If the majority of your understanding of how tariffs work is from Twitter, CNN, or Fox News, I encourage you to go read Trump’s China Tariffs Hit America’s Poor and Working Class the Hardest. And, if you think China is paying the U.S. directly for the tariffs, well, no …
We have a lot of hardware companies in our portfolio so I’ve been living in the world of “what to do about tariffs” for several quarters. My fantasy at the beginning was “ignore and hope they go away.” This quickly evolved through “are there any ways around this” to land at “deal with the reality of increased cost, research, and compliance.”
It also became apparent, almost right away, that startups had a huge disadvantage over larger companies that had significant U.S. lobbying activities. We explored a few paths to engaging with the U.S. government around this and basically were told some version of “go away – you are too small and unimportant.”
Once I accepted the reality that the startups were going to have to pay the tariffs directly, that they had little control on what the tariffs would be, how and when they would change, and whether or not they’d get exemptions, I started operating under the assumption that 100% of the cost associated with the tariff would fall on the startup.
So, I started observing what other companies, especially large ones, were doing beyond the lobbying efforts of BigCo that resulted in exemptions. Would they absorb the tariff as an increase in COGS? Would they increase prices? Would they pass on the tariff to the customer?
A little more research showed what is pretty obvious in hindsight. Many BigCos are simply treating the tariff like a tax and passing it on, either directly or indirectly, to the consumer. This is similar to what is happening with state taxes, as states come up with lots of new taxes for out of state vendors, both physical and digital.
This shows up a few ways. While some companies are increasing the cost of their product to include the tariff (or even a markup on the tariff), many companies are trying to hold their price the same while passing the tariff on through other approaches.
Some companies are adding a line to their invoice called “Tariffs” and charging that to customers (I’m seeing this mostly in B2B situations). This looks like:
Product Price: $X
Total: X + Y+ Z + T
Others are including Tariffs in the Shipping line.
Product Price: $X
Shipping and Tariffs: $Y + $Z
Total: X + Y + Z + T
But the one I’m seeing the most is simply including Tariffs in the “Taxes” line, where Tariffs are considered a tax.
Product Price: $X
Taxes: $T + $Z
Total: X + Y+ Z + T
While some BigCos appear to be eating the cost of the tariff, this seems to be the exception. Startups should pay attention, and act accordingly.
If you are a hardware startup and have either seen, or figured out, a different approach, I’d love to hear about it.
For starters, let’s look at some Golden Retriever puppies instead.
I watched most of the Apple announcement last week (I was on vacation and hanging out waiting for Amy, so I just plopped down on the floor and watched Special Events on the Apple TV channel.) I fell asleep for a few minutes part way through it. I turned it off about halfway through the iPhone X announcement.
I’ve been an Apple user for many years now. Every few years, I switch to an Android phone for a month (whatever the newest model is) but always end up going back to my iPhone. Whenever each new iPhone model has come out (for at least the past five years) there’s been a mad rush among my partners to make sure all of us have a new phone the day they ship. I even sported a rose gold one during one upgrade cycle just because I could.
When Amy and I went to lunch after the iPhone 8 and X announcement, she asked me if I was going to get a new iPhone. I said no. I realized I was profoundly uninspired – both by the new phone and the way the Apple team presented it. I’d go so far as to say I was bored, which as a lifetime nerd, is unusual when Amy lets me hang out and do anything related to computers (including watching TV about computers.)
Amy then said, “I didn’t mean the 8, I meant the X.”
For some reason, I’m completely uninterested right now in the iPhone X. I don’t know why. It might be the presentation. It might be that’s it’s not available for another few months. It might be that I just spend too much money and time fixing my iPhone 7+ screen (twice) after dropping it. Why twice? Because the first time I stupidly sent it over to one of the non-Apple “we can fix your iPhone for you for less money” stores who replaced the glass but totally screwed up a bunch of other things (the home button, the touch dynamics, and the edge feel of things.) That resulted in me buying a new iPhone 7+. Dumb Brad – just to go the Apple store even if it’s five miles further away and you have to drive instead of walk.
