CELLPHONES: Qihoo in Strange Bid for Cheap Smartphones

Bottom line: Qihoo’s new Dazen smartphones stand a low chance of success, even if they provide better quality to comparably priced rivals, due to their late entry to the overheated ultra low-end of China’s smartphone market.

Qihoo unveils Dazen smartphone

About a half year after announcing its intent to enter China’s crowded smartphone space, software security specialist Qihoo (NYSE: QIHU) has unveiled its new product under a brand name that sounds clever and catchy but is decidedly downscale. Qihoo has just announced that its new smartphones will carry the brand name of Dazen, and will sell for a bargain basement price of 899 yuan, or about $150.

The move appears to be an extension of Qihoo’s longtime strategy of selling products cheaply or even giving them away for free, and then using those products as a marketing tool for its other paid products and services. But in this case the strategy of going after the ultra low end looks a bit questionable, since that part of the market is already quite crowded and many brands are believed to be losing money.

Despite its overheated state and declining sales, China’s smartphone market has continued to draw new entrants this year even as no one shows signs of quitting. The latest entrant has been video services provider LeTV (Shenzhen: 300104), which recently launched its new smartphones that are aimed at the middle of the market. Qihoo is taking the low road with its new Dazen Note 3, which will go on sale July 27. (English article; Chinese article)

According to the reports, the new Dazen model will mainly be available through a partnership with e-commerce giant Alibaba (NYSE: BABA) over its popular Tmall online platform. An Alibaba spokesman said Tmall is aiming to sell 1 million units of the new model, which some media reports are also calling the F2. The model will use an operating system based on Google’s (Nasdaq: GOOG) Android. But Qihoo is aiming to roll out its own OS later this year (previous post), and the new Dazen models will have the ability to be upgraded to that system.

Qihoo announced its decision to make smartphones late last year. It is producing the phones in its new Qiku joint venture with manufacturer Coolpad (HKEx: 2369), an early leader in China that has more recently fallen on hard times due to stiff competition. Coolpad surprised many late last month when it also announced another major equity tie-up and production agreement with LeTV. (previous post)

Late Entry to Tough Market

Now that we’ve recapped all the details and important background, let’s look more closely at Qihoo’s new smartphone play and its likelihood of success. As I’ve said already, I’m slightly surprised that Qihoo is setting its sights on the low end of the market, which is already quite crowded with models from the likes of powerhouses Lenovo (HKEx: 992) and Huawei, as well as smaller homegrown players like Meizu and Coolpad itself.

Qihoo will have a difficult time finding an audience for its products in such a crowded market, even if the actual phones are slightly higher quality than rival products. The company’s decision to develop its own OS also looks questionable, since many people are familiar with Android and might be reluctant to change over to an unknown system developed by a small company like Qihoo.

But all that said, Qihoo does have a very strong track record for developing new products and services that manage to find an audience, even in the face of stiff competition from well established players. The most notable example has been the rapid rise of its Haosou online search service, which has rapidly stolen share from the dominant Baidu (Nasdaq: BIDU) and now controls about a third of the market just 2 years after its launch.

We’ll have to see what kind of reviews the new Dazen model gets, and also what the new OS looks like before we can comment much further on Qihoo’s chances of success. But based on what we’ve seen so far and current market conditions, I would still set those  chances at a relatively low level of perhaps 20-30 percent.

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