Test commercial feasibility and do the easy stuff first

By Thomas Klem Andersen, Published on september 14th 2015

This week Jakob Svagin from Scion DTU and Andreas Cleve Lohmann from Copenhagen Lean Startup circle are challenging the participating hardware startups in Danish Tech Challenge on their value propositions and market assumptions. Here are some insights from the kick off talk yesterday when the lean-rubber hit the road.

Running lean is different than “just doing it” (a mystic approach to entrepreneurship based on intuition) and the approach of traditional innovation management (an approach based on plans, specs and waterfall processes with way too long feedback loops). Running lean is neither about chance or planning rather it’s about optimizing learning under circumstances characterized by extreme uncertainty.

You have to build to test. And there’s a bunch of things you can do without even building anything because it’s crucial that you test your entire business model and not just the technical feasibility. Sure you need to test your technical solution. But you need to conduct commercial experiments and generate commercial data as well. 

Recognize that your big vision is based on assumptions and they all need to be tested. Test your value hypothesis, your market hypothesis, your growth hypothesis – which include sales channels, partners and customers. These are all part of the uncertain context which your technical innovation needs to adapt to in order to achieve problem-solution fit and product-market fit.

You should build minimum viable products (MVP’s) of your actual product. But you should also build and hack MVP’s for how you interact with key partners, suppliers, users and customers. You can do that very early on and long time before you finish your product development (if you ever do). It’s never fun to be sold a bad product, but it’s always fun to be part of building something that can become big, so have an inclusive mindset from the start.

Most likely your potential customers aren’t out there actively looking for you. So the questions you need to ask yourselves are:

•          How can you make them care?
•          Why is your product valuable to them?
•          Do you know their criteria for buying?

Your technical product development might take six months or longer. But testing commercial feasibility can be done in a matter of days and is essential to developing a sustainable business model. So go do the easy stuff first!

Investment issues for hardware startups

SKTA Innopartners blogpost by Ilgiz Akhmetshin, August 6 2014

It is widely accepted that the hardware startup funding ecosystem is broken. There are a lot of reasons why investors hesitate to invest in hardware (and even more so in semiconductors):

·         High R&D expenses

·         Longer time-to-market

·         Expensive proof of concept

·         Potential manufacturing issues

·         Expensive to scale, etc.

Therefore, most VCs won’t consider investing in semiconductor companies. Given these reasons, even with the best material or the ultimate chip, fundraising is very tricky, if not impossible. A typical semiconductor startup requires about $5M of seed funding to validate the design and to get to proof-of-concept on an FPGA and then an additional $20M to launch the product. Although this number may vary from one startup to another, it will always be order of magnitude more costly and take longer to reach commercial viability than a software startup. Usually, entrepreneurs can invest their own money or raise angel funding to get started. However, to become venturable, a hardware startup requires much more. Here are a few ways of raising additional money. 

Venture Capital 

Although there are a number of VCs who have recently invested in consumer hardware (e.g. Menlo Ventures, Highland Capital Partners, Samsung Ventures America), extraordinarily few will invest in the early stages. Early stage semiconductor companies may not have much more than a concept and some gross calculations. Armed with only this, it’s much too early to seek VC funding for a traditional Series A round. To become “venturable”, they will have to find $1M-$5M to get first prototypes or at least simulations run. 

Crowdfunding 

Recent success of hardware startups on Kickstarter (Pebble – $10.3M; Form 1 – $3M),  or Indiegogo (Ubuntu Edge – $7.4M; Scandau – $1.6M) prove crowdfunding can be a viable source of startup funding that does not dilute founders’ equity. Moreover, projects not only get funding, but also PR and a customer base. However, crowdfunding is only viable for consumer electronics and devices. We should keep in mind that Kickstarter’s and Indiegogo’s models work this way:

1.       Backers pre-order products or services from a startup

2.       The startup uses this money to start manufacturing

3.       Backers receive pre-ordered goods or services

This works perfectly for consumer devices, but won’t work for any upstream hardware. There is hardly any consumer who needs a single next-generation bluetooth chip if it is not integrated somewhere. Other crowdfunding options include gust.com, angel.co and f6s.com. When the JOBS Act takes effect, everyone may invest in startups via crowdfunding platforms (today, it is limited only to accredited investors who meet special accreditation requirements). Even though these platforms bring more potential investors to the table, it is unlikely that b2b oriented startups will be able to benefit from this opportunity. Consumers are not moved to invest in “holy grail technology”, such as EUV light sources, for example, because they don’t understand the device and the benefits to solving the lithography problem are too far removed.

