<aside> 💡 Key learnings
1️⃣ Finding a business model that suits your technology, market, and customer needs is crucial
2️⃣ Founders should aim for models that reduce capital intensity and increase the share of recurring revenues
3️⃣ Understanding your customer segment, their metrics, and ability to pay is key to effective pricing
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📝 Contents
For over 37% of our surveyed climate investors, the business model and long sales cycles are reasons to not invest in hardware companies, and many founders neglect thinking deeply about their business model. Hardware is often associated with one-off equipment sales thus steady, low gross margins where enterprise value only scales linearly with volume. It doesn’t have to be that way. In the following chapter we want to highlight how the right business model is elemental for your success. Why should you care? Traditional hardware businesses face commoditisation: When asking climate hardware founders about the top purchasing criteria of their customers, over 38% mentioned price as #1.
<aside> 💡 According to our interviewees, the role of pricing is “huge” and should never be underestimated. This means climate hardware startups need to be equally innovative with business models than they are with technology.
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From licensing, to hardware-as-a-service and sale of your final products - to more exotic models like the razor & blade model - there are many different ways in which you can capture the value of your technology.
While 60% of investors don’t have any business model preferences the data shows a stronger investor bias towards licensing and service-type business models with lower interest into project-based and carbon credit-dependent models.
“Generally most VCs are very rigid in the business models they look for (SaaS/ARR) and makes it difficult for hardware based companies” — Early-stage founder
We are not advocating for a specific business model, it should just be the one that works best for your technology, as well as your customers. The right answer will depend on the nature of your innovation and the structure of the industry that you’re deploying in. However, where possible you will likely have two goals: minimising the amount of capital you need to raise to reach commercial scale (as it will limit dilution and attract more early-stage investors), and maximising recurring revenues (as it will tend to boost the multiples and valuation of your company).
There is a range of business models you could adopt for your HCS startup, but we can broadly chart them along two axes: how you make what you make, and how you sell what you sell.
While certain parts of your business model are pre-defined by the tech that you are working on, ultimately you decide how you run your business.
<aside> 💡 The level of vertical integration you’re aiming for, between “full stack”, where you’re controlling the entire process from raw inputs to final products, to “licensing”, where you’re essentially providing a process that other people execute on or deployment, where you distribute other people’s technology.
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Borrowing examples from the chip industry, you can be Samsung (designing and producing your own chips), you can be Arm (your design is embedded in everyone else’s chips), or you can be ASML (you make a machine that is a key part of someone else’s production line).
In Hardware Climate Solutions, full stacks tend to make more sense in very nascent supply chains, like carbon utilisation, where you can’t rely on mature value chains to provide you with the inputs you need: if your core innovation is a catalyst to reduce CO2 into CO, you might have to design and manufacture CO2 electrolysers yourselves (because no-one really sells them at the moment), and you might also integrate downstream to transform the CO into high-value chemicals to improve margins. Licensing will be an easier swing if you’re selling into established supply chains where you’re replacing/improving an existing step: if you’re making green cement, you probably don’t need to have concrete trucks, you can just sell the cement to concrete producers. In more mature industries, like solar, value can be accrued further down the value chain. We’ve seen companies like 1Komma5 or Enpal entirely focusing on existing technology’s deployment and rollout.
As a rule of thumb, full stacks are much more risky, because they introduce many more failure modes: the more complex your production process is, the more things can go wrong. And as good old Murphy keeps telling us, “Everything that can go wrong, will go wrong”. Plus they tend to be the most capital-intensive, because you need to get involved in many more steps, which requires higher CAPEX. They also sound more ambitious (think Tesla), and are sometimes required to truly disrupt a sleepy industry. One of the key challenges in those models (whether they develop their technology or ‘just’ deploy it) is to scale capital efficiently and attract non-dilutive financing. This might even be true for startups pursuing licensing that still need to deliver a first industrial proof points before licensing their technology to others.
Another consideration that many materials companies face is whether to focus on a single technology or opt for a portfolio approach, with the latter offering the prospects of positioning yourself as an R&D and product development company rather than a manufacturer. In either case, as a tech startup, you should focus ruthlessly on the one thing that you can do better than anyone else, and leave everything else for others. It’s unlikely that you can be the best at designing chips, making wafers, producing and packaging chips, and assembling them into devices. Not everybody is, or should be, Apple. It's therefore wise to choose your position in the value chain wisely.
Value chain positioning is very dynamic and evolves as industries mature. Direct air capture companies for instance currently have to develop their own projects now but will probably develop toward becoming technology providers in the future. To find the right positioning, analyse these market dynamics and understand lock-in effects, bargaining power dynamics, and where value is accrued early on.
Irrespective of how you make your product, you need to consider how you make money from it. Generally speaking, anything is better than a lumpy once-and-done sales process where you incur a large CAC that you only get one chance to recoup through a large sale of machinery. There are three main categories of models: