This blog series shares learnings from the Elevate program (see info below) for the benefit of the wider hardware community. Contributors to the content presented herein include: Tom Harris - The Design Technology Co. & Ferroustek Group, Matthew Pryor - Observant & Tenacious Ventures, Vela Georgiev - HardworX, Elaine Saunders - Blamey Saunders Hears, and Kirsty Battista - Allume Energy
Any entrepreneur will tell you: managing risk is a key component of scaling. While many startups and SMEs want to develop hardware products: the process can be complex. Scaling successfully is challenging and most hardware startups will, unfortunately, fail.
Here we discuss what it takes to successfully scale a hardware company. Core themes covered include:
Scalable business models and practices.
Minimum Viable Product (MVP) and right-sized development.
Cost of running a business - Strategies for managing working capital.
Managing risk and leveraging the supply chain.
Developing a Minimum Viable Product (MVP)
The failure rate is high for hardware companies. CBInsights found that of 382 hardware companies they tracked through their fundraising journey, 97% eventually died or became self-sustaining. The top reason they found for failure: lack of consumer demand.
Image source: CB Insights
You can develop a well-designed product, but if a market doesn’t exist for it: the business is doomed to fail. Oftentimes companies who seemingly do all the right things, still do not succeed in the competitive hardware market. That’s because many founders are not creating market disruptive products. While disruption can be risky––it’s an important part of market success. A willingness to innovate––and be disruptive––is naturally a key ingredient in most hardware success stories.
One way to ensure consumer demand exists is to develop and go to market with a minimum viable product (MVP). An MVP is a semi-polished early-stage product, which is ready-for-market and can be used to gain early adopters.
For Dr Elaine Saunders, co-founder of hearing aid company Blamey Saunders Hears, developing an MVP meant building more than a piece of hardware. It meant designing a product with a new business model that changed the experience for industry experts and consumers––ultimately, disrupting the market.
‘We had the desire to create a hearing aid which was desirable and fostered an emotional connection with the end-user,’ said Dr Saunders. ‘For us, it was an ethos of desirability, not disability.’ By doing so, they discovered that consumer demand existed for their product.
Keep in mind: an MVP is not the same thing as a prototype. Prototypes are early-stage and allow you to test product design, usability, features and get input from stakeholders. Often there’s a focus on technical risk migration during prototyping. MVPs, on the other hand, focus on product risk and have the necessary core features to solve the market problem but don’t require over-investment at the early stages. Ultimately, an MVP allows you to test before you invest.
You can think of the MVP as a “proof of market” - the first time you are asking someone to pay for your product based on the value it provides.
Things to remember:
Prototype ≠ Minimum Viable Product
Designing an MVP is about choices and trade-offs
Choices and trade-offs should advance the velocity of learning
Products evolve. An MVP isn’t the product endpoint: it’s the starting point
Image source: O'Reilly
Cost of running a business - Strategies for managing working capital
Another key reason many hardware startups fail: a lack of capital management. It’s not just raising capital that matters: how quickly a company spends manages cash, ie. burn rate, is a key determinant of success. Cash is needed to run every aspect of the business and failing to manage cash results in many startups falling into the ‘valley of death’. Remember: in hardware, cash is king.
Successful scaling is impossible without a focus on cost management. Expectations for startups around costs, and how these scale at volume, can be wildly inaccurate. This lack of knowledge can prove problematic.
Scaling too quickly, without time to pivot and adapt, can also be problematic for many would-be success stories. Kirsty Battista, Chief Technology Officer at solar power company, Allume Energy, recommends balancing the pressure to be aggressive and accelerate quickly against risk-taking and managing costs. Scaling at a slower, calculated pace can be more sustainable over time and allow time for investment and revenue to catch up.
Scaling hardware companies can, and should, iterate over time at a pace that suits the particular organisation best.
“Turnover is Vanity, Profit is Sanity, but Cash is King.”- Anonymous
Cash flow management tips
Understand if your product cost will scale with volume, and by how much
It’s essential to manage expectations around cost and how these will scale with volume. Keep in mind: high complexity, low volume products tend not to scale. That’s because they’re very expensive to produce.
Pricing the product correctly can be the difference between success or failure.
One pitfall companies find is pricing products at the wrong cost point because of unrealistic volume cost expectations. Another is not taking into account how they are going to pay for certifications, materials, manufacturing, inventory, shipping, and distribution, etc., and ensuring adequate product margins.
Consider certification cost and timeline blowouts early. When creating a new type of technology or class of products, there’s no specific guideline to follow.
Effective management of working capital is essential.
This requires business processes as you scale. Alignment of sales forecast and manufacturing forecast is crucial and sales forecasting is one important aspect of cash flow management.
