When to Sell the Hardware
Recurring revenue is cool, but an IPO five years from founding is cooler
Sun Microsystems was founded in 1982. By 1986 it was public, and by 1988 it was doing $1B in revenue.1
Dell Computer was similar. Founded in 1984, $250M+ in revenue by 1988, went public that same year.
Today, the idea of a startup generating hundreds of millions in revenue less than five years into company founding only seems achievable for software businesses. It’s also seemingly consensus that it’s especially challenging for Hard Tech companies to get to significant revenue. Both of these ideas are wrong. Sun and Dell are two cases in point.
In my view, these ideas have less to do with business fundamentals and more to do with the current capital market environment. Today’s venture ecosystem typically supports companies staying private for longer given they have more capital to put to work. That abundance of capital generally encourages the pursuit of vertically integrated, operationally-intensive, recurring revenue business models that have the potentially to generate multiple billions in enterprise value. This makes sense from multiple perspectives and allows founders and investors to take big swings.
But what if we just sold the hardware? Could we go faster? Build a cool new system that enables something novel in a fast growing market (like personal computers in the 80s…)? Why not just sell it at 80%+ gross margins and 40%+ EBITDA margins? You generate hundreds of millions in revenue, grow the business and reinvest the cash flow to expand into the next product line? That’s how grandpa did it!
The hard part about this is that every case is unique. It’s high friction for founders to tell this story, and high friction for investors to grok it quickly. There’s a lot one needs to believe! In order for selling the hardware (and forgoing the high margin recurring revenue opportunity) to work, market demand needs to significantly outstrip supply, and you need to do three things exceptionally well:
Develop the technology that meets the customer need;
Market that technology to customers effectively; and
Manufacture that technology at scale, and have the capabilities to provide ongoing support (customer service, warranty, maintenance, repair, etc.)
To say it all differently…if you’ve got an idea for a novel system in a fast growing market, ask yourself twice before slapping the “high margin recurring revenue” slide together. Maybe selling the hardware is actually the more interesting path…
https://www.alexanderjarvis.com/original-sun-microsystems-business-plan-by-vinod-khosla/