The current chronology followed by Silicon Valley hardware startups is slow and disordered. But that could change with a new incubation model emerging from an unlikely group – China’s global hardware manufacturers. Usually, when launching a hardware business, startups make prototypes, then raise capital so they can fund production. They then often turn to China, where they begin the arduous process of identifying and trying out multiple suppliers, manufacturers and logistics companies.
After a time-consuming and, frankly, painful process of speed-dating, fraught with miscommunication, startups will choose their partners. These relationships are transactional in nature, which means right from the onset, there is a fundamental misalignment of interests between volume on the supply side and quality, brand equity and sustainable growth on the startup side. Without pushing large volume, startups are unable to command quality from the supply chain. Eventually a product is produced and brought to market, though it is not always the intended original design.
Take Kickstarter campaigns, for example. Of the campaigns that successfully deliver a product, only about 15% ship on time. Many more never come to mass production. Lily, the drone startup, is notorious for failing to produce after raising $34m in a crowdfunding campaign. Even VC-backed well-funded US hardware companies struggle to align their designs with production processes and cost realities. Nest, Pebble and Jawbone are all examples of Silicon Valley-backed hot brand names that struggled to play the hardware game as prescribed by US venture capital rhetoric.
Meanwhile, China is well known for its hardware manufacturing capabilities. More than 90% of the world’s electronics move through China at some point during their production process. This reputation as the world’s assembly line masks two things – China has best-in-class large-scale industrial production know-how, and Chinese companies have incredible engineering prowess that is reality-based, not theoretical. Many of these manufacturing goliaths are hungry to move beyond their low-margin wheelhouse.
The dawn of something new
This desire of China’s manufacturing goliaths to be more than hired labour gives startups an alternative to the traditional Silicon Valley VC path. By taking their prototypes directly to manufacturers and taking a small seed round from those companies, startups are able to tear down many of the barriers that continually plague Silicon Valley hardware companies.
When the supplier has skin in the game, several interests align, as the potential profit-sharing from a startup’s success can be far beyond a nominal manufacturing margin. The supplier now has an incentive to keep production costs low, a disincentive to work with any competitors or abuse the intellectual property, a sense of responsibility to maintain the highest quality controls, and an urgency to bring the product to market as quickly as possible.
Aligning interests with a supply chain partner, startups can leverage the partner to buy or lease all the production capacity needed at below-market production rates. Startups are creating products that engineers have put together using the best materials and best possible traits of existing products. It is a combination that has enabled startups to create a completely new and unique model and open up a brand new product segment that did not exist before, more quickly than ever before.
This trend is logically more prominent in manufacturing capital-intensive industries. Sunwoda, China’s largest consumer battery pack manufacturer, has invested in two prominent Chinese startups, Anker and JieDian, for example. Scud, the second largest in the battery pack space, has invested in LaiDian and Xiaole. With manufacturing secured and products already on the market, these companies can later turn to VCs for growth money at more advantageous valuations.
This is done instead of diluting valuations simply to raise VC money to bargain with manufacturers on R&D costs and bridge cashflow gaps on early production runs. Moreover, when the manufacturers are on the startup’s side, they can help optimise costs, mitigate frequent production errors and extend payment terms on early production. It is difficult for VCs to match that platform, and these Chinese startups have begun to realise that fact first.
Global startups starting to follow suit
When my company began designing our first product, we sought our supply chain partners prior even to incorporating. At the inception level, we gave minority equity stakes to Scud, which I mentioned above, and ESID, a consumer electronics industrial design firm. These supply chain partners became not just suppliers or investors but rather proud founding members of the team at the initial incorporation stage. They have incubated and guided our supply chain every step of the way, working with us, not for us.
In less than 11 months we designed, developed, produced, and shipped 5,000 units of our first product, a sophisticated energy storage system, to 21 countries. We have also shipped a full range of accessories and are in preproduction for a second product launch – and we have hired more than 10 full-time employees. To date, we have yet to raise a round of angel or VC funding.
Gi FlyBike is another exemplary pioneering global startup – an e-bike company founded by a group of Argentinians. After a successful crowdfunding campaign, Gi Flybike took its designs to Yadea Technology Group, a global leader in e-bike manufacturing with nearly two decades of history. The manufacturer sells more than 3 million e-bikes to five continents, with almost 15% global market share. The Gi FlyBike R&D team is based inside the Yadea Technology Group manufacturing plant, entering its first mass production stage.
Startups that hatch ready to hit the market
We are at the beginning of a new era of Chinese and Chinese-western startups that hatch ready to hit the market. The needs of these companies are, and will be, different. They are able to leverage locals in China’s manufacturing centres with strong knowledge of the supply chain as well as experienced founders who know the end markets. They are creating new value in unused capacity, in back-of-envelope sketches and offbeat ideas from some great engineers.
While this hardware manufacturer incubation model could, and will, be replicated around the world, rich and hungry Chinese manufacturers are probably the most ready to engage today. It will be difficult for western manufacturers to compete with the cost, speed, niche specialisation and production scale of the new China.
There is a new cadence for global hardware companies, and it does not have to start in Silicon Valley with venture capitalists.
This is an edited version of an article first published on VentureBeat