The consumer electronics industry isn’t dead; it just needs to adapt its business model
Innovative companies are finding new ways to do business, and this shift is revolutionizing the way we interact with our hardware.
You may have heard Marc Andreessen’s now-famous quote: “Software is eating the world.” But where does this leave hardware? With companies like Jawbone, Juicero and Hello going through very public failures in recent years, many would have you believe that the industry is struggling. Those failures, however, provide valuable lessons on the challenges consumer electronics companies face and how they need to adapt.
There are many reasons for companies not succeeding. For startups with a transactional model, the need to forecast inventory build for the year in advance of consumer demands is tough, with even small deviations proving costly. Revenue is onetime and unpredictable, while the need for continuous investment in sales and marketing to acquire new customers can burn cash fast.
Today, the most nimble and innovative consumer hardware startups are adapting to the traditionally tough hardware market by optimizing their products and their business models. As a result, these companies are offering such products as smart speakers and home thermostats for little to no upfront cost in exchange for premium paid services or access to a software marketplace or simply your data.
Having a competitor’s hardware in the consumers’ hands is a big barrier to entry. One of the most valuable companies in the world — Apple — has been built off of that. When a hardware product is owned and installed, it becomes very sticky. Unlike Uber and Lyft, it is much harder to switch between pairs of Sonos and Bose headphones or between a Nest and a Google Home thermostat. Owning the consumer through a physical product establishes a great moat. For consumer electronics companies, the shift to a new “software-like” approach, where the device is basically free, is a big deal. Once the customer has the hardware, the next challenge is to monetize it.
Internet companies like Netflix have found success with subscription-based models that give unlimited access to the entire product offering for a recurring fee. Others, like Spotify, employ a “freemium” model in which they offer their core product for free and subsidized the cost with ad revenue and premium accounts. Facebook produces massive revenue streams solely by selling a different kind of product: data freely offered and generated by an active user base.
The same market dynamics that shaped the growth of these internet giants are emerging once again in the consumer hardware space, as high-profile failures and selective “risk” capital are forcing companies to take a hard look at how they approach the market and generate revenue. And it’s working. Many of these companies are finding success by leveraging the data and connectivity enabled by their devices and applying this to the business practices traditionally reserved for software. As head of Silicon Valley Bank’s Frontier Tech group, more than ever before I am seeing hardware startups introducing subscription elements — or having other partners pay for the offering (for the use of data).
The last challenge for startups is financing this new approach. My colleague Matthew Wright wrote about this in his recent post about the evolving financing needs of frontier tech companies. One of the most commonly cited business models for these tech startups is the aptly named Hardware-as-a-Service (HaaS), which relies on the sale or lease of a device in exchange for a recurring fee, often in the form of a monthly or annual software license or service charge. Rather than attempt to maximize gross margins on the initial sale, HaaS companies optimize for high lifetime value through recurring fees.
A lot of consumer electronics companies are collecting unique data sets combined with iterations of the “software” revenue model. One of the most high-profile success stories is the consumer electronics company Peloton. Having raised $994 million to date, valuing the company at more than $4 billion, Peloton offers a luxury spin cycle and treadmill with an integrated tablet designed to give users an immersive fitness experience. Users can stream the company’s live, instructor-led classes for a monthly subscription. The company is already generating annual revenues of $400 million.
Another prime example of a consumer-facing frontier tech company using this model is Deep Sentinel, a smart-home company that offers AI-enabled security sensors and cameras that detect suspicious behavior; the company charges users a small monthly fee in exchange for the hardware-enabled service.
Similar to the HaaS model is the hardware-enabled service model, where the service accompanying the device is optional rather than required. This model will inevitably be used in frontier tech–related hardware, such as virtual-reality headsets with optional subscription-based content or consumer drones with optional paid upgrades, software and servicing subscriptions.
Finally, we see some consumer hardware companies employing the “consumables” model that Gillette made famous with its disposable razors. This familiar business model relies on a onetime hardware sale of the “dispenser” and continual sales of the “consumable.” This is one of the most difficult models for consumer electronics companies because it not only requires integrated software and hardware products but also demands fast and efficient distribution. A perfect example of this is the air-filter company Molekule, which sells a dispenser-like hardware device and generates recurring revenue through the sale of its replaceable air filters.
One day, we may see insurance companies offering free wearables that track and monitor every aspect of our health. We may see entirely free Uber rides in exchange for watching a few advertisements on the way. We may even see robotic house-cleaners offered for a small monthly service fee. The exact model isn’t clear, but what is certain is that consumer electronics companies must adapt their revenue model to bring stability and future capital to the market.
