Hardware startups seem to be “in” one minute and “out” the next in Silicon Valley. For years, venture capitalists wouldn’t go near hardware startups. They were, as Wired put it, “the ugly stepchild of venture capital.” This started to shift a couple years ago thanks to cheaper parts, rapid prototyping, and crowdfunding. However, the tide is turning once again. VC investments in hardware now seem to be slowing. We’re seeing a drop in funding to IoT, for example, and fewer deals in smart home hardware.
We’ve also seen some big failures in consumer hardware. Take Lily, a drone startup that raised $34 million in preorders in 2015 and announced in January that it will not be going into production. Or consider Google’s acquisition of Nest, which has been described as a “disaster.” Pebble is another example. The smartwatch startup sold to FitBit for a fraction of what it received during previous acquisition offers (and less than it raised in funding).
However, a drop in interest from U.S. VCs doesn’t mean hardware startups are left with no options. In fact, it opens up the opportunity to seek out funding in China, where VCs are not making the same mistakes. Chinese investment and home field advantages will spur the next era of innovative companies.
Here are five reasons why:
China is known for its low costs. What used to be a hallmark for cheap products and inexpensive labor has now evolved to become the premier market for any hardware company. This is critical, because one of the main reasons why hardware startups fail is they run out of money or can’t make their product at the price point consumers are willing to pay. For a sector already prone to high production costs, working with affordable parts and labor is essential.
Faster speed to market
Hardware products can take a notoriously long time to bring to market, particularly for new and inexperienced companies. For example, a study from CNNMoney found that 84 percent of the top projects on Kickstarter shipped late. Engineering, designing, and manufacturing hardware is complicated, and a lot can go wrong. It’s also easy to underestimate the amount of time it will take to bring a product to market.
The U.S. does not have the infrastructure, talent, or technical expertise in place to provide a streamlined and swift system for bringing hardware products to market. China does. The country has spent the last 10 years investing heavily in its infrastructure. It is equipped to meet the needs of hardware startups, minimize delays, and bring products to market faster.
An eager audience
With 1.4 billion people, China is the most populous country on earth. It is a massive market filled with consumers who are interested in buying and using new technology. For example, it leads in the adoption of many cutting edge technologies, like VR. Hardware products do well there, and startups can tap into the Chinese consumer base without worrying about the U.S. market for a while.
When they are ready to join the U.S., the transition shouldn’t be too difficult given how cross-border the market is today. Furthermore, the incredibly competitive nature of the Chinese hardware market means that if a startup succeeds there, its chances for success in the U.S. look pretty good. The reality is that consumer electronics are not sustainable in the U.S. because they are easily copied, and Chinese companies will always be able to scale faster and cheaper. Companies that build their roots in China won’t have to worry about being outpaced.
Hardware startups will also have an eager audience with VCs. The local VC market is huge, and Chinese startups are raising most of their Series A rounds locally. While American VCs are steering clear of hardware investments, Chinese VCs are embracing them. Many Chinese VCs made their own money in hardware or it’s where the money they manage originates, so they are excited about hardware opportunities.
Beyond the money itself, Chinese VCs offer a number of benefits. To start, they have a specific understanding of what is required to build hardware and look at every aspect of the design and manufacturing process when evaluating investments. They don’t just scratch off a check because it’s trendy. They are also unlikely to get impatient with entrepreneurs because hardware takes a while, whereas U.S. VCs are more accustomed to the rapid pace of software development. Chinese investors are focused on solving a real market need, hitting milestones, and being patient enough to see their vision through.
And, yes … manufacturing
The Chinese economy was built on manufacturing and mastering the supply chain. It has the best manufacturing infrastructure in the world, with everything a hardware startup could need to put their idea into production. This is a tremendous advantage. It lowers the barrier to entry, speeds up time to market, and reduces mistakes — all at a low cost.
Another benefit of China’s vibrant manufacturing sector is that manufacturers often invest directly in companies they work with, which means they have more skin in the game. Manufacturers can be valuable investors because they can work closely and transparently with startups to support the product, set expectations for delivery, and prevent shipping delays. A great example of this is Shenzen Valley Ventures, which recently opened a Palo Alto-based incubator for hardware companies in partnership with a major manufacturing partner in China that works with Xioami and Samsung.
In China, companies have more opportunities to build trust with manufacturers and treat them as partners, rather than contractors — something that American companies are not yet doing. American startups tend to worry about getting locked into manufacturing terms, stuck with one vendor, or manufacturers stealing their IP. The trust isn’t there and this can slow things down.
The U.S. venture capital community may not be interested in hardware startups, but China definitely is, and this is a good thing. Hardware startups should embrace this opportunity and put their energy towards drawing on all China has to offer, beyond manufacturing expertise alone.
Slava Solonitsyn is Managing Partner at Ruvento Ventures.