Accurate sales forecasting helps ensure cash isn’t used on extra inventory and unsold goods. Accurate forecasting is also one of the hardest things for a scaling company to do. It’s worth investing early in company processes that enable a robust forecasting process.
Decide whether you will produce ‘made to order’ vs ‘made to stock’.
'Made to order’ products have longer lead times and are best for highly customisable goods.
‘Made to stock products’ have shorter lead times, and are best for standard products, which can be stored. However, if sales forecasting isn’t accurate, a lot of capital can be tied up in unsold stock.
Have extra capital to cover unforeseen circumstances
Tom Harris of Ferrostek Group, a structural steel fabricating business based in Melbourne, recommends calculating how much capital is needed to run your business, then adding 20% to cover unforeseen circumstances. He then recommends applying a continuous improvement approach to sales forecasting to tweak expenditure and ensure there is always enough cash flow within a business.
Calculate the cash conversion cycle (CCC)
Keeping CCC to a minimum reduces the amount of interest paid on loaned funds to pay for inventory.
At Ferrostek Group, the business runs with a low CCC, designed so that the company receives funds before having to pay suppliers. This setup ensures sufficient cash flow is running through the business and avoids potential capital issues.
Create payment terms that work for you
Payment terms state the rules of engagement and are very important.
Be specific: include all critical terms for your business.
Know what terms you can afford to offer, weighing the business appetite for risk, the value of products and your CCC.
Cash Conversion Cycle (“CCC”)
Formula: CCC = Days Inventory + Days Receivable - Days Payables
Aim to reduce your CCC to be as low as possible.
Quality & Cashflow
You only have two cost levers to adjust profit margin: Cost of Goods Sold (COGS) and sales price.
Warranty can be a killer but ultimately, you need to do right by your customers. Do the math and factor in your warranty obligations when setting the sales price for your product. Remember: it's the total cost of ownership margin, not the sales margin that you need to optimise for.
Flow on Investment
Managing risk and leveraging the supply chain
Managing risk throughout the business is critical. When it comes to the supply chain, it’s no different. The supply chain is a reliance on third parties at many stages and each of those reliances means risk. Few businesses could have predicted COVID-19 for example.
Identifying issues within the supply chain can help reduce risk and increase revenue. Like most elements in hardware manufacture: the earlier issues are identified, the better.
Tips to mitigate supply chain risk
Have diversity in the supply chain
Understand the broader capability of your supply chain––designing with your supply chain capabilities in mind is key.
Feed their capabilities into your design processes.
Leverage their expertise to improve your products.
Keep choices broad
Have alternative suppliers for your regular purchases.
Have alternative methods for producing your key parts.
Explore all options for sourcing your key components.
Leverage the supply chain
Many companies focus on increasing revenue through expanding their customer base and market share. Paying close attention to the supply chain is another, often under-utilised, way to improve an organisation’s bottom line.
Be proactive and solicit feedback early via DFM reviews.
Implement processes to manage and control manufacturing changes.
Work with your supply chain to understand the cost drives and tradeoffs.
For Matthew Pryor, AgTech Pioneer, who co-founded Observant, which helps farmers reduce costs and improve productivity, taking advantage of the supply chain helped turn the company around. By leveraging a newly established supply chain, with better manufacturing partners, Observant successfully resolved critical quality issues. Over the long term, this helped reduce time-to-market for new products and transformed the capital efficiency of inventory to sales.
Scaling successfully and sustainably
It’s known that many hardware businesses fail before they even have a chance to scale. And this occurs for many reasons: lack of cash flow, lack of a visible market, poor planning, and many others. One mistake some company’s make: keeping ways of working static. In reality, scaling means transforming the business. As a company scales, ways of working must adapt to accommodate those changes. It’s necessary to decide how quickly you will scale and whether to be aggressive and accelerate quickly vs taking risks and gradually adapting as you grow the business. This balance should be considered continually when starting out and as you grow.
While the failure rate for hardware startups is high: success stories show that there are many ways to reduce risk and scale successfully. Ensuring a strong consumer market exists for your product through the development of an MVP, keeping strong cash flow through the company, and taking advantage of the supply chain are some ways to manage risk and improve chances of scalability.
About the ELEVATE program
Elevate is an innovation education series developed and delivered by HardworX and Western BACE, and supported by LaunchVic. It’s hardware content for hardware innovators, by hardware innovators. As a community-driven event, Elevate engaged with stakeholders across the hardware innovation ecosystem to design and deliver bespoke content. Elevate consisted of meetups, masterclasses, and bootcamps to help startups scale, anticipate risk, and establish manufacturing. This blog series shares learnings from those events for the benefit of the wider hardware community.