All in + Hardware
Some entrepreneurs think that contracts with component suppliers, manufacturers and distributors would govern everything, which could not be further away from truth. When you work at a large corporate, you can rely on contracts. Your company has the resources and luxury to spend money and time to enforce the contracts, sometimes even by going to the court.
As an entrepreneur, sadly, you never have enough time and enough money.
The general feeling is that if you're working on B2C products, you don't have to interact with too many adults other than your investors or potentially your acquirers.
This is definitely not the case in the hardware space. The reason is very simple: to deliver a product to the consumers, the hardware entrepreneurs have to work with suppliers, manufacturers, distributors, stores, logistics partners, etc.
Locking oneself in a garage, even with a 240 IQ, won't get these things done.
Startups do not have volume, especially in early stages. For an EMS company to work with a startup, the EMS company has to take a long-term view. If the startup will just easily switch to the cheapest supplier, then why should the EMS firm even work with them from the beginning?
On the other hand, by working with the startups on industrialization, building testing programs and QA programs, the EMS firms know the startups won't easily switch. That allows them to take the long-term view and hammer out multi-year growth plans together with the startups.
On the EMS side, they now have all the incentives now to "pump up" the numbers of NREs. What might well have been a healthy $500k NRE might suddenly be listed as $1.5M, including many service items that were not necessary for a startup.
On the startup side, it will try to use a high valuation to bring down the dilution but the EMS might never agree with its valuation since most early-stage startups are pre-revenue. EMS's thinking is all about P&L numbers. Without revenue numbers, it could not even "pretend to" do a proper valuation.
This debate could drag on for months. The next thing you know, product shipments are delayed, cash burns out, other VC investors walk away and a promising startup dies for wasting too much time on this wrong debate for no good reason.
The key to the success of a consumer electronics hardware startup remains marketing and branding. In other words, how to sell products faster and achieve scale and defensibility of sort faster than others.
Every buyer in consumer electronics by default churns. Only when the company is able to lure them back to buy the next generation product or other related products would there be any meaningful discussion of future expected contributions.
And only product itself and branding would bring them back to buy the 2nd or 3rd products. CAC itself won't.
The truth is, today a lot of the expenditures categorized as marketing in accounting are actually channel costs. Specifically I'm talking about the on-line advertisements on Google, Facebook, Twitter or any other social network platforms.
Whether it's in the forms of texts, images or videos, the kind of on-line advertisements that lead the users to the product pages on the web stores usually do not contribute to the general perception of the brand.
It's also apparent that while Fitbit relied on words of mouth and community effect to leap frog other competitors in the early years, it's now relying heavily on classical marketing tools to deepen market penetration, e.g. to cover the late adopters that are not the community-type. Interesting enough, this is more well explained in the Risk Factor section of the 10-k.
However, unlike some VCs who chose to move to Silicon Valley to gain that prestigious postal address – or to Sand Hill Road if they really really desire to feed the fat belly of the landlords – we were born here in Paris. We have been feeding our energy to and getting fed with the energy from the Parisian hardware entrepreneurs for roughly 3 years. We were not follower but rather witness and contributor to this renaissance that's spelled in French. Even though now we diversify to global deals, we continue to see great startups with potential coming out of France – the deals obviously flow to us by default these days. With the right execution and the right investors, they have every bit as high a chance to become the next Nest, GoPro or Fitbit.
Therefore, I feel the question "Why France?", though kind of a passé within our firm, is definitely worth a explanation, for the sake of the foreign VCs that are puzzled by this phenomenon as well as our EMS and retail partners around the world.
Isn’t Chinese market supposed to be very price sensitive and foreign brands should suffocate in the face of the cheap local copycats? How could these stories be true? Even if we rule out Fact 1 using the all-too-convenient “Apple is an exception” excuse, it still doesn’t explain the other two facts about GoPro, a very young brand that didn’t go IPO until 2014, and Misfit, a much smaller startup that was only 4 years old.
The truth is: no consumers make purchase decisions completely out of rationality. In fact, the more developed an economy, the more its consumers make shopping decisions irrationally. And this of course also applies to consumer electronics in China.
By nature venture startups are both about risks and uncertainties. Risks are more or less visible to all experienced VCs in their respective realms. As long as VCs could do a fair assessment on all the visible risks, it won't stop them making investments. On the other hand, uncertainties are what keep VCs awake in the middle of the night – things that are out of control but that are crucial to the success of the startups.
In the world of hardware startups, manufacturing and retails are actually more like risks than uncertainties.
