaomi meanwhile suffered an attack in the online sales space from a brand called Honor, which is owned by Huawei, the world's third-largest smartphone player by shipments. Over the past two years, the Chinese company has been expanding its product portfolio, releasing products from rice cookers to segways. These products are produced with partners but with Xiaomi branding.

Oppo's R9 flagship smartphone with fingerprint scanning technology
Oppo
Oppo's R9 flagship smartphone with fingerprint scanning technology

It has also tried to expand to new areas like India and Brazil but suffered setbacks in both markets. Ericsson hit Xiaomi with a patent infringement lawsuit in India, while the handset maker said this year it was reducing its operations in Brazil.

The release of new products, rather than a focus on their core smartphone business, has hurt the company, analysts said.

"Xiaomi's strategy is completely muddled. They had three years to invest in R&D in smartphones but they chose to become more of an Internet of Things company and flood the market with new products which are less meaningful from an operational perspective," Neil Shah, research director for devices and ecosystems at Counterpoint Research, told CNBC by phone.

Xiaomi comeback?

But Xiaomi is fighting back and hoping to reverse its decline in fortunes by opening physical stores, a change in strategy from what made it so popular in the first place.

"We already have built about 30 flagship offline stores, these are experience-based stores that you'll find in large urban environments…but we are even already experimenting with opening these experiential flagship stores in third and fourth tier Chinese cities," Hugo Barra, vice president of international at Xiaomi, told CNBC in a TV interview on Friday.

"Our approach to even entering the more traditional retail market which is offline is very very different, it's very unique. We think that we have a pretty good shot at reinventing offline retail, just like we reinvented online retail for cellphones here in China."

But the risk is that more stores will lead to higher operational costs and Xiaomi losing the one advantage it once had – price.

"Once you are relegated in mindshare to a low-cost cheap device maker, if you open offline stores that add to operating costs, that means your price of devices increase. The only advantage you had which was cost leadership will go," Shah said.

This article was updated after an Oppo spokesman corrected the number of points of sale that Oppo has.