The road to recurring revenue for hardware startups

If you look at the most successful startups today, you’ll find plenty of proof that the hardware-enabled service (HaaS) model works: Peloton, Particle, Latch and Igloohome all rely on subscriptions along with product sales. Even tech giants like Apple are rapidly reinventing themselves as service companies.

Yet, if you currently rely on device sales, the prospect of changing your entire business model might seem daunting.

At Minut, we are building smart home monitors (privacy-safe noise, motion and temperature monitoring) and recently made the transition despite the lack of resources on the process. Here are the seven lessons we learned:

1. It is a question of when  —  not if.
2. The transition will have company-wide impact.
3. Your current and future target audience may differ.
4. Price should reflect the value for the customer. Your revenue should grow with theirs.
5. Avoid your free offer competing with your premium ones.
6. Be transparent (internally and externally) about the changes. Over-communicate.
7. Start the process early, check regularly with your team and set measurable targets.

Why subscriptions are the future of industry (and your startup)

Hardware has one advantage over software: customers understand there is a cost to your product. Now, this allows hardware startups to generate revenue with their first iteration, but it’s unsustainable as the company grows and needs to innovate: the software and user experience need continuous improvement and excellent support, just like in a software-only startup.

That’s why we see most hardware startups eventually launching a subscription model and limit what’s available for free. Even established companies  —  think Strava or Wink  —  often end up having to radically limit free features after years of operations.

Experienced founders and financial markets favor subscription models and recurring revenue. Market valuation multiples are typically much higher for companies that benefit from service revenue in addition to sales.

If you’re considering the transition, you might worry about:

• Technical obstacles and business complexities that need addressing.
• Pushback from existing customers (because no matter how clear you are that changes are coming, some will inevitably miss it).
• There will also be many unknowns. When do you start (and complete) the process? What will the pricing structure look like? What steps do you need to take?

Starting the transformation

Moving to a recurring business model can’t be rushed. The transition for Minut took more than a year, in several stages:

• It required research to set the right price that would allow for growth, yet was competitive from the start.
• We needed to determine which features would convince customers to subscribe.
• We needed to decide on a target audience for the subscription plan and balance all these considerations with the expectations of the existing customer base.
• Once all the decisions were made, we implemented changes in stages and made sure to time new features for existing customers with others aimed at our professional customers.

The switch caused ripples across the entire company:

• Leadership and Operations spearheaded the project from its ideation.
• Product and Engineering developed a list of new features for the paid tiers and made signing up a breeze.
• Marketing and Sales overhauled the way we communicate with customers.

Choosing your target

The target audience for your subscription service could be a subset of (or completely different to) your existing customer base.

In our case, we found that our professional customers were more willing to pay for the service compared to our consumers, and decided to focus on the former.

Moving from primarily serving consumers to companies is a transition in itself, which will change how the company is perceived and operates, but it’s a surprisingly common one among hardware startups.

When deciding on your audience, keep in mind that:

• Consumers are used to great service at extremely low prices. They will inevitably compare your startup to streaming giants like Netflix or Spotify (which is a really high standard to be held to).
• Businesses, on the other hand, will expect return on investment. You need to show them how they can save time, money or preferably both, so be prepared to prove how your subscription plans make financial sense for them.

How do you price a service?

Another important decision we needed to make was setting the pricing for our new plans.

Unlike with physical products, there’s no simple cost basis to subscriptions, so the right approach is to price according to the value received by the customer:

• How often do they use the service?
• How much are they saving thanks to your product?
• Are some of them taking advantage of more features than others?
• Is the price high enough that if you become the market leader you reach your target revenue?

