Hardware is hard. Consumer hardware is even worse.
As an ex ecommerce seller with years of experience manufacturing overseas, I can tell you dealing with suppliers, MOQs (minimum order quantities), quality control, cash flow and even LTV are tough.
Unlike SaaS where you build it once and sell again and again with almost no added costs, hardware requires cash. Manufacturing 10s or 100s of thousands of products requires massive upfront investments that most startups cannot afford.
And while every sale helps make up those margins, it is still nowhere near SaaS. Worst still is LTV (lifetime value of a customer). And like a one night stand, one and done isn’t efficient in the long run.
Fishing vs farming for customers
Constantly acquiring new customers takes time and money. CAC (cost of acquisition) kills your margins. High unit costs make economics even worse.
Most startups and brands fall into the fishing category. They launch product: let’s say a smart lock, an autonomous drone or a time machine… then they think about the business. “Well, obviously we Kickstart this, right?”
As an ex-crowdfunding consultant, I saw this all the time. The “build it and they will come” mindset kills more businesses than Facebook. Without proper planning, founders often scale unsustainable business models
Single purchase behavior is a like treadmill. Without repeat buyers or recurring revenue, businesses must constantly fight the same battle.
Exceptions to this rule build strong organic acquisition channels (see this post).
But even then, one and done loses every time.
Farming is a 10–100x better business model. Rather than kill or be killed, startups that acquire recurring customers need a much lower hit rate to succeed. Why hunt rabbits when you can domesticate them?
The same is true of customers. Companies that effectively milk customers merit MUCH higher valuations and become more sustainable, long lasting brands.
Repeat vs recurring business
There are two ways brands build success: repeat customers and monthly service fees. As a rule of thumb, these represent B2C and B2B businesses respectively.
As an investor, I only invest in hardware/IoT companies with recurring revenue components, ie typically B2B plays.
But today we are talking consumer.
Later in the article we will discussing B2C recurring revenue businesses and how hardware can be your businesses trojan horse.
Repeat buying behavior
There are several ways to prop up LTV here. Traditionally these include:
- New products — shoes, socks, shorts, shirts etc…
- Consumable products — toothpaste, contact lenses, lipstick etc…
- Replacements — new iPhone, new laptop, new fridge etc…
- Accessories — earbuds, Xbox games, HDMI adapter etc…
Are you an Apple fanboy?
You are on this article because of Apple, let’s start there.
News broke recently that Apple was screwing customers, surprise surprise. The company that brought you the iPhone was conveniently slowing older ones down, right after new versions were released.
In my opinion Apple is scumbag company. It didn’t use to be. But recently under leadership of Tim Cook, Apple has been only focused on numbers 3 and 4 above — the least innovative and most expensive of all.
But the iPhone issue is still especially troubling. Apple is a two trick pony, constantly reverting to the same old shit to drive sales and stock price. The iPhone and iPad are EVERYTHING for the company. They drive the lionshare of the sales and update the line every 1–2 years.
Because Apple’s branding built a fanboy culture, their early supporters are brainwashed into buying the latest (barely differentiated) product. And this has made Apple the most valuable company in the world.
But be honest, when they remove the headphone jack, ask you to buy 3 new dongles, change it all again in the next iPhone and slow down your old device to force an upgrade scenario, can you really keep supporting that shit?
Apple is unsustainably taking advantage of their customers and failing to innovate.
What great brands do
We all accidentally eat rotten apples. Instead of feeling sorry for Apple suckers, let’s look at what real brands do to build businesses.
1. Launching new products
Since the beginning of the industrial era, new products have dominated the world of consumers. Every year, new automobiles are released with better mileage, better performance and better customer value.
While companies like Ford and GM wanted consumers to upgrade, rather than slashing your tires, they would offer trade in deals, extra warranty, additional tires and more to sweeten the deal.
But the idea of updating existing product isn’t where most brands thrive. Instead, most companies create new products and innovations on a pretty consistent basis.
Like Cortez, the idea here is land and expand. Build a relationship and trust with consumers and begin servicing their other needs. Amazon did this with books and slowly expanded into new categories. You can too.
The key here focus. The best brands build a vision around a particular niche and expand horizontally.
Look at Disney. Most wouldn’t regard this media empire as a product company, I would. Disney World is a product. The movies are products. The toys, stuffed animals, clothes and posters are all products.
The machine behind Disney is unparalleled. As of 2013, Disney’s merchandise sales accounted for $40.9B in revenue. That is hardly chump change.
Not only does a larger product line allow you to serve more potential customers, it creates more channels to pull consumers in. This is definitely true in the Disney example. From Frozen to Mickey Mouse, Snow White to Monsters Inc, Disney is devilishly good at attracting kids and creating upsell after upsell after upsell.
And acquisition after acquisition, Disney brings more characters to the battle: including Marvel, Star Wars, the XMen and many many more.