Seed funds / Accelerators / Incubators 

There are quite a few startup accelerators that focus on hardware. Some of them are affiliated with major semiconductor or hardware manufacturers. This partnership can be beneficial for startups in multiple aspects; strategic partners can bring industry and technical expertise, seed funding and opportunities to scale up (Read the original post to see a list of US based hardware accelerators).

The Hardware Startup Movement

Excerpts from an Undercurrent blog post May 15 2012

The reigning model for entrepreneurs seems to be:

(1) make software-based (predominately, web-based) tools and (2) scale it up.

We see few entrepreneurs pursuing hardware startups, and for good reason. Challenging the Samsungs, Apples, and GEs of the world seems onerous without generous capital, long lead times, IP, and research budgets.

Today, software is an easier course of action for entrepreneurs. The barriers to entry are low, with frameworks (Rails, Jquery) and services (Heroku, AWS) making it dead simple for anyone to take on the technical burden of building an app. Equipment is easy: a laptop and server. Combine this with the lean startup ideology and a small, young team can build just about anything within a reasonable timeframe.

What's interesting is that the same dynamics are beginning to shape hardware too. The forces that made software so alluring to entrepreneurs are finally permeating to hardware: open source platforms, lower capital requirements, and easier development.

Open Source Hardware

While open source software platforms have been commonplace for decades, we're finally seeing significant progress in hardware. It's allowing for amateurs to build and manufacture products without significant professional expertise, akin to emergence of web frameworks that democratized web development over the past decade. Recent estimates approximate 350 open source hardware projects, the most significant including Arduino (physical computing platform), Makerbot (3D printing), and Sparkfun (electronics).

Many hardware developers are opening up their designs (e.g., CAD files) and firmware to allow for a sort of remix culture for hardware. We're not at the point of "APIs" for hardware, but small communities are quickly building amazing open source projects. Wikispeed, an open-source car, and Open-source Ecology, industrial machinery, are great examples of this.It's fueled by the thriving maker movement, a return to making physical stuff by a growing population of hobbyists and engineers.

Personal fabrication

Hardware startups can operate on the same principles as lean software startups, quickly iterating and operating with only a few thousands of dollars in capital. Prototyping was always problematic—a one-batch run of a product can be incredibly costly to fabricate, yet it's a necessity to secure funding. While traditional manufacturing requires labor-intensive tooling and setup, new technologies such as additive manufacturing and CNC tools operate like desktop printers, taking in files and outputting physical objects. Every garage is a potential high tech factory, making it much easier for an entrepreneur to move from hardware idea to finished product.

Makerbot, a $2,000 3D plastic printer, democratizes manufacturing at the consumer level. The company has managed to drop materials costs down to pennies per cubic centimeter, a big difference from the industrial printers running at $300,000 per machine and $100 per cubic centimeter of plastic. Mid-tier priced equipment allows for "Kinko's of manufacturing." Techshop, Fablab, and 100K Garages are all examples of small, decentralized manufacturing operations where individuals can fabricate prototypes and end products without approaching traditional factories.

Long Tail Manufacturing

As with software, lower costs and easier manufacturing will allow access to new markets for hardware. We're predicting a long tail of manufacturing—niche hardware products made possible by low volume fabrication, on-demand manufacturing (and consequently, no inventory), and a shorter learning curve. Economies of scale is no longer an issue.

This is substantiated by the numerous hardware projects on Kickstarter without mass appeal, but sustainable at lower volumes due to greatly reduced costs. 

Realizing this future and its potential has a lot to do with the maker movement. Education seems to be the biggest hurdle, as technology is finally at a place where cost and capability are not barriers to entry.

The metrics that really matter for hardware startups

Blogpost by Marc Barros from Marcbarros.com

The hardware revolution is not only challenging the existence of billion dollar brands, but altering the very metrics we use to define their success.

Previously held hostage by retail, consumer hardware companies used to measure their business by the number of units sold, growth in revenue, points of distribution, and gross margins. Mainly because the hardware experience ended when the product was shipped to retail, hardware companies used the only metric they could track: Sales.

