Is Hardware really that hard?
After the collapse of the internet bubble, entrepreneurs and investors alike avoided starting and funding hardware companies. At that time, developing hardware was capital and resource intensive. Products had long design and adoption cycles which often resulted in an unfavorable risk/return profile. Much has changed in the ensuing 15 years to suggest that hardware offers an interesting investment opportunity and capitalizes on many of the same trends that have made software such a compelling investment. Increasingly, the line between hardware and software is blurring.
Innovation in hardware is being accelerated by the global ubiquity of smartphones, the proliferation of the Internet of Things (“IoT”) as well as rapid prototyping enabled by 3-D printing. Today’s hardware companies have attractive business models because their value lies not only in the devices, but also in their ability to monetize the data devices generate, or to embed software that provides a recurring revenue stream. Funding of hardware companies is also evolving to provide entrepreneurs, many of them schooled in software, with the specific tools and knowledge required to develop and scale their products. As a result, there is a growing ecosystem of accelerators and incubators poised to help entrepreneurs turn their ideas into product, and products into businesses, with crowdfunding sites serving as an additional source of capital to fund development. Lastly, the recent success of GoPro’s IPO, as well as well as the acquisitions of Nest and Dropcam by Google, Oculus by Facebook and Jawbone’s billion-dollar financing has renewed venture capitalists’ interest as there is now an established exit path for these investments.
SMARTPHONES
In 2014, smartphone penetration surpassed 65% in the US. More than 200 million Americans, and 1.75 billion people globally, carry pocket-sized devices that have the computing power to execute millions of calculations and to connect wirelessly to a multiplicity of devices. As a result, hardware developers spend less time and money integrating display and processing capabilities into their products. Instead, these devices incorporate complex software applications which are deployed on users’ smartphones, allowing the hardware to be smaller, lighter, faster and cheaper. Hardware devices can now be relied upon to take measurements which are relayed to smartphones. The software component then synthesizes these inputs and execute commands, as is the case with activity trackers such as Fitbit and home automation nodes like SmartThings.
Additionally, the sheer volume of mobile phones manufactured globally has significantly reduced the price, and increased the availability, of components used to build hardware. Mobile sensors, screens, processors, memory and batteries are all readily available. Contract manufactures can also be sourced globally, which lowers production costs at scale. Although hardware has not followed Moore’s law precisely, some of the same principles are manifested in the development of new products today.
INTERNET OF THINGS
The Internet of Things refers to smart devices capturing and interpreting multiple data inputs gathered by sensors, resulting in a more connected everyday life. Much of the focus to date has been on consumer-oriented devices similar to those mentioned previously. However, the IoT has the potential to disrupt enterprises in major industries as well. Workplaces will become more connected, processes will become further automated and businesses will become “smarter” in every sense. Given this potential, Gartner is forecasting that there will be almost five billion connected devices by the end of 2015, and 25 billion by the end of 2020, representing a market in excess of $260 billion.
BUSINESS MODELS
Given that software is now a major point of differentiation for hardware devices, business models are in a period of transition, shifting towards those that can capitalize on their software and the intelligence it provides. In today’s market, the device serves as an entry point and customers subscribe to services based on a software-based connectivity layer, providing hardware companies with a recurring revenue stream. Dropcam, for example, sells its home monitoring cameras for $150–200 each and offers an optional, cloud-based recording service that provides an expanded set of capabilities. This recurring revenue stream, in conjunction with Dropcam’s connected device, made the company attractive to its acquirer, Nest Labs (Google).
Rapid Prototyping/Manufacturing at scale
The proliferation of 3-D printers at increasingly lower price points has enabled prototyping to be rapid, cheaper and more accessible for companies of all sizes. Although hardware developers still invest substantial time and effort to refine their prototypes, 3-D printing enables teams to iterate different models more quickly, and to test various materials. This allows for an enhanced product development process and optimized bill of materials. As a result, production costs are reduced and time to market is accelerated. Once ready, entrepreneurs can globally source the best contract manufacturers. Services like Dragon help qualify these firms, with similar services available online from companies like Alibaba. Needless to say, none of this existed a decade ago.
FUNDING MODELS
Entrepreneurs are also benefiting from innovation in funding models. Crowdfunding websites such as Kickstarter and Indiegogo enable consumers to buy products pre-production. This provides entrepreneurs with valuable insight into the viability of their product in the market, as well as capital for manufacturing if their idea is well received — both of which substantially de-risk the venture. Notable crowdfunding campaigns include the Oculus Rift (head-mounted virtual reality display), Pebble (smartwatch compatible with Android and iOS devices) and Coin (connected device that resembles and replaces credit cards). According to CB Insights, 443 hardware crowdfunding campaigns exceeded $100,000 in 2013, and venture funding to crowdfunded hardware startups exceeded $200 million across 23 deals. 2014 is on pace to eclipse these numbers.
In addition to crowdfunding websites, a number of hardware accelerators and incubators have been established with the goal of helping early stage hardware companies establish product/market fit. These firms typically house portfolio companies on-site for 6–12 months, where engineers and industrial designers work closely with founders as they develop their prototypes. Tools such as lathes and 3D printers are also provided.
The importance of this new approach to hardware development has also caught the attention of corporations. Recently, GE partnered with Quirky to launch Wink, which is aimed at developing a full line of app-enabled devices for the home, with the modest goal of “changing invention forever”. Autodesk launched a $100 million fund called Spark to spur innovation and collaboration in 3-D printing. Autodesk also has a partnership with Bolt, a seed fund investing at the intersection of hardware and software. Other corporations with venture initiatives, such as Cisco, Intel and Qualcomm, are investing heavily in these new technologies as they see significant business opportunities.
Software-enabled hardware excites entrepreneurs, investors and most importantly consumers. Devices are tangible, unique and have a meaningful impact on people’s lives. From fitness tracking to brain monitoring to home automation, software-enabled hardware has made its way into many facets of our everyday routines. Hardware is still “hard” given that to be successful these products require broad adoption, and need to be manufactured at scale to achieve attractive margins in the long term. However, the value of such companies is being recognized by the savviest financial and strategic investors.
It is still early days in the evolution of hardware. Nonetheless, we expect to see many more venture-backed startups in the future, and are hopeful that some of those with large outcomes find their way into Accolade’s portfolio.
