Business models in Hardware

Traditional business models rely on just selling the hardware for a good margin and upgrading the product every 12–16 months’ time frame. This traditional business model is not viable in the current scenario because of advent of modern tools for product development. The affordability of cheaper electronics, development platforms and 3D printer technologies has reduced the product development cycle. This technological development and customer need for new hardware products is making the companies to choose alternate business models to increase their profit.

Hardware business operates very differently to software. Hardware products are priced about 4 times the Bill of Materials (BoM) cost to account for manufacturing and distribution overheads. Since there is no distribution cost involved in software, it is very easy to distribute software via Internet.
Bugs and software upgrades can be done easily over the Internet for the software product while it is impossible to fix a hardware product if there is a bug. Hardware companies have to recall the product in case of bugs. Thus it is very important to get the hardware product right and bug free.

Pricing of the hardware product has to take into account all the cost involved from designing the designing the product to distributing the product.
Software products are harder to copy while hardware product is easy to copy. Thus to protect your hardware product business, your business model should be fool proof and made it hard for your competitor to copy.

1. Hardware-as-a-Service
The most commonly cited business model for connected hardware startups relies on the sale or lease of a device that only works when a recurring fee is paid. Almost always this fee is a software license or service fee, sometimes paid on a time basis (annual, monthly) and sometimes on a metering basis (per byte or user). Hardware as a service companies optimize for high lifetime value through recurring fees rather than a hefty gross margin on the initial sale.
Some of the startups such as Meraki, Particle, Karma and DipJar who adopted this model are acquired by big MNC.

2. Hardware-enabled Services
Hardware-enabled service products are almost identical to hardware-as-a-service products but the service is optional. While this may sound like a small tweak, it fundamentally changes the economics of the business. Every hardware product that uses this business model must make a significant margin on the sale of each unit. To date, this model is largely found in consumer products where freemium behavior is already common.
Startups such as NEST, DropCam and Fitbit make money not only by selling their hardware but also on the services enabled by the hardware.

3. Consumables
An increasing number of startups are starting to experiment with a business model popularized by Keurig/Green Mountain. It’s one of the most challenging models for hardware companies, but one that’s extremely defensible. This model relies on a one-time hardware sale of the “dispenser” and continual sales of the “consumable” that users are excited to purchase but require the dispenser to consume. Not only does this model usually require a web/mobile software product (hard) and a hardware product (harder), it demands a super-efficient and fast custom distribution system built from scratch (hardest).

Amazon Kindle is the classic example for Consumables. Amazon makes money by selling content through Amazon Kindle while it sells the hardware at its cost!

It is clear from the above business models that selling hardware is not enough to make profit but recurring profits from the hardware product services should increase the profit margin of the profit considerably.

Synergy between hardware product and its software services powered by analytics and apps will create more business opportunities. Hardware companies must have good engineers who can understand these synergies and optimise the performance of the whole product to satisfy customer requirements. These synergies should be fueled by business model that make the hardware companies sustainable and profitable.