The Hard Things About Hardware
Why it's difficult for hardware-first companies to succeed and what steps need to be taken
Physical technology isn’t as sexy as software. That’s been the case for years, with 2021 exemplifying just how skewed investment sector trends are. The image below shows venture investments by vertical over the first quarter of 2021. As you can see, internet-company investments dominate. Non-internet software isn’t too far behind (It’s considered different than cloud-based, I assume). All the way down under industrial you’ll see computer hardware and services coming in at a cool 5% of the total investments into internet and 32% of non-internet software.
(Statista, Value of venture investment by sector 2021)
Hardware is hard to make, and even harder to make well. As Marc Andreessen of the prestigious VC firm a16z once said “It’s called hardware for a reason”. He’s not wrong. Successful hardware companies are certainly harder to find nowadays, with software-first companies abundant in the limelight. For every Apple Watch, Nest, etc. there is either a knockoff available on Amazon or another supplier undercutting prices. Amazon is well known for product cannibalization.
Bringing hardware to market takes a lot of money and an equally taxing amount of time. Hardware requires immense development, testing, and iteration because once it’s in a customer’s hands, it’s only fixable post-recall. Unlike software, bugs can’t be updated and refreshed easily. Finding product market fit is also difficult, since demand can often be short-term hype and not lasting value.
So what does a brand selling hardware need to do to survive and thrive? From my observations, there are three core strategies for success.
The first thing they need is to build a value-driven moat around a differentiator. Apple Watch dominates the wearables market because of the fluidity of using it in tandem with the most common phone in the world. Eight Sleep figured out a way to match your bed’s temperature with your body temperature to provide the perfect sleep. Rather than competing in the comfortable mattress space, they opted for extra-smart mattresses. The key to the success of moat-building is being explicitly clear about the value prop a hardware product offers. Once that value is clear, it becomes difficult for competitors to encroach on the market without blatantly copying. And if the tech behind one company’s software is better, then there is no competition. Conveying that value prop can be done with precise marketing or word of mouth.
Since Apple Watches are fairly ubiquitous at this point, Eight Sleep is a slightly better example for this blog’s purposes. Eight is known for their best-in-class mattress, technology, and app. The first of which comes at a fairly steep cost, even for good mattresses. But, because of the investment and volume of research that goes into buying a new mattress, a common thread on Twitter is “what mattress should I get?” Eight has built up a cult following for the value it provides its owners. It improves their sleep, cuts down their electricity bill, and gives them valuable data. Arguably it also gives them clout. But Eight’s marketing can be run through its customer base’s product promotion and hype. Its founder, Matteo, is also very active on Twitter. He pumps up the brand and engages with random users. Even me! That kind of ears to the ground involvement helps to push its vitality and encourage prospective customers.
The second tactic is to not be wholly dependent on ha(rdware. This often comes with platform-building, which drives incredible success. A great example of this is the iPhone. While the iPhone initially focused on building the world’s best phone, it evolved into a platform for apps to be built upon. Exploring a couple of other recent tech darlings instead, let’s look at Square and Peloton. Square currently has a market cap of about $110 billion dollars. It’s no small fry. But it started out with just the Square Reader, that little box you’d swipe a credit card through when attached to a phone. Next came the Stand, which could be used with an iPad. But as Square’s physical products gained traction, they started to back them up with services like Square Capital, a booking tool, Payroll, and more. Square doubled-down on their product market fit by offering a full suite of point-of-sale (POS) products and services. They’ve only continued to expand and improve the sales funnel from Reader to services.
Peloton executed differently. Granted, their demand was pulled years forward during the pandemic, but they are not a pandemic-dependent business. Peloton first rolled out their stationary-bike with a video player. While a lot of their growth came from rapid funding, they realized that just focusing on the bike hardware wouldn’t distinguish them from a standard exercise bike. They wanted to retain existing customers and bring new customers in, even if the bike’s price was prohibitive. So they made their app and the classes that come with it available to the masses. Eventually, they also added an optional “premium tier” with classes that came with a subscription. Again, each step improved conversion rate and widened the sales funnel.
(Source: The Flywheel)
The third and final strategy (which is expected of all businesses) is to iterate and launch more than just a single product. Peloton did this with the Tread, Fitbit did it with products for different levels of “intensity”, and Square did it both with hardware and software. Upgrading an existing product isn’t enough. To get ahead, companies have to innovate and execute quickly. Margins are slim in hardware until companies find product market fit and can scale. Continuous improvement and expansion to new customers is required to prevent churn and grow conversions.
With markets in their current state, hardware almost always has to come with software. And there has to be a way to build upon it. Building hardware companies is hard, but when they meet a customer need, the opportunities are bountiful and flywheels tend to pick up quickly. Margins are difficult at first, but venture fervor and quick iterations can solve cash issues. There’s a reason there are fewer hardware companies popping up. They’re difficult. Following the strategies above can certainly help, but execution and product market fit are critical. To start a hardware company, the value prop needs to be clear and there needs to be ample preparation for making the shift to being partly a software company.