This blog post is the first in a new 10-part content series to help entrepreneurs build a connected hardware startup.

Twenty years ago it was clear how you made money as a hardware startup: sell high volumes of your product at the highest margin possible. However today, the advance of Internet of Things’ (IoT) technology, combined with the growing competition in the hardware space, has led to the creation of new revenue streams and potentially longer-lasting business models. All sounds promising, but what effect will these new models have on the relationships connected hardware startups need to have with their customers? And what economics need to be kept in mind, both in terms of fundraising and unit costs?

The Four Business Models for your Connected Hardware Startup:

Device-enabled Service

A startup will lease out their device (or charge a very low upfront cost) and charge a recurring fee for a customer to use them.

A good example of this is Industrial IoT startup ThingTrax. Factories use their device to monitor their machines, with ThingTrax then able to provide real-time maintenance alerts on an ongoing basis. There is a small charge for the device, and a monthly fee thereafter for the analytics.

For startups targeting B2B customers this cost structure is well suited. Companies are familiar with the payment model; they’ve been paying for ongoing software services for many years, whether that be for antivirus security or web hosting. However, this model is still a new approach for customers of B2C startups to adjust to. When such customers buy a product they traditionally don’t expect to incur further charges to simply see the benefits of it. For customers to understand and accept such ongoing costs the benefits of using a connected device need to be so compelling that they can be seen almost 24/7.

This ‘device-enabled service’ model is an attractive one to investors, particularly those who have been wary of hardware in the past, concerned about a hardware startup’s ability to secure recurring revenue that isn’t just dependent on a new version of a product every 2-3 years. For those operating in the B2B space it’s certainly the go-to option, but keep in mind that non-existent or low upfront costs for customers mean that it will take a while for you to break even on unit costs.

Device-enabled Experience

Customers buy your product and then pay additional fees for an increased experience of it.

For example, customers can pay for more storage or additional features much like in the freemium model of Spotify. Eskesso, a startup developing a connected sous vide cooking appliance, is similar. You can use their cooking appliance to cook food you buy at the supermarket, but you can also make your life even easier by buying Eskesso’s freshly prepared food parcels through their mobile app.

There are two things to note with this ‘Device-enabled experience’ business model. The first is that you need to make money on the device to begin with; you can’t rely on ongoing subscriptions or potential fees. The second is that in order to get a customer to purchase additional features you have to strike the balance between your existing features being valuable (to make someone want more of them) but not so valuable that a customer thinks they have all they need from your device.

Investment wise this business model is regularly seen across crowdfunding campaigns. Startups will have a range of ‘perks’ that potential backers can buy, with more expensive perks having more features or services.

Device-enabled Subscription

Startups sell their connected device, however their main source of revenue comes from consumables or replaceable elements sold.

CityCrop, a connected indoor garden for your home, use this approach. You buy their device first, followed by the pots of seeds (the consumable) you need in order to grow strawberries or salads. These pots can be bought as part of a monthly subscription, making the hardware a dispenser for more products to be sold. Other businesses, such as XYZprinting and MakerBot, will restrict the use of 3rd party consumables with their device, meaning you have to purchase additional filament materials directly from them.

This is clearly a robust business model, and one that isn’t reliant on the hardware. Technically a startup could begin by building out the subscription element of this business model, building a community of customers around the consumable and thus generating revenue, before having to incur device manufacturing costs with or without an Angel or crowdfunding investment. Few, if any, have been able to do this successfully but it’s something to look out for in the future as investors push connected hardware startups to demonstrate traction before their funds go towards a device’s manufacturing.

If a startup can pull off both sides of this model then the heavens open. This is a big challenge though. You have to build out both sides of the model whilst making sure that the two are connected in the minds of customers. Juicero is an example of what not to do here. Their consumable (a pack of fruit juice) didn’t actually need the expensive connected juice machine they built. Customers now see through what was, and is, simply a way to make more money. Furthermore, it’s important to remember that any consumable element needs to be better than competitors on price and function to ensure you retain control on both sides.

Device-enabled Ecosystem

Money is still made from the sale of devices, but a startup mainly profits from others developing on their platform, or by monetising a previously untapped resource.

Oculus Rift will sell third parties the rights to develop on their platform, whilst they’ll also look to build out their ecosystem with content providers. Meanwhile HomyHub, a device that turns your smartphone into a garage door remote, allows other companies to benefit from the fact that someone’s garage is now a useful part of their life. Garage owners can earn money by leasing their garage to someone, whilst delivery companies can save money by securely accessing a garage without the need for a remote, thus avoiding missed delivery costs.

This business model is clearly very attractive to customers who see the initial benefits of using the device, as well as the benefits that the ecosystem brings. Both the startup and the customer can make money from the services that those in the ecosystem provide, and for the customer this new income makes the initial purchase of the device much more palatable.

The challenge for connected hardware startups is then building out an ecosystem to allow this to happen. This takes time and patience, not something regularly afforded to startups by customers or investors, so the success of the model really comes down to the startup’s communications. You cannot promise the world and deliver a map. You’ll need to validate the ecosystem quickly to make sure you’re still remaining product focused and not just developing ‘nice to haves’. Then you’ll need to on-board third party services, providing them with just enough value to compensate for the small community of customers that you’ll have at the early stage of your ecosystem.

Common Business Model Pitfalls:

Deciding on how you’re going to make money as a connected hardware startup is just the beginning of your journey. In the coming weeks we’ll be going through the next areas you’ll need to consider but, in the meantime, the below are some final things to think about when developing a business model…

Clearly define your success metric. Failing to understand what success should look like is likely to steer a whole business in the wrong direction.

Don’t market to everyone. Your targeting efforts need to be specific, especially at the start with early adopters.

Have an unfair advantage. Your passion alone won’t suffice, you’ll need something more to fend off competitors and hardware copy-cats.

Offer a strong and simple value proposition. If you have a proposition that is different and matters you stand a strong chance against competition.

Know who and where your customers are. Regardless of how much funding you have, or how good the product is, you need to be able to reach customers at scale.

Don’t fall in love with your solution. Focus on your MVP and how it can deliver value to customers as quickly as possible. Don’t look beyond this.

Up Next…

In the coming weeks we’ll move onto discussing customer development, testing value propositions and finding product market fit. In the meantime, applications for our next Startupbootcamp IoT program close at the end of this month (July 31st). If you’re building a connected device, and looking for some support, do take a look at applying – f6s.com/startupbootcampiot2017.