Hardware is Hard

The VC industry loves recurring revenue and the sound of a software startups’ account going cha-ching every month makes it quite appealing. Hardware on the other hand, has always been the dull cousin of software, when seen from a venture capital funding point of view.

Today, hardware is mostly used as a Trojan Horse to sell software. Some brand it as HaaS (Hardware as a Service) while the others a bit differently. Developing hardware is a long and difficult endeavour. Hardware development requires significant engineering expertise, ability to figure out the supply chain, has more points of failure, the gestation periods are longer, and the feedback loop is slower. Manufacturing, both onshore and offshore, is complicated and there are 10 additional challenges to deal with. So, it doesn’t come as a surprise that a majority of the founders want to build software startups rather than hardware ones.

The VC industry isn’t any different either. Only a handful of them have experience in building, selling, or investing in hardware, which makes it difficult for them to evaluate and provide feedback to founders. While there have been outliers, most VCs have not updated their views around hardware because it requires technical ability, time, patience, and inclination, to evaluate hardware startups in any meaningful way. In addition to that, hardware also requires specific skills and attributes such as domain expertise, supply chain and production management knowledge, among others, making it even tougher to evaluate them. So, VCs either pile on their existing thesis around SaaS, Content, E-commerce etc. or start evaluating hardware startups from the lens of a software investor. However, evaluating hardware start-ups using SaaS metrics is as good as measuring the capability of a fish by judging its ability to climb a tree.

Despite these challenges, both on the founders’ as well as the investors’ end, we believe that there lies great opportunities to build hardware start-ups. And yes, we’ve learnt this the hard way. By investing in and putting in the efforts to learn about the space. As many as 6 of the 17 investments we made from our growX fund I, were hardware first companies. CynLr, a DeepTech hardware start-up is revolutionizing vision for robots. While Pixxel, a DeepTech space start-up is revolutionising the satellite based hyperspectral imaging industry. Bellatrix, another space start-up, designs and develops thrusters for satellites (yes, literal rocket science), while LightSpeedAI Labs is building Lego-like Optoelectronic Processors and Interconnects for Data Centre and near-Edge computers.

Why does hardware make sense right now? Difficulty isn’t necessarily a bad thing!

1. Overcoming challenges: Many problems associated with hardware have been solved, including outsourcing, availability of electronic components, and faster prototyping with 3D printing and simulation software.
2. Internet-ready hardware: New-age hardware is internet-ready, enabling constant feedback on product usage, retention, and churn, facilitating faster iteration cycles.
3. Growing demand: The demand for hardware is rapidly increasing, driven by the intersection of AI and IoT, with an estimated 20 billion internet-connected devices by the end of the decade.
4. Higher barrier to entry: Hardware ecosystems have higher barriers to entry compared to software, providing long-term advantages for startups.

Looking at hardware via the Merak lens

Hardware being difficult would work in a startups’ favour in the long-term because the barrier to entry is much higher in a hardware ecosystem than a purely software one.

As always, while there are multiple ways to look at things, here’s how we see hardware.

• We are big proponents of hardware + software startups: Customers would rarely switch to something that is only incrementally better, so the revenue predictability and stickiness increase manifold. The risk of the solution getting commoditized is far lesser. There is opportunity to score both one-time and recurring revenue, e.g., Google Nest and Kindle.
• Consumer hardware is tough: Covid and the ZIRP (zero interest rate policy) era consumer hardware start-ups have almost universally performed very poorly. Whether it be companies like Peloton in the consumer health space, or in the home security space, a company like Latch. Consumers aren’t used to paying for hardware subscriptions for their run of the mill devices and the road to educate and change their behaviour is a very tall mountain to climb.
• Enterprise hardware – not so much: Enterprise hardware is a whole different ball game. And we believe this is where our team (at Merak) enjoys an unfair advantage. We have invested in enterprise hardware for years, and over time, have developed great appreciation of the space. This helps us understand and evaluate opportunities from a slightly different lens, when compared to funds which do not have a thesis for deep tech hardware.
• Macro & India specific headwinds, both in favour: Investing in hardware has suddenly become a global phenomenon. Every country wants to be independent from a supply chain perspective, when it comes to state-of-the-line hardware.
• Public market validation: Each of the top 5 largest companies in the world manufacture hardware. While companies like NVIDIA and Apple are primarily hardware first companies, Amazon, Google and Microsoft also produce non-trivial amounts of chips and other hardware.
• Scope: Over the next 5 years, 60% of new revenues in the technology industry is going to come from hardware, even though hardware has received just about 10% of total VC funding over the past 5 years. Even if we discount the data for new revenues coming from large hardware powerhouses, there will be enough room to play for a plethora of hardware first companies working on both FOAK (first-of-a-kind) hardware and also for the ones producing a better version of an existing hardware.

Over the past few years, we’ve all seen the meteoric rise of Tesla and NVIDIA. This suggests a fundamental shift in the market and its precipitation on hardware first companies. While the failure rate in hardware is still higher than software, it’s still a bet worth considering for both the founders and investors alike.

So, whether you’re a fund which would like to collaborate with us on deals, or a founder building in the hardware space who’d like to seek feedback or funding, reach out to us.