Why everything is a subscription - YouTube

- When you show up and you're like

well, what's your business plan?

You're like well, we sell robots.

And they're like, get out.

(laughs)

This needs to be a lot more clear than that.

- We were sitting with one of these well respected funds,

and my co-founder was running late.

We were very nervous to meet them.

Overall, I remember the part of being very interested

in the technology we were building.

The problem, taking lots of notes,

and I remember getting an email after the meeting,

and the email basically said something

along the lines of love the product,

it's a worthy pursuit,

but we're not really interested unless

you have a path to a recurring

revenue stream of some sort.

- I think it's always risky to change the business model.

If you think about Adobe, when they switched

from buy once and own it,

to essentially renting the software,

people were up in arms 'cause it felt like a betrayal.

It felt like a real betrayal that

at some point you were able to own a software,

and now you had to rent a software from them.

- Making just the gadget doesn't cut it anymore.

Hardware creators have to not only

build a brilliant tech product,

but also find a sustainable business model

that keeps cash flowing in long after people buy a device.

Subscription plans are everywhere,

but why are they so prevalent and so important

to hardware startups now?

(percussive music)

- We literally needed probably 100 million dollars.

So that's the thing that, nowadays we've raised about 170,

but at the very beginning we raised one,

and we did five, and then five, and then 10,

and then 50 and a lot more,

but it was very incremental.

It was like let's me see if you can make this at all.

- Adam Wilson is one of the co-founders of Sphero,

a connected toy company that makes programmable robots.

You've probably heard of them.

The company came up through an accelerator called Techstars

which forced them to hone their business

and think about how it could be sustainable.

Although the company still sells

one-off robots to people like you and me,

that's only part of their business.

Sphero has an entire team that's dedicated

to selling robots to schools on a recurring basis.

- We usually one 30 pack per school,

sometimes more if it's a school

that will be doing it a lot,

and that's why the 30 pack needed to come in

a little Pelican case with wheels

that plugs into the wall for all of them

because we realized again if you ever watched,

or had to help a teacher,

that was a thing, get involved with it for real,

but we had to help teachers carry 30

of these boxes from this class to this class,

and then get 'em all out and charge 'em

and you're like oh my gosh,

there's no way this will work.

- How many schools are you in?

- About 40 thousand now.

- Oh my gosh.

- We're in quite a bit of schools.

That's worldwide.

So how did we make it so a,

you can get professional development on this,

'cause that was a huge question,

it was like that's great, how do I teach this?

And so professional development

is a good recurring revenue.

We do have a program, sort of the unlimited program.

So here's your thing of 30,

if any of 'em break for any reason,

we'll replace any of 'em all the time.

- Have you guys pitched investors

since education became a big part of your business?

- It's changed a lot.

When we first started, we got laughed out of a lot of rooms.

It was none of this other cool stuff, no education,

just hey man, we wanna make a robot ball,

and you connect it to an iPhone, and that's the product.

A lot of people did not,

like what is that, I don't get it.

And a lot of investors nowadays wanna see

a recurring revenue model because

hardware sales are very, very challenging.

- Businesses with the best economics

are subscription businesses because

there's this low cost at acquired the user,

and then you're making money in a recurring revenue

basis on that existent sunk cost.

And the successful business we've looked in this space,

it's always been hardware sort as this Trojan horse

for a software play of some sort.

Lynq is what we affectionately call a people compass,

and what that means is anywhere in the world,

if you have one and I have one,

it's gonna give you a really simple

arrow and distance that updates in real time

for working with ski resorts, music festivals,

amusement parks, and we recently launched

a successful Indiegogo campaign.

We hit 1.7 million in revenue in two months,

and sold 20 thousand units in under 60 days.

Because Lynq is unique in the sense that

we are independent from phones or networks

or apps or anything of that nature,

we had to be a little more clever

or creative about how we got to that recurring revenue

and that's where that rev share model came about

where we're licensing the hardware,

and then rev sharing on the rentals to the end customer.

- Both Lynq and Sphero found a way

to keep the cash coming in,

but finding the best business model for them wasn't obvious.

Haje Kamps is the director of portfolio at Bolt,

a hardware-oriented venture capital firm.

He advises companies on how to make their businesses

work and how to make themselves profitable.

- I think really,

what you end up looking at with any business

is how much money does it cost you to acquire a customer.

Now, for some companies, that might be $100.

So you spend $100 to get a customer,

you haven't made any money yet.

The second part of that equation is how

much money is that customer ultimately

going to spend on your company.

So if you spend $100 to acquire a customer

and you make $80, you've lost 20 bucks.

One half of that equation is usually known

as CAC, or the customer acquisition cost,

the other half of that if the lifetime value, or LTV.