The price also needs to grow with the value for the customer, aligning your revenue with the benefit they receive:

• At Minut, we charge per home, but other common ways are to pay per user or a certain percentage of revenue. This way, the price scales in relation to customer size and earnings. When your customers grow, so does your business.
• You could also decide to add tiers to your offer and price different services differently. This way you could achieve a better match between your subscriptions and different use cases.
• Some of the more advanced features you offer might be costly to develop and maintain and only appeal to larger companies. In this case, creating a premium plan with access to enterprise solutions probably makes sense.
• Tiers are also an opportunity to position the more affordable paid plan as the standard for all users, as the enterprise rate will make its price seem more reasonable in comparison. Pricing is often psychology and not always necessarily logic.

At Minut, we decided on three tiers  —  each reflecting a development stage for our customers so that we can grow together:

• Starter is for individual homeowners and businesses that are just beginning to generate revenue.
• Standard is for those that are still growing and prefer to do most management on their own.
• Pro focuses on automation, saving large property managers time and effort.

We settled on those three brackets because they map to both our existing customer base and the wider market. They will allow us to stay competitive in the segments we’re already strong in (small to medium-size property managers), while supporting our growth ambitions with large companies.

While catering for different users’ needs is key, there’s also value in keeping the structure simple. The simpler the model, the fewer headaches for both the product and sales teams down the road.

Should you offer free service for some customers?

For software business, freemium models go in and out of fashion. They provide wide distribution, but often low retention and fierce competition for the premium plans. When you add hardware to the mix, the picture gets more complex.

Any customer using your product will have to pay something for the device. This often makes them more motivated to use your product than someone who just installed an app. However, many of them feel entitled to functionality and service forever because that’s how physical goods typically work. That’s why you need to think carefully about keeping some features free.

On the one hand, it enables increased distribution opportunities through channels like Amazon and offline retail. On the other, determining when to start charging can be quite difficult:

• If you are too generous with your free offer, few will upgrade.
• If you make the free tier too limited, distribution partners and offline customers will take issue and you will see a large number of products returned.
• Having a free plan also means that you will need to continue servicing customers (potentially forever) who are not bringing any revenue.

Another consideration is whether to have a free trial for your subscription offer.

For Minut, we’ve found that it’s best to complete the conversion at the time of purchase. We attract fewer customers that are interested only in the free tier and we shorten the customer journey. Compare pre-purchase, purchase to trial and trial to subscription with just pre-purchase to subscription. This way we limit the number of opportunities for potential customers to drop off.

Communicating change

Once you have the transition plan ready, you’re a service company first:

• That means you’re no longer in the business of selling devices, and your website and all communication should look like you’re a traditional software-as-a-service company that happens to require some hardware.
• This is usually a drastic shift for marketing, previously tuned to selling the devices at an acceptable acquisition cost. They now need to think in terms of lifetime value rather than sale price. Consequently, they can afford much higher acquisition costs.

Another common roadblock is the fear of pushback from early adopters.

We started to talk about subscriptions as the future of Minut during our 2018 Kickstarter campaign. We’ve emphasized transparency from the start, and it has served us well in general, but it paid extra dividends this time, as the vast majority of customers expressed support rather than concern. Customers were willing to understand and contribute, especially when made aware of what they’re being charged for  —  in Minut’s case: privacy, dependability and a constantly improving service  — and the alternatives, such as selling their data or displaying ads.

Final steps before you start the transition

Frequent internal communication and measurable targets were crucial in the process.

Because the project required people across the entire company to be in sync, even the slightest oversight in documentation had the potential to cause widespread confusion, so make sure to involve key members across your team from the very early stages.

Also, start the process early! People’s minds can only be changed so quickly so give yourself plenty of time to communicate changes before they happen:

• This way you can also take feedback onboard and align your product roadmap and feature releases with the pricing changes.
• Customers have an easier time understanding pricing changes when they coincide with improvement and innovation.

Last, there are many moving parts involved and important decisions to be made that you will want to avoid going back on in the future. It’s hard enough to change your business model once; so try your best to not put yourself in a position where you’ll need to do it again!

VCs and startups consider HaaS model for consumer devices