Seem unfair, it is. But any brand can accomplish similar feats — land and expand.
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2. Consumable products keep selling
My favorite from an business perspective have to be consumables. The best part of SaaS is the recurring revenue (followed by huge margins). But with consumable products, these economics can be similar.
Dollar Shave Club built a $1B valuation incredibly quickly, just by selling consumables. Guys need to shave and repeatedly need new razors. Acquire a customer and you can potentially keep him for life.
That helps LTV/CAC ratio.
But not only subscription companies benefit from non-reusable products.
Coca Cola started as a soft drink company — one secret formula. Leveraging the success of the product and brand, Coca Cola has become a giant today, owning Dasani, Powerade, Nestea, Hi-C and more (clearly employing a #1 and #2 strategy for strategic growth).
And every time you grab a Coke or pound a Powerade, you are padding Coca Cola’s bottomline — a healthy $41.6B in 2016.
Why most brands die?
Assuming you have already built a successful brand, are four primary reasons brands die: competition, cash flow, disruption and greed (or lack of innovation).
When markets saturate, everyone gets squeezed. Pricing power dies and margins dry up (for strategies to avoid this, see this post). The exception of course is the market leader. Given strong enough differentiation, the top dog often is able to survive and even thrive as others rip themselves to shreds in a race to the bottom.
2. Cash flow constraints
Businesses can outgrow themselves. Due to the cash intensive nature of physical products, when sales spike too quickly or founders try to expand product lines too rapidly, they can shoot themselves in the foot. Running out of money is a real risk and the reason why product entrepreneurs should setup a line of credit in case things get tight.
3. Classic disruption
Classic Clayton Christensen disruption theory. When a 10x better product enters the market, typically as a result of a stepwise change in innovation, incumbents fall. The iPhone is the perfect example, look at Blackberry.
4. Greed (lack of innovation – Apple…?)
These are one in the same and the reason Apple is dying. When a company hoards a war chest rather than focus on truly disruptive innovation, they are eventually overtaken. Taking advantage of customers kills brand loyalty and breaks business models, just wait and see…
Recurring revenue B2C hardware is best
B2B is great. You work with companies and solve pains they are willing to pay for. And with today’s SaaS model, recurring revenue allows founders to build sustainable businesses and reliable cash flows to scale up.
But I promised we would talk sexy SaaS-like MRR (monthly recurring revenue) for consumer hardware. We finally got there.
NOTE: Recurring revenue from consumers is hard. And many products and business models cannot accomodate a SaaS service model. But some can.
The sneaky trojan horse
Think of your product like a loss leader, a way to get your foot in the door. The best consumer hardware plays make some money on product and way more on the backend.
Tovala’s a great example. Tovala’s a specialty, connected oven that allows even Dad to deliver restaurant quality homemade meals without the hassle. The IoT oven combines steaming, baking and broiling for a programmable, perfect meal.
The beauty isn’t in perfecting the combination cooker however, but the subscription service. Tovala sells premade meal kits designed specifically for their oven — just pop in the package and the oven handles the rest, with pre-programmed cycles for each of a almost a dozen delicious dishes.
And the mouthwatering part is the monthly subscription fees. Sure, homeowners don’t need to buy Tovala kits to cook, but if you spent so much money on an oven, might as well get your money’s worth, right? Let the upsells begin.
That is a good business model.
Hardware + Software
IoT is the key to great consumer hardware companies. If there isn’t a service component and strong recurring revenue, LTV is hard.
Great examples include connected home companies like Nest and Ring. Both charge upfront for the device and have monthly or yearly monitoring/usage costs. With both, failure to pay results in a worthless product, and buyers remorse. So of course consumers stick around, which is a big part of the reason Google paid $3.2B to acquire Nest in 2014 (plus to better invade your home and compete against Amazon).
The beauty of software is that it is constantly changing and improving. Companies like these can continually improve the quality of their service, like Tesla, just by pushing code. As the experience becomes better and better, customers become less and less likely to churn….
Note: Most recurring revenue subscription box companies aren’t great businesses. Here is why, with an in-depth analysis of how to improve them.
Great brands do several things incredibly well. They differentiate and delight customers, building core defensibility directly into the brands. And the truly great ones keep customers coming back.
But at the end of the day, it is a relationship built on love, trust and value. And Apple clearly forgot that.
Is the abusive husband really the best way forward for brands? I say no. And yet, at the date of this article Apple is the most valuable company in the world.
That is an interesting insight into the public markets and mindset of consumers…
Will we see a correction? Will customers tolerate this? Where did Apple go wrong? Does over-optimizing for short term bite Tim Cook and Apple in the butt?
Would love to hear your thoughts and opinions below?
As a consumer, as an entrepreneur, as an investor… what do you think? What is your reaction?
As always love to debate and hear other smart people’s perspectives.
And if you need help designing any of this into your business model, I’d love to work together.
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