A Silicon Valley truism used to be “hardware is hard.” It was a space not just overlooked but actively avoided by investors who agreed with Marc Andreessen’s prescient mantra that software is eating the world. And while software is indeed eating the world, hardware is becoming an increasingly diversified delivery vehicle through which software-based services reach consumers. Investors have caught on. Dow Jones VentureSource reports that in 2014 U.S.-based hardware startups raised $2.6 billion in venture capital through 159 transactions, marking a 53% increase in dollars raised and a 67% increase in number of transactions since Andreessen’s 2011 statement. While we fully expect this trend to continue, supported by the plethora of hardware-focused incubators, accelerators, and funds now coming to market, it is valuable to look back on what factors have enabled the most recent hardware revolution and convinced us to expand our investment thesis in 2013 to include hardware.
Fundamentally, there are four major developments driving the re-birth of hardware investing.
The first enabler is the third-party platform. Analogous to how Amazon Web Services innovated IaaS, democratizing access to servers and lowering the cost of application development and delivery, companies like Intel and AMD have developed off-the-shelf, easy-to-integrate components for connected devices. Even startups have gotten in on the game, with Electric Imp having raised $23 million from VCs for its Internet connectivity chip. Similarly, Bluetooth Low Energy provides an energy-efficient common protocol for wireless communication between devices from different companies. A whole ecosystem now exists making it vastly easier for small, lightly funded teams to create amazing products, without the need to build every piece of the stack or worry about communications protocols.
Advances in prototyping
The second enabler is the advent of quick, affordable prototyping. Technologies such as 3D printing and sophisticated design software not only quicken the hardware development and iteration processes, but they also allow makers to share their tangible designs with both investors and consumers before having a viable, marketable product. Further lowering costs, shared spaces such as TechShop provide makers access to these technologies at a reasonable fee.
Prototyping ends up facilitating the third enabler: pre-sales campaigns. Startups can now show off their product prototypes to interested consumers, who pay cash now for the promise of the product’s delivery in the future. Not only does this provide substantial additional capital to re-invest in production or additional marketing, but it also provides valuable, timely market feedback, as consumers vote for or against a product with their wallets. If pre-sales are a flop, there remains time to optimize or pivot as the device has not reached its final production stages. Before pre-sales, hardware businesses had to be built through a cycle that started with mom-and-pop shops, moved to regional retailers, and finally ended up with national chains like Wal-Mart and Target. The upfront costs associated with developing a final product before market feedback and then slowly selling up from local to national retailers hindered venture investment in hardware, especially at the early stages.
Manufacturing at scale
The fourth and final enabler is the ability to manufacture at scale. Once a hardware startup has validated its product through pre-sales, it can now attract contract manufacturers quickly and affordably. Outsourced manufacturing is much easier than it used to be, and there are numerous alternatives available, whether in foreign markets like China or Mexico or even within the U.S. As the number of successful hardware startups increases, creating ever bigger and recognizable brands, companies up and down the manufacturing value chain become increasingly willing to cater to upstart hardware ventures, creating a positive feedback loop.
Each of these enablers has done its part to bring down the cost to makers of building out both tangible technology products and the business models associated with them. Now that the lean startup concept can effectively be applied to hardware companies, these ventures have gained a much-needed advantage when competing against established behemoths like Samsung, GE, and Honeywell. This collapse of costs has also allowed early-stage investors like Tandem Capital to become effective partners to device startups, further accelerating innovation in the space.
Featured image courtesy of Wonderlane via Flickr.