Keurig vs. Fitbit: what's the right way to make money doing hardware?

Keurig vs. Fitbit: what's the right way to make money doing hardware?

Here's one you've heard before - hardware is hard. You've got to design it, prototype it, verify it, manufacture it, and distribute it. Building a great hardware product will have you hustling (and pulling your hair out) in a way software will never quite manage to achieve. And at the end of all that strife - what do you get? Well, the satisfaction of having created an awesome, physical piece of technology, no doubt. But along with that, you probably want a paycheck.

How do you make money doing hardware? Ben Einstein over at Bolt breaks that down for us in a recent post:

Keurig accidentally created the perfect business model for hardware startups
 

Now, this is a great writeup - go read it. But to keep things moving, I'll offer a quick summary. Traditionally, you make money as a hardware business by selling your gadget for a chunk of change more than it cost you to make it. You pocket that difference - maybe 30% of your product's cost. And while this works, it's a slow and risky way to scale a big business. Compare this to software (specifically SaaS), where the cost of goods is rock bottom, and profit margins are sky-high. Bummer for hardware, right? Maybe not. Ben describes how modern hardware outfits can achieve software-like revenues by bundling a hardware product enabler with a software-like service. Keurig sells you a machine (low margins) to get you going, while selling you lots of Keurig cups (K-cups) over the years (high volumes and high margins). Ben goes into a lot more detail on how to execute this business model the right way, but you get the idea.

A Keurig machine with the real breadwinners - the k-cups.

So I read this, and I think - "brilliant." I internalize Ben's lessons, and start analyzing all the hardware companies I come across through a haze of Keurigs and K-cups. That is, until I came across a stellar breakdown of Fitbit's IPO by Hardware Club partner Jerry Yang. He claims that...

Fitbit's IPO is the reference for the modern hardware startup

Jerry goes on to dive into the financial history of Fitbit. Fitbit has been hustling since '08, making non-trivial revenue since about 2010, and has achieved exponential growth in revenue during the last couple years. Overall, they're doing great. They have a gross margin of around 50% - right up there with giants like Apple. And the kicker? These guys are (by and large) just selling products like a traditional business. Jerry quotes this from their S1 form:

We generate substantially all of our revenue from the sale of our connected health and fitness devices and accessories. We also generate a small portion of our revenue from our subscription-based premium services. (Source: Fitbit S-1 Form)

Let's think about why this works. First, Fitbit is selling a product with a high perceived value. Wearables are a hot new category, and people are okay with paying a premium for the best of them. Additionally, Fitbit is selling a product they can get people to replace. Consumers are already in the habit of upgrading their portable consumer electronics every 18 months or so from the smartphone revolution, and it's a safe bet that willingness will extend to wearables.

Fitbit is killing it, blazing a path that previously only Apple has trod. In Jerry's words:

... Fitbit is letting us know that: you don’t have to be Steve [Jobs] or Tim [Cook]. You can be a startup and do the right things in design, engineering and marketing, and it will lead to a healthy gross margin for your business.
  Fitbit is the current king-of-the-hill in the activity trackers space.

Fitbit is the current king-of-the-hill in the activity trackers space.

So, we've got two ways of doing business here. Which is king? Before we get dramatic, note that I don't want to create a false dichotomy. Ben admits that you certainly can achieve a strong business with a traditional hardware sales model (it's just long, hard, and risky). And Jerry is optimistic that recurring revenue is an important part of Fitbit's future. But we do have two very smart people nudging us to focus our efforts in different directions. What's the right way to shoot to make money out of your hardware business?

Well, the reality is either one could work - but, you should probably make sure you're doing one or the other. If you're thinking through a hardware business model, ask yourself:

1. Am I selling a product that is a portal to a high-volume, high-margin, and high-value service (not razors and blades)?

2. Am I selling a high-margin product that people will be okay with (or excited about!) replacing every 18 months?

3. ...Am I doing both?!
 

If you're not doing one of these things, you'll want to think carefully about how your revenue stream will work. It's easy to forget in today's climate of sky-high valuations for young companies, but a solid revenue stream is the foundation of any business, big or small. Indeed, it's even a popular opinion that Nest sold to Google to put off having to worry about revenue. And you'll notice - Nest doesn't fit our models.

You've probably heard this one, too - money makes the world go 'round. It'll also keep your hardware company afloat, so plan carefully.

Why your hardware product needs a market (or the dangers of being too tech driven)

Why your hardware product needs a market (or the dangers of being too tech driven)

Seriously - what is product/market fit?

Seriously - what is product/market fit?