Software is eating the world, but the world still runs on hardware

We spend an entire day interacting with our physical world. That makes hardware providers the platform owning the most users per day (yes, more than Android or Google Search). At the same time Snap calls itself a “camera company” – Facebook is developing lasers, satellites and drones. Your VC friend calls it oldschool, vintage or a marketing stunt. Maybe. It’s easy to believe them that “software is eating the world” – but today the commercial hardware startups ecosystem seems like an undervalued, often overlooked business category which is starting to re-invent infrastructure how we know it. In the end, software might be eating the world but in the end the world still runs on high end hardware.

Hardware doesn’t fit the learned pattern

The strange thing is that hardware startups typically doesn’t fit into the investment pattern of VC’s. Looking at the PCH hardware’s weekly newsletter which lists recent hardware investments, more than 60% of the average investments in early stage ventures are led by strategic or corporate investment vehicles. some recent examples: 21st Century Fox investing in a VR smart glass company; Foxconn, Sharp and Roc Nation investing in a sound amplification technology; GE Ventures, Microsoft Ventures and Qualcomm Ventures investing in an IoT development company. Where are all TOP silicon valley VC company names? Typically not the first ones on that list.

The abundance of VC’s from the hardware startups industry seem at odds with the market. Ground breaking commercial innovations today gets funded past the eyes of the VC’s you’d think of first to fund them.

Why investors learned to keep their hands off hardware

There are 3 distinct reasons why investors learned the hard way to keep their hands off hardware startups:

  1. It’s hard to fulfill a 10k unit Kickstarter order with fully working units and avoid 50% broken returns basically ruining your reputation and emptying your bank account. We’ve seen that happen in the past with numerous examples. Mostly it’s investors who are asking for these presales as proof points: When we started Kisi, investors asked us how many units we pre-sold on Kickstarter. When we told them we cancelled our pre-sale campaign because people from all over the world started ordering and we anticipated a fulfillment nightmare, most thought we didn’t have enough traction.
  2. Another nightmare playbook move was to give away hardware as a “hook” – a gadget that draws you into the software use.  This results in low-tech engineered, cheaply manufactured and over-styled products – a big reason why startups can show sales ramp-up, but the device itself begins to fail after two weeks.
  3. The major reason why the venture capital industry keeps its hands off hardware is because many investors have been burned by home automation. Home automation as a category today is still failing and an immature concept. Most devices are not secure enough, don’t have reliability capabilities, and do not live up to modern customer expectations whose space goes beyond one room with perfect wifi, wireless charging and lifelong battery life. At home, there is no IT manager to take care of the connected hardware inventory and young professionals have no interest in becoming a part time IT manager. This results in devices having to be sold “dumbed down”, turning into a vicious cycle. Till today there is no service company that has even come close solving this problem.

What investors don’t know about hardware

Today we are on the verge of a new type of hardware startup. TheB2B infrastructure revolution is driven by secure hardware platforms with a deep stack, replacing their entire category of legacy infrastructures with software-enabled quality hardware. In Brooklyn we have hubs like Newlab who only focus on exactly those types of companies [full disclosure, at Kisi we are a tenant].

Having a standard software startup playbook is great. But it also makes investors likely to overlook the small but impactful proof points on the sidelines that speak for hardware as a great business. Hardware startups have produced their products in the shades until recently. Here are seven overlooked factors most software investors are not aware of:

  1. 35% of the IT budget is pure hardware – companies can’t buy routers and printers every year. Who is actually competing for this budget? Compared to the other 50% owned by software spend there is an infinitesimal low competition in the hardware corner. (source)
  2. The source of rich data is always a deep stack owning the hardware. Software can be very smart – but the data points it plots and the data it collects is defined are limited by hardware. That means hardware dictates how and what data can be used. As a result an app never can be as deep of a data source as the hardware device that is producing it. In the end the App will always be fully dependent on the goodwill of the hardware platform to give them the data.
  3. Hardware designed right exponentially increase the companies’ brand awareness. A software used in an office is mostly not visible to anyone. Amazing hardware that does its’ job will be noticed. With our proximity reader at Kisi, we basically have a billboard in front of every office! People who see it for the first time often get excited about it, tell others, and create the coveted viral loop.
  4. Business focused hardware has subscription characteristics with shorter update cycles that investors don’t yet have a name for – let’s call it HRR – hardware repeating revenue. Anything Bluetooth, NFC or internet related typically has 18 – 24 months update cycles. It’s similar to the smartphone buying cycle you might be in – upgrading your iPhone every 18 months. Does anyone doubt businesses handle it differently if there is something out there that is better, faster and more secure? They almost always upgrade.
  5. Hardware makes it much easier (not harder) to get a proof of concept installed since someone can come on site and help set it up. Compared to a new sales tool you might want to use, you have to get the buy-in from a busy engineer on staff to actually deploy it.
  6. SKU’s allow for easy repeat ordering. It doesn’t need a whole lot of change to a contract for a customer to start re-ordering hardware and deploy at new locations. So rolling out hardware is actually easier than software – once the IT manager has a clear POC playbook for their use-case, they can scale it across their entire organization. With software contracts you might need to re-negotiate your deal – IoT enabled industrial hardware scales from unit 1 – including the pricing.
  7. Advanced manufacturing makes B2B hardware extremely cost efficient to manufacture. Manufacturing a high quality device today that is ‘Made in the US’ is probably as difficult as programming a mobile App about 10 years ago.

We are still believers in a digital world

Don’t understand this wrong – we are the biggest fans of the mobile-enabled self. But more and more we realize this vision of a digital world can only work with the commitment to an underlying robust infrastructure. The apps, API and AI layer is 100% dependent on infrastructure. Resilient, secure, and fast services can truly only be provided by companies who own the stack including hardware infrastructure – some call it ‘Industrial IoT’. In the past this infrastructure has been provided by multi-national corporations with products so complicated that it seemed hard for anyone to break into. But exactly those services are now showcased as highly inflated, vulnerable, and bulky. Industrial IoT startups allow for more scaleable, secure, and integrated infrastructures.

Is Silicon Valley still what it started out as?

What we often like to forget is that Silicon Valley started with hardware. In fact, it’s name originates from hardware: silicon chips. Over time it just happened that development cycles got faster, there was a shift towards software which was promising faster and higher returns. The individual serial entrepreneur / investor was replaced with institutional VC’s. All of a sudden instead of a 20 year bet, investors needed to plan on a five year 1 out of 10 exit.

The question is: Is this a mindset Silicon Valley started with or wasn’t it to change the world with technology? What if the next Salesforce is a speech recognition headset that doesn’t even need manual data entry anymore? Imagine the next Marketo has local AR-enabled, local sales agents? What if the next Microsoft comes with your workdesk? Now is a good time to stop eating the world and start producing it. 

Greetings from Brooklyn.

This post is part of our contributor series. It is written and published independently of TNW.

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