20. July 2016 Fabian

The Difference between Hardware and Software Startups

Hardware is expensive to build, complex to produce and has to be perfect from the beginning. Additionally, hardware is often merely a Trojan Horse to sell software. Software, by contrast, is boring, abstract and has to endure more intense competition. An article about the differences between hardware and software startups.

A few days ago I gave a podcast entitled “Why Hardware Is More Complex Than Software”. Click here to listen to it (podcast in German). I subsequently promised people I would write about it in more detail. I will describe the differences in products, teams, business models, sales, operations and funding.

Hardware Has to Be Faultless – Software Can Have Bugs

The difference between hardware and software is easy. Hardware startups build physical products – software startups have virtual products. Furthermore, hardware companies have to build a complete 1.0 version and then decide whether to develop a new product (like iPhone 5 and iPhone 6) or improve on the existing one (like iPhone 5S). If the products don’t work properly, however, they could experience significant backlash from their customers.

Software startups have it easier. They can develop their products in iterations. They start with an alpha version, have private or open beta and then a public 1.0. Most software products are buggy; perfection looks different. Software can be constantly improved and developed. It is an ongoing process with releases.

Hardware Teams Are Bigger

It’s easy to start a software company. You need 2 developers and a part-time business guy. They should be able to cover front end, back end and machine learning. Don’t worry if you don’t have the business guy. Most SaaS teams make it pretty far without them. If you do e-commerce or online marketplaces, it is often the other way round. In such cases, it is common to have two ex-consultants who then hire a CTO to start.

For hardware companies, it is more difficult to put the team together. You need a product designer, a hardware engineer, two software developers (front end and back end) and a full-time businessman, since the processes are complex right from the beginning.

Hardware Companies Try to Sell Software

Business models for software companies are well known: e-commerce, online marketplaces, lead generation (advertising, affiliation), platforms, SaaS and APIs.

There are fewer ways to earn money with hardware.

Sure, you can always sell the hardware. However, you then have no customer lifetime relationship and no returning revenues. Everyone who once earned money with software and enjoyed MRR (monthly recurring revenue) struggles with this.

With hardware-as-a-service, you charge on a monthly or yearly basis, comparable to software-as-a-service (SaaS). Most often you rent your hardware to you customer and provide them with services on top. These can include analytics or access to cloud services.

Using hardware-enabled-services is an additional way to increase revenues. On top of selling the hardware, you can upsell with premium features. Fitbit takes a yearly fee if you wish to see more detailed statistics and data. If you want to store the videos of the surveillance camera Canary, it costs extra. It also costs more if you wish to have 3G mobile Internet access for independence from WiFi.

The final business model is hardware-as-a-platform. In this case you sell software, effectively using your hardware as a Trojan Horse to do so. The hardware is merely the access point to an app store where users spend their money. Take Oculus Rift. First you buy the hardware and then you have access to their app store, where you can buy virtual reality applications. Facebook also has two revenue streams. Or consider the Amazon Kindle. Without buying eBooks, the hardware itself is useless.

Hardware Companies Make Money before They Produce

One of the few advantages of hardware companies is in sales. Hardware startups can use the existing infrastructure of retailers, wholesalers and online marketplaces. It is also possible to pre-sell your product on Indiegogo and Kickstarter. Even if you don’t have a product yet, you can generate paid pre-orders.

Software is most often sold over marketplaces and platforms. This usually entails the use of social marketing, content marketing and performance marketing.

When a company is doing B2B (business-to-business) sales, there is no way around picking up the phone and cold calling customers.

Hardware Is Complex

 If you develop software, it’s easy to get it tested by your users. Either you have a demo server, use TestFlight for Apple apps or give people beta access. And once you are live, you can steer your company with KPIs (key performance indicators) like conversion rates, DAU (daily active users), churn, retention, CAC (customer acquisition costs), CLTV (customer lifetime value) and MRR (monthly returning revenues).

 Hardware, by contrast, is very complex. You start with a working prototype, usually no more than a shoebox with cables and an Arduino board. Then you start to 3D print your first casing. After months of developing, you start to source suppliers and look for producers. Once you have negotiated all the contracts, you get quotes and timings from the producers. You then have to worry about assembly and logistics.

Next you start your series-0 of the first ten to fifty produced parts. You have to pre-pay for tooling and start with testing. You will most likely realize that many parts of your product need redesigning. As a next step, you start with testing and grapple with inventory management, working capital, supply chain management, customs, taxes and local regulations.

Hardware Is Expensive

It is cheap to develop software at the beginning. At my former company, Wunsch-Brautkleid, we invested less than €1,000 to have an initial MVP (minimal viable product). Thanks to WordPress, GitHub and AWS, developing software is cheaper than never. However, speed is still of the utmost importance.

Software teams can find a product/market fit with less funding – usually between €100,000 and €300,000. Great teams often need even less.

Money is needed to improve on the product and for marketing purposes. The general rule is that more funding equals faster growth. Since it is often “winner takes all”, speed means survival.

It’s easy for a software company to collect money. Everyone is investing in digital.

For hardware companies, however, things are tougher. The first prototype may well be simple (less than €100 for some boards, cables and sensors), but to test a product/market fit, you have to produce and sell something. For that you need at least €500,000. Most teams burn between €2m and €5m before ever delivering their first physical product to customers.

A further hurdle to overcome is the fact that without money, you can’t build stock. Without money, no suppliers or producers will work for you. If you wish to grow, you have to finance your sales before generating any cash.

There are a few groups, however, who do finance and support startups. To name them: HAX, Hardware Club and Bolt.

 Why Should I Start with Hardware?

Hardware is expensive, difficult and complex. There are good reasons many avoid it. Why should you start a hardware company? For starters, you reach customers you won’t reach with software. There are plenty of opportunities to earn money with hardware. Hardware is exciting. People love hardware. On the flip side, software is subjected to more pressure through tougher competition. The slow ones lose.

 Ultimately, the choice is based on how you would rather spend your lifetime.

Tagged: ,