In terms of "manufacturing", an experienced VC would be able to quickly spot all the weaknesses in a hardware startup in doing manufacturing: Is there already DFM or DFT in prototyping phase? If not is it salvageable? Are key components single-source? Are certain components srouced from Taobao.com during prototyping phase actually EOL ones? Is there any part of the product that requires special reliability test? Or standard electronics tests suffice? etc
Whatever the offering is and however the clients are, B2B hardware businesses almost always have to rely on door-to-door sales process to push revenue growth. Marketing does not have that much effect. Yes, one can join all the conferences, setting up booths & LCD TVs showing beautiful videos and all that, but ultimately the deals are closed by the companies' salespersons. This is why B2B sales or pre-sales people in the technology companies (including startups) have the sweetest bonus incentive structure compared to other employees in the company, because without them, the deals just won’t close.
This also means that B2B business expansion is not only slow, but also potentially expensive. And it’s really the slow part that really kills the vibe. Early-stage VC funds have a very high required rate of return to meet for their LPs. If a hardware startup does not have the potential to grow exponentially in revenues, it’s basically VC un-fundable.
On the other hand, consumer electronics has always been a marketing game. With an exciting product, effective and flexible marketing strategies and solid operations, a startup today has the opportunity to grow exponentially, as evident in the revenues of Fitbit in the past couple of years before IPO.
Mistake #1 – A perfect manufacturing contract is all I need
Mistake #2 – I have a $1M Kickstarter campaign so manufacturers will fight for my business
Mistake #3 – I have a teammate that speaks Mandarin, so it will be a piece of cake for me
Mistake #4 – I don’t want to do manufacturing in China coz’ they will copy me
Mistake #5 – China labor cost is rising and industrial robots are coming so maybe I should do manufacturing in US or Europe
Mistake #6 – China is such a foreign country to me. I prefer to consign manufacturing to a 3rd-party full service company based in US or Europe
Mistake #7 – There’s an exact answer to any question I ask regarding manufacturing in China
This article was first published on RudeBaguette.
When I joined my partners at the Hardware Club to re-focus myself on investments in hardware startups, my former boss at my previous VC firm warned me, out of concerns about my career, that hardware startups were capital inefficient and would not be able to generate the investment returns as well as lean startups.
At the time I did not try to refute him, party due to that there were not enough data back then. Since then various hardware startups such as Nest, GoPro, Oculus VR and now Fitbit made their way to great exits either through IPO or M&A, making generous returns for their investors. In addition, various young hardware startups have nudged their way into the realm of unicorns, led by the ridiculously fast rising Xiaomi. I feel that it’s time to do an official analysis and refute this popular myth of capital inefficiency in hardware startups compared to their lean brothers.
Let me jump to the conclusion first: successful lean startups are as capital efficient, if not more, as their lean counter parts. They will generate as good, if not better, returns for their VC investors.
In fact, almost all of the consumption is driven partly or mostly by wants or desires, way beyond needs. Especially in the developed economies, it's actually easy to calculate the monthly consumption driven purely by needs, such as water, gas, electricity, public transport and health care. Almost all the rest is heavily influenced by wants or desires.
For food almost everyone spends way more than required to keep the body running healthily, and in various types of cuisine to keep us from getting bored. In terms of housing it's very common that people stretch their budget to go for an ideal apartment, either in rentals or especially in purchases.
And almost everything we buy on Amazon or in Walmart fit the wants or desires profiles better than needs: books, music, movies, consumer electronics, gardening, beauty, toys, sports, etc. In fact, take a look at the Amazon directory page and one would be hard pressed to pick out a product/service category that is truly "needed".
In any case, excluding the Shangzhai model or fairly standard markets such as routers and set-top boxes, it’s hard to imagine a decent contract manufacturer could work with a startup to produce a small amount of high-quality products with brand new designs.
Unless, that is, there’s a way to align the long-term interest of the contract manufacturers and the startups.
In other words, contract manufacturers would like to work with startups that have higher chance to grow into high volumes in the coming years, not just a one-time luck with Kickstarter or Indiegogo campaigns. By working with the really brilliant startups early on, the contract manufacturers hope to earn advantages in familiarity and specific manufacturing know-hows, so that in the later stages the said successful startups would continue to work with them on manufacturing.
A good example would be our portfolio company, Prynt. I wrote about the emotional aspect of their products as well as defensibility in another article here. But essentially we can say that Prynt is a polaroid smartphone case that is NOT.
For Prynt it is not really about printing physical photos and sharing them with friends and memories. What made it hugely successful on Kickstarter was the AR-style video playback part. Like the campaign said, "your memory comes alive". In other words, Prynt is actually in the business of keeper of the memory. By storing precious living moments for users while triggering the playback via physical photos, Prynt avoids all the awkward and oft-tried models of tagging, categorizing, face-recognition, etc on other big and small video platforms. If they can manage the memories of people properly while enabling a range of memory-related services on their crowd platform, they will be satisfying their users much more than just providing a printer or a video platform or the combination of the two. They will become the keeper of the memory and see a lot of smileys on their users' faces.