Road To Recurring Revenue: A Guide To Subscriptions For Hardware Startups

Any founder will tell you that speed is key to succeed as a startup. You need to launch early and iterate quickly. If you’re dealing with hardware in addition to software, the first few stages of the journey can be doubly difficult. Funding for hardware startups is scarce, but being able to show early revenue can help the case. That’s why most hardware startups, faced with limited time, funding and resources, turn to the sale of the product itself as their first source of revenue.

The consideration is simple: you can always charge for hardware as customers can easily understand the cost that went into its production. Software on the other hand might be harder to sell at the first iteration. Since it has such a low marginal cost, there’s an expectation that pre-release software should be free. Most startups should launch as early as possible, but also generate revenue at the earliest opportunity. Perhaps counterintuitively, an advantage of hardware startups might be that they can get paying customers sooner, giving valuable insight into how the market responds to the product long before it’s actually ready.

Charging for hardware is an easy way to kickstart operations but it’s unsustainable as the company grows and needs to innovate. The customer journey only starts with the purchase — there’s a long road to travel afterwards. The software and user experience need continuous improvement and you need to provide excellent support. You always need to keep up with the changing market and apply everything you’re learning from your early customers to the product, just like in a software-only startup.

All of that demands continuous effort — and continuous cost — that’s difficult to predict at the start. It’s impossible to cover an indefinite commitment without charging a recurring fee. That’s why we see most hardware startups eventually launching a subscription model and limit what’s available for free. It’s hard to get the balance between paid and free functionality right on the first try and even established companies — think Strava or Wink — often end up having to radically limit free features after years of operations.

Why subscriptions are the industry’s (and your startup’s) future

Experienced founders will tell you that having a subscription model is the best way to ensure that your hardware startup can be sustainable in the long term. The financial markets reflect this as well. It’s notoriously difficult to raise funding if you can’t show a path to recurring revenue, and market valuation multiples are typically much higher for companies that benefit from service revenue in addition to sales.

If you look at the most successful startups today, you’ll find plenty of proof that the hardware-enabled service 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.

Subscriptions are clearly the future; but if you currently rely on device sales the prospect of changing your entire business model might seem daunting. There will be technical obstacles and business complexities that need addressing.

You should also be prepared for 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?

At Minut we’ve recently made the transition and found that there is a lack of resources out there that can guide hardware startups with the process. This inspired us to share our learnings — let us know if it’s helpful!

Starting the transformation

Moving to a recurring business model can’t be rushed. The transition for Minut was executed over more than a year and involved 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 operational impact of this project shouldn’t be underestimated either. At Minut, the switch caused ripples across the functioning of the entire team. 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, while 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. We found that our professional customers were more willing to pay for the service compared to our consumers and decided to focus on those who were using Minut in their business. 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 one 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 and 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. So whatever you do, don’t overcomplicate it — 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, considerations change and 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 (potentially forever) servicing customers who are not bringing any revenue.

Another consideration is whether to have a free trial for your subscription offer. It might make it easier for customers to try out the service, but they won’t always convert and bring revenue. 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, 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. Despite being as transparent as we reasonably could from the start, we still anticipated some users taking issue with the changes once the details were announced. It’s always been in our company culture to be transparent and it’s served us well in general, but it paid extra dividends this time. The vast majority of customers had known about this for such a long time that more people expressed support than concern.

It turns out that if you’re honest and open in explaining why the transition needs to happen, customers are willing to understand and contribute. Especially when made aware of the alternatives — such as selling their data or displaying ads; and what they’re being charged for — in Minut’s case: privacy, dependability, and a constantly improving service.

Final steps before you start the transition

Something we also learned was that frequent internal communication and measurable targets were crucial in this process. Since 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.

Finally, 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.

In recap, wherever you are in your journey, remember the following:

• Establishing a service model for your hardware startup is a question of when — not if.
• Don’t underestimate the company-wide impact the transition will have.
• The target audience for your subscription offer may differ from your existing customer base.
• The price needs to reflect the value for the customer. As the client’s usage grows, so should your revenue.
• You might want to keep some features free, but think carefully about which ones they are so you don’t end up competing with yourself.
• Be transparent (internally and externally) about the changes. This is a case where you can’t over-communicate.
• Set measurable targets, check in regularly with the team and start early.

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.

If you’re a hardware startup founder on a similar journey, feel free to email me at nils@minut.com! I always try my best to be helpful so don’t be shy.