 

At Contour I got stuck in this same trap, and because of it, I build the company in the wrong order. We often prioritized our retail channels over our customers, and so we focused on channel growth without really understanding our customers, how often they used the product, and how to profitably reach more of them.

The good news for hardware startups is that these metrics are now irrelevant. The new expectation is that hardware ships with amazing software, and that means you can track your customers after they buy the product. This is new for hardware and opens up fantastic opportunities to measure lifetime customer relationships, metrics that were previously impossible.

The bad news is that this will expose hardware’s dirty little secret: Customers buy and then stop using your product.

If you are building or investing in a consumer hardware startup you should be thinking about the following metrics.

Cash Is King
Hardware is a cash-flow business. It takes cash to build your product and when ready, cash to build your brand. It’s why I’m a big believer that your hardware MVP is about the fastest path to cash.

When getting to market all you care about is how much cash it takes to start shipping your MVP. Whether you raise capital or pre-sell your product through Kickstarter, most hardware products should get to market for under $500K. If you have been around the block you can raise additional capital upfront to make a more robust MVP, but otherwise you want to get your MVP selling as soon as possible to start driving positive cash flows.

Once your product is shipping, and for the entire life cycle of your company, you care deeply about the cash float between when you get paid and when you pay your supplier. If your supplier provides 60-90 days of credit and on average you collect payment in less time (known as your average days outstanding), you are in good shape. But if not, this float gets very expensive to fund. Banks will only provide cents on the dollar against existing assets, while equity requires you to give up big chunks of your company just to fund customer demand.

Running out of cash is a very expensive problem to fix.

Reaching Market Fit
This is an incredibly important milestone for hardware startups. Not only is it the point people can’t stop buying your product, but it’s also the point you understand how to replicate a profitable business model.

Not everyone will agree, but growth is not the most important metric in reaching market fit. Although growth is great for getting investors excited, it doesn’t help you fully understand what is and is not working in your business. In trying to reach market fit you should care about deeply understanding your customers, why they buy the product, and what works to grow your customer base.

In addition to cash you will want to track three more metrics:

1.     Customer Love
I’m a big believer in Net Promoter Score (NPS). It is the single metric you should use to measure your customer even when you only have a few hundred of them.

2.     Customer Engagement
You want customers who can’t stop using your product because it will help you learn even faster about why they bought the product, how they use it, and which features you should be prioritizing. You can track this metric in a variety of ways, but make sure you pick a single metric that tells you how often they are/aren’t using your product.

3.     Customer Acquisition Cost
One of the most expensive parts in building a hardware company is reaching new customers. You want to understand what is and isn’t working in reaching new customers, especially early on when you are experimenting with every kind of marketing channel you can think of. Don’t make the mistake in ignoring how much it costs you to reach a customer through retail. Your true customer acquisition cost is what you spend in sales/marketing and the margin you give up in selling through retail.

Growing Your Company
Once you reach market fit you are ready to build a company. It’s a point that most hardware startups never reach and a point most entrepreneurs will find less exciting because once you get here, you spend most of your time repeating the same 18-month cycle: Introduce a new product, advertise it, repeat.

On top of the cash, customer love, customer engagement, and cost to reach a new customer you should care about four more metrics:

1.     Market Share
You have to be the brand of choice or you risk losing your very existence. Investors don’t fund number two without a clear path to how you become number one in the market.

2.     Number of Customers
You care about customers, not units. Reaching 100K annual customers with a single product is important, reaching 2M puts you in a small class, and passing tens of millions makes you one of the largest hardware players in the world.

3.     Lifetime Value
People get it wrong when they ask how much of your revenue is from hardware vs. software. The real question is how much is your customer spending with you over time? Whether it’s from buying another unit, accessories, or paying for your software doesn’t matter. What matters is that you can continue to drive more revenue (and profits) from existing customers. Apple and Amazon both demonstrate how important this metric is. The larger the number, the stronger the business.

4.     Profits
In hardware profits ultimately drive everything. Not only are they important for raising working capital, but they allow you to properly re-invest in the business. A handful of investors will fund losses as you build a massive empire, but most will demand you are profitable as you scale your business.

Conclusion
Picking the right metrics for your hardware startup matters. What you track will shape the decisions you make. Getting these metrics wrong, will leave you with a company you can’t fund.

No longer held hostage by retail, hardware startups can begin measuring their business by the only metric that really matters: their customers.

Image Credit: Louise Docker