Sure, moving up market is difficult - until you do. But there are a ton of examples in and out of IT of successfully doing just that, whether disruptive technology or just new mean contender. (fond shimmering flashback to that first Honda...). Sun riseth, sun setteth...
Did I hear the bellweather of "can't do it unless a monopoly?" Fortunately for Xiaomi, they're in China, where the chance of getting a monopoly due to locking out foreigners looks quite fortuitous and auspicious. Margins may be low now - might be raging in 2 years. That is what moving up-market's about. Of course when you have the Chinese government behind you, "margin" includes the gov payoff, just like Elon Musk's bottom line includes $1 billion from the state of Nevada (and Apple's include tax largesse/avoidance from the country of Ireland). It ain't over till it's over (or accounted for, deducted, depreciated, litigated, etcetera).
BTW, bitching about Xiaomi being no JFK/Apple is about as useless as complaining Oasis was no Fab Four - the Gallagher brothers pulled out some half a billion quid playing this cynical note, and I'm sure are quite happy with the result, aesthetic success or not. Xiaomi is certainly already happy riding the Apple vibe to investment and IPO, and no fear of "there's no there there" - only Gertrude Stein cares.
Last, but most important - this is the first time that China's gotten its shit together marketing-wise, and should scare the bejeezus out of the rest of us. Rather than just dumping cheap crap on the rest of the world, having Mommy (gov) super-subsidize its way to success, or using some flashy western interloper to make most of the gnosh, they're actually successfully putting all the pieces together including brand management on the way to the user's hands as a quality enjoyable piece of gear - e.g. satisfying user expectations. If the Chinese can do that with cars, designer apparel brands, colognes, and what-not (airliners and weapons sales?), there will be much gnashing of teeth among the Foreign Devil Gweilos along with a change in economic/political status.