Advantage: Cost?

(Could be subtitled: Learning from Some Past Mistakes!)

Have a Series A startup that makes a new kind of device for a hot market?  Photovoltaics, displays, 2D or 3D image sensors, intertial sensors, batteries, solid-state lighting, FLASH memory replacement?  Is “• lower cost” a bullet point on Slide 1 of your pitch?  That’s probably a mistake– unless you have a comfortable 10x cost advantage on the competition.

As I was reviewing my venture experiences & observations, it dawned on me that this low-cost promise to customers and investors is the root of many, if not most problems with venture-backed device startups.  It is such a tempting promise to make, however.  Who doesn’t like the concept of “plug-compatible, half the price?”  You should have some enthusiastic customers.  Hiring a sales team won’t be much of an effort.  So, VCs love it too– and let’s just admit it: they are the primary customer of an early-stage device venture (they buy a lot of stock!).

The problem with the promise is that it sets you up for a race you can almost certainly not win.  The rare case that “wins” is where a big sucker buys the company in a competitive frenzy.  The more likely case is that you run out of money somewhere on this trajectory:

The Timeline

  • Discovery – “it works!” in the lab and it looks simple to manufacture.  Claim big cost/price advantage over last-generation incumbent.
  • First hiccup – choose from hiccup sources below.  Adds 25% to cost to fix it, and 1 year to development.
  • Second hiccup – same deal, over again.
  • Finally ready to go!
  • Low volume production start at high cost… catch up with incumbent with volume, experience.

Each time a hiccup hits, you’ll observe with increasing dread the falling prices of the incumbent technology.  In a hot market, you better reckon with 20%/year price reductions.  So if your original 3-year commercialization plan turns into 5 (optimistic), the incumbent has dropped prices by 67%.  You’ve added 56% to your anticipated costs.  That has eaten up a 5x initial cost advantage.  Add a 2x margin, and you see where my 10x rule of thumb comes from!

Hiccups
For device startups, there are three typical hiccups (besides the technology turning out not to work).  If you’re lucky, you only experience one.  More likely, you’ll deal with two or three.  My entirely redundant illustration:

  • Operating condition failure.  Doesn’t work properly at temperature, voltage, vibration, etc.
  • Reliability failure.  Doesn’t survive accelerated testing.
  • Yield failure.  Doesn’t yield well off the production line.

Manufacturing Scale
By the time you are ready, the minimum manufacturing scale has grown significantly.  This means a bigger manufacturing investment, and even higher early costs.  The resulting cumulative losses in the early production years are often unsustainable.  Any reaction by incumbents can make this gap significantly more painful.

In the Obama era the strategy to fill this gap (for solar or batteries, at least) seems to be to insist the taxpayer should fund it.  That’s not something a new venture can count on.

Related/Resulting Venture Problems
There are a couple of potentially fatal issues that result from the “race for cost advantage.”  They can be the basis for future posts here.  Briefly, they are:

  • Premature bulk-up / spending.  Have you seen the ventures with only 5 possible industrial customers for their device, no beta units to ship, but featured in the New York Times and other “hot tech” outlets?  It’s a symptom of a team that has grown too quickly and in the wrong dimensions.
  • Wobbly technology tower.  Running too fast causes you to assume too many things, and work on conjecture.  You fail to do properly designed experiments.  You fail to measure capabilities. You develop in parallel to mate up with high-risk paths at fantasy dates.  One result is that when there is a hiccup, you often end up doing enormous amounts of work over again instead of having a good foundation to build off of.

So – What?
My advice is to find an axis other than cost on which you can compete– even if in only a niche of the overall market you are targeting.  If your technology’s only advantage is lower cost, think twice about starting in a hot market (if it’s a stagnant market, and you can create a new segment, it’s a different story).  Ideally, you have a near-term “performance” story, and a long-term cost advantage story that can be realized as volume grows.

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