How Xiaomi is able to sell its smartphones at a cutthroat rate

Chinese smartphone vendor Xiaomi has made a name for itself with its stunningly affordable products.

So how can it afford to undercut the competition? A willingness to stay aggressive, said Hugo Barra, the global vice president of Xiaomi.

You may not have heard of Xiaomi, but the company, which is the world's most valuable startup, is starting to make waves beyond its home country. Xiaomi officially opens its online store in the US and select European countries on June 1, part of a broader push to build its brand in more mature markets. But Xiaomi is moving cautiously -- it isn't selling smartphones at first, just accessories such as a fitness band and headphones.

Like its smartphones though, the products are attractively priced. The headphone will sell for $80, which Barra compares to similar $300 headphones in the market, while the fitness band, the Mi Band, will sell for $15.

Xiaomi has been able to grow by selling products at or near cost in a quest to generate a tiny profit off of a myriad of products. The strategy has paid off with a community of what Barra calls "fans" who are loyal to the brand.

Barra, speaking on Wednesday at Recode's Code Conference in Rancho Palos Verdes, Calif, explained how Xiaomi is able to pull it off.

The company eliminates much of the overhead by sticking to online distribution, removing the retailer and distributor margin. Barra boasted that Xiaomi is the third-largest e-commerce retailer in China.

As a large vendor, Barra said the company has been able to negotiate competitive prices for components. For example, Xiaomi is Qualcomm's third-largest customer, he said.

"We have amazing relationships with suppliers," he said.

But the trick is to forgo profit early on. Barra said Xiaomi doesn't make any money at the beginning of the smartphone's life. As the product stays in the market, it becomes cheaper to produce, increasing the margins.

Xiaomi is sensitive about making too much money -- Barra said if it gets too profitable, the company will slash the price once or twice near the end of its life cycle.

"We do the price drop because we want to remain aggressive," he said.

Xiaomi in the US

Will Xiaomi sell a smartphone in the US? Barra didn't offer many clues.

"We don't have a set plan," he said. "We haven't picked a date to bring a smartphone to the US. We're sort of dipping our toes."

Part of the challenge is to build a brand and marketing presence in the US. The store is part of its effort to build awareness of the company.

"There's so much competition for consumer attention," he said.

In addition, it isn't as price sensitive a market as China, he said. The subsidy model, which obscures the true price of smartphones, also eliminates much of its cost advantage.

Its Mi Note costs a little more than $300, while an Apple iPhone 6 starts at $650. But an iPhone 6 only costs $200 when a customer signs a two-year contract with a wireless carrier.

It's also difficult to sell a smartphone directly to consumers, with many people opting to shop for their smartphones through a carrier. The need to strike deals with the carriers, which are notoriously fickle with their vendor partners, is another challenge.

Xiaomi also needs to get the customer service right, including offering locations to get devices repaired. It's a process that could years to accomplish, Barra warned.

"All of this takes time to play out," he said. "And I can't live in Bangalore and San Francisco at the same time, so we're doing this one at a time."