On the other hand, iOS 11 just installed on my phone while I was writing this post. A cursory glance shows that it’s working fine but other than different fonts, new icon styling, shading on an iMessage reply, and a different control center, it looks the same so far. At least I can play with fun new apps like Occipital’s TapMeasure to see how ARKit works.
I’m perplexed by the current Apple release cycle dynamics. I know they’ll mint money with the new phones, but my feeling of disappointment lingers as a user. Suddenly, I’m more inspired by Amazon’s new hardware.
I’m seeing an endless stream of hardware-related companies these days. In our world, we are focused on software wrapped in plastic, a line I think I first used some time in 2012. If you understand our themes, it fits squarely within human computer interaction for us.
There was a point in time – probably less than six years ago – where very few VC firms would even consider an investment in a hardware related company that was aimed at consumers. Every financing for every company we’ve invested in this area has been extremely difficult. We were not the first, nor are we the only, but in 2010 it was a very large, very dusty, and very dry desert landscape.
Suddenly, hardware related startups are all the rage.
While there has been more clarity on the core long-term economics of a hardware business, I continue to be baffled about the lack of understanding – by both VCs and entrepreneurs – of the core economics of a business like this at scale. A few folks, like our friends over at Bolt, have written great blog posts on this, but I fear that they are being overlooked, unlike the 3,671 blog posts on SaaS software, especially around SaaS metrics.
I was listening to a panel recently where several hardware entrepreneurs were discussing their businesses. I asked a simple question: “How do you think about your gross margin?”
The answer was all over the place. There was a lot of focus on current gross margin %, vagueness about how to compute gross margin, and discussion on subsets of cost inputs. There was no consistency in definition or view, especially at different scale points of the business. I could tell the panelists were uncomfortable with the discussion and the audience seemed to want to just move on and talk about something else.
I expect over the next year there will be 174 VC-based content marketing posts about how to build a successful hardware business. If they emulate the 3,671 posts about SaaS-based businesses, there will be plenty that discuss gross margin and how to think about it. Hopefully they’ll include a bunch of derivative metrics around pricing, BOM, shipping, and channel mix. Maybe they’ll even include information at different scale points of the business and tie the metrics to marketing and sales expense.
For now, if you are a founder building a hardware-based business, I encourage you to get to know other founders who have built successful hardware-based businesses at scale and go deep on the financials of their journey. You might be surprised how little equity is actually required to build a marketing-leading, cash flow positive, high growth, hardware related company.
Over the past few decades, the most compelling engineers and entrepreneurs I’ve met have tended to be working on problems that can be solved with software. Software has some great advantages but it comes with a few big drawbacks, namely it’s tied to a few standard types of input, although we are trying to impact that with some of our investments in our HCI theme.
Along with the rest of the tech ecosystem, I’m starting to see more and more entrepreneurs with a piece of hardware in their development plan. These are not your parents’ hardware products. Instead, they are software companies that happen to have a physical component in their stack – something I call software wrapped in plastic.
Adding the plastic around the software is no short order. MakerBot, FitBit, Orbotix, Sifteo, Modular Robotics, Pogoplug, Slingbox, and a slew of others have taught me that even though much of the business-side is similar to a software company, the product-side most definitely is not. From an outsider’s perspective, it’s stunning how much damage one bad component on a PCB board can do to a company’s bottom line, or how different industrial design is from software design, or even how the brains of a software person and a hardware person collide in bizarre ways.
I’ve learned how critical it is to get the right kind of help for young companies with a piece of hardware, which is why I invested in Bolt. Bolt is one of the more unique accelerator programs I’ve seen. Ben and his team have designed, developed, manufactured, and financed a long list of successful products and they’ve built Bolt around best-practices for these kinds of companies. Over 6-months, accepted companies get a long list of benefits, the most valuable of which are a full-staff of senior engineers and designers at your disposal and 24×7 access to their $1M of prototyping equipment.
If you’re a startup with a piece of hardware (or plan to have one) check out Bolt and apply to be part of their first accelerator class. Applications close in two days – Wednesday, May 22nd at midnight.