I recently overhead a phone conversation between two venture capitalists who were comparing Google and Samsung, specifically their newest hardware sales numbers. The key difference between Google's rising market share in this category versus Samsung's stagnation was, as one VC put it, 'because Samsung wants to sell you hardware. Google wants you to help deepen their user base and ecosystem.' This technique gives Google the flexibility to craft an experience and a suite of products not concerned with maximizing the off the shelf margin, but instead on thinking in terms of the lifetime value of a customer.
This perfectly underscores the distinction between a hardware company (like Samsung) and a software company (like Google). I also believe this is a key feature for the growing internet of things marketplace. Today, most IoT creators are focusing deeply on their hardware, painstakingly creating beautifully designed, engineered, and packaged devices. Crowdfunding hits like the Misfit Shine, the Pebble Watch, and the Skully AR-1 motorcycle helmet are gorgeous and functional hardware products. As such, hardware startups like these are able to charge a premium for these products, partially due to their differentiating features, but also because of their own costs in lower volumes.
This is the natural cadence of introducing a new device to the market: high prices and low volumes at the beginning, and over time the product matures (and competitors come in) to result in a high volume, low price good. USB flash drives are a great example; I remember buying a 1GB flash drive in 2006 for $50. By 2009, 2GB flash drives were giveaways at job fairs and tossed in the nearest trash can.
However, the internet of things presents a unique opportunity, and challenge, for innovators. To compete with the incumbent device in any given category (like traditional thermostats), a connected hardware device can grow volumes more quickly by introducing their product at a truly competitive price point. Nest’s thermostat was a runaway hit by all accounts, building a superior product and a superior experience. In spite of this, I often consider the lost revenues in the huge portion of the market that Nest still today cannot effectively court. For most consumers, the chasm between a $25 regular thermostat and Nest’s $200+ connected thermostat is massive, a leap that just does not make sense for Joe Consumer, even one interested in the product. What if a Nest thermostat was just $40 or $50? By surrendering margin upfront, Nest could plausibly have grown their customer base exponentially faster. [I know I would be a customer!]
What really keeps customers around, and therefore creating value, is the software built on a particular platform. The power of Nest isn’t industrial design, great packaging, or even their incredible UX…it’s data. Connectivity. The opportunity present for IoT makers is to grow their products at the rate that viral software platforms grow (think Facebook, Instagram, Snapchat, etc.). In this model, the digital ecosystem is built by distributing the hardware aggressively, removing the cost barrier for consumers who will default to the established and trusted brands selling cheaper and still totally functional products. By crafting purposeful business models that take advantage of the connectivity, monetization in terms of lifetime customer value should still resemble or exceed that of selling really expensive devices to a small group of wealthy customers.
Hardware commoditization is inevitable. To me, at this stage of IoT, growth rate should be as critical as gross margin in that equation, as there are still a disappointingly thin amount of reasonably-priced connected hardware products. Brand name wearables are $99, most connected health products are at $150 and above, Philips Hue lights are a $200+ endeavor. A concerted push for viral user growth rates, akin to what software startups call success when launching a new digital platform, should be replicated in hardware as a strategy to cement connected devices as a part of (all people’s) everyday life. Only then will IoT go from the much-hyped near future to full fruition.