Hot hardware: The smart money's taking notice

After years of private tech investors favoring software startups, new hardware companies are attracting keen attention. Witness Wednesday's $30 million investment in Webcam startup DropCam. Software still gets more buzz -- and yes, more money -- but in the last couple of years, more than $711 million was poured into hardware startups, according to a recent blog post by Renee Di DiResta, a principal at O'Reilly AlphaTech Ventures.

It's an uptick that correlates with the rise in smartphones, according to investors who say recent hits like Dropcam, Nest and Fitbit are just the tip of the iceberg.

"You have more and more people with computing and engineered devices in their pockets and on the go," said Menlo Ventures Principal Sunil Raman, who sees the start of a tipping point for hardware. "It's become a lot more interesting for hardware."

Hardware startups were, and still are, a tougher sell. They have higher failure rates and cost more to get up and running. But despite their caution, investors are nonetheless voting with their wallets because of new opportunities created by the growth of mobile and cloud-based computing.

Historically, hardware has meant chips and silicon, switches and routers -- the bits and pieces behind the machines that delivered the software. The new wave of hardware tech is more focused on consumer products, not just the things that power them -- in particular, an entirely new category of software-driven hardware which have accompanied the rise of cloud computing.

It's a slow-motion trend that has been in the works for about five years. In the last 24 months, though, interest in hardware startups have gone into hyperdrive. Consider what DiResta found: in 2012, venture capitalists poured $209.5 million into hardware companies, spread over 52 early-stage investments. By comparison, VCs have already invested $222.9 million in 47 startups during the first half of this year alone. DiResta's data crunching is based off of CrunchBase's figures for early funding rounds of both enterprise and consumer hardware products, and she created an interactive graphic where that lets you see which companies were funded.

Hardware startups in 2013 are also tapping into new sales and marketing opportunities that did not exist, say, in 2003. In particular, the availability of social media marketing campaigns and crowdsourcing sites like Kickstarter now lets companies go directly to consumers and generate buzz among the early adopters, instead of first needing to convince skeptical retailers to carry a little-known product. It's still in the early stages but in the last two years, the amount of money Kickstarter users poured into hardware products multiplied more than tenfold to $22.7 million from $2.6 million. Some of this originates with the maker movement, but even that mentality has changed, according to DiResta.

"The bar has changed in the last two years, you've got to have an incredible, well-designed product," she said. "It's a shift from maker culture to consumer."

Venture capitalists, like Version One Ventures founder Boris Wertz, points to an increase in the number of quality hardware developers coming out of the maker movement, a confluence of cheaper prototyping and manufacturing costs, an increasingly connected world, and easier ways to reach and sell to customers.

Other investors agree. Sameer Gandhi, a partner at Accel Partners, said it's increasingly cheaper to produce prototypes.

"If they want to do hardware, there's probably a low-cost part that exists out there and you don't have to build it from scratch," he said. "It's just going to become easier for people to build prototypes and figure out concepts and ideas."

Startups also have also been utilizing 3-D printing to create cheap prototype parts quickly while designing and developing their product. Interestingly enough, DiResta's figures also show that Google searches for the phrase "3d printing" started accelerating in 2011, reaching its all-time high this year. She used the search to illustrate the interest of 3D printing on a more global scale, not just among those in tech.

Google Trends

In addition to lower initial costs, hardware products are now living up to the expectations of a world where people are used to instant gratification and constant improvement.

"They used to say the best products don't always win, but guess what, now it's all about that," Shasta Ventures Managing Director Rob Coneybeer said.

Hardware companies are now consistently shipping out software improvements, adding new features to enhance the hardware as well as the connected. This is how companies continue to add value; it's why Apple updates iOS for the iPhone for free, or why Nest ships software updates on an almost monthly basis, according to Coneybeer, who wrote a guest post on PandoDaily last month about hardware startup branding. He said these frequent updates is a social media marketing opportunity for products:

"So why does this matter? Because for the first time, physical products evolve and improve the longer you own them -- rather than degrading over time. This creates an ongoing word-of-mouth opportunity. Every new feature, assuming your customers perceive it as valuable, creates new opportunities for that customer to deepen his attachment to the product and share that with the world through word-of-mouth and social media."

Attaching products to mobile apps also means another place for consumers to find your product, according to Raman, who said the Apple App Store and the Google Play Store are starting to feature hardware apps as well.

With all these rosy accounts of interest in the hardware space, there's not lot of hardware startups that brag about how many units they've sold. DiResta acknowledges her own data doesn't necessarily reflect what the mass market outside of the tech industry thinks of this new wave of connected devices.

"Yes, you can sell things on the Internet and e-commerce are growing. But in overall retail sales, a huge percentage is still going to big box stores," she said. "While you can do a fairly significant amount of getting things out there, there are certain audiences that aren't on Kickstarter."

We can't definitively say mainstream consumers are hot on hardware. At least, not until the first slew of devices are as widespread as the iPhone.