And really what you try and do

is to have a lifetime value of a customer

that is big enough to be a significant multiple

over your customer acquisition cost,

and if that works, then basically you've made it.

- Basically what Haje is saying

is that it could take $100 worth of Facebook,

Instagram, and subway ads to finally

convince someone to buy a new $300 coffee maker.

That $200 of revenue is about as much as the coffee company

is going to get out of that customer maybe forever.

People don't upgrade their coffee makers that often,

and therefore these coffee companies need

a way to get a more steady revenue.

So, that coffee maker company could

sell propietary coffee pods which

are required to use the maker,

and that serves as its recurring revenue source.

And it's that additional revenue

that eventually makes up for that initial $100 ad spent,

and then keeps cash flowing in.

So to bring it back to Sphero and Lynq,

they both found a different way

to get that recurring revenue.

Sphero's education market

allows them to sell robots to schools,

while Lynq takes advantage of a revenue sharing

option by working with amusement parks

and other big spaces that license

the devices from the company,

and then share the profit they receive

when customers rent them.

Basically, companies have gotten creative.

- I think in the hardware space there's a couple

of companies that really, really made it.

I think Peloton is a really, really good example of that.

For one thing, 'cause it was a weird idea.

It's an exercise bike.

Are people really gonna spend two grand,

two and a half grand, whatever it is,

on an exercise bike, and on top of that spend

40, 50 bucks on a subscription every month

to be able to ride that bike you've already bought.

It was a huge gamble.

The thing that was actually turned out

to be really interesting is that,

if you think about the $400 exercise bike

you can go to Costco and buy, versus the Peloton,

yeah the Peloton is nicer,

but ultimately you get the same exercise.

So the real value from Peloton came from the content.

I'm a massive media nerd,

I think content is really important,

and I think that is a way to build

a real relationship with your customers.

And so what they discovered was,

we're not a competitor to the $500 Costco bike,

we are a competitor to spin classes,

to SoulCycle, to all those kind of things.

And so, if we want to replicate the SoulCycle experience,

it isn't the bike that makes it good,

it is the fact that there is somebody

at the front of your room pushing you

that over time you build a relationship with,

who points at you and goes, "Haje, you can do better!"

Yes, I can do better!

And you work a little bit harder.

And what they were very good at doing

was replicating that experience in the home.

- Armed with its subscription plan,

Peloton is now reportedly looking

to go public with an IPO.

It's said to be worth at least eight billion dollars

and to be profitable all thanks to that recurring revenue.

It's obvious why investors want

to see that constant cash flow.

It ensures they'll make more than

they invested in the first place.

- As a person who does invest,

and I have other things that look to investment,

if you don't have that recurring revenue,

you are literally gonna spend a certain

amount of money per robot or per device

or whatever it is to sell them.

Your market cost.

And currently, in this world,

that plus the build the materials

for any hardware is usually about the price

that you can sell it for.

So without the recurring revenue,

you just can't make a lot of money.

If you want to, you could,

but it'll be a much slower business,

and that's not what VCs look for.

I wanna see. (rocket sound effect)

And so, you do need to build that in.

I can't imagine a robot or hardware

or any other company that takes off without it.

You think of Nestor Ring or any of those

people who are like, the hardware part,

honestly pretty simple.

Camera, wifi thing.

The recurring revenue, the software,

the access, the easy use, there's your company.

- So I think what's great about

a lot of these subscription business

and licensing is that it kinda works better

for both sides of the equation,

especially in our case, the end user

is getting this really low barrier

to trying the product over and over again,

it's less capital to outlay,

and then the business is able to generate

better economics on the hardware,

the assets that they built.

As an end user, you're paying this small,

nominal monthly fee that obviously does add up

over the longevity of the product,

but generally what that comes with

is new updates, new products,

the ability to use whatever is newest,

and latest and greatest.

- I think there are definitely

hardware businesses that can do perfectly fine

without subscription models.

Casper being an example, they're doing perfectly fine,

but I think it all really boils down

to the CAC to LTV arbitration.

So how do you make sure that your

lifetime value is high enough

to make it worth acquiring the customers.

And for a lot of companies, I just think that means

that unless you can figure out a way

of having a subscription model attached to that,

it is very hard to meet that ratio

that makes any sense.

- I've always wondered what it'd be like

to live in a world in which I don't own anything,

and I soon might be able to find out.

I can already rent my car, my home, and my clothes,

so why wouldn't I rent my gadgets too?

That might be one of the only ways

to keep the hardware business alive.

Hey there, thanks so much for watching

this episode of In The Making.

Stay tuned, May 14th is our final episode,

so be sure to subscribe to The Verge

so you don't miss anything.

Alright, we'll see you later.

Bye!