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Why Software Companies are Investing in Hardware

Posted in tech

There’s a fallacy in the tech community where pundits argue hardware is being commoditized. Viewing software and hardware in individual vacuums, it makes sense. The ability to scale software solutions and the low startup costs put software at a considerable advantage when compared to hardware. On top of this, value from the hardware market is shrinking as components can be bought for cheap from overseas thus minimizing the innovation window and overall margins.

However, looking at hardware from a holistic perspective shows true value for investing in hardware. In fact, hardware exits over the last five years offered a greater median return than other key areas in tech including electronics, software, Internet, and mobile.

Median startup exits from 2010 to 2015

One trend among established software focused firms is their move towards adding hardware to their regime of products. Google, Microsoft, and Amazon are clear industry leaders who are paving this transition.

Exposure to cloud services

The main value for software companies to increase investment in hardware is the increased value towards their proprietary cloud services. With increasing competition among software companies, it’s becoming difficult to get your software in the hands of consumers. Thus, by developing hardware, companies can use the hardware as a platform to expose their native software and cloud applications to consumers.

Think about Microsoft’s Surface Pro 4 or the Google Chromebook. Each use their hardware to upsell their cloud services. The Chromebook, as an example, pushed Drive integration by offering 1TB of free storage with each purchase.

An extreme example is the Amazon Kindle, which Jeff Bezos indicated they produced at cost. The $79 Kindle is estimated to be produced for $84.26, according to iSuppli.

Amazon Kindle cost of production breakdown

Amazon more than makes up for it by exposing over 43.7 million Kindle users to Amazon Web Services, Amazon Prime, and the Amazon Library.

Investing in hardware is one method to break down the barriers of entry for consumers to use your software products.

Owning more of the value chain

By manufacturing their own hardware, companies are able to monetize additional components of a product’s value chain. Although the commoditization of hardware is lowering the value of hardware in respect to software, it does not void hardware of all value. In fact, the added value should be used to augment the existing value from software.

The key distinction is that the commoditization of hardware does not mean there is no value. It means it should provide ancillary value to existing software.

By owning the entire value chain, companies can compete vertically in spaces where they couldn’t before. Increased vertical integration through the marriage of hardware and software internally provides exceptional value to the company. This is then ideally translated through a seamless experience to consumers - exponentially increasing outwards value.

By having an existing software business, hardware can be used to augment a company’s value chain and thus scale their revenues up.

One important note to make is that this does not preclude other companies’ current involvement or access to software, in fact it creates better reference platforms for OEMs.

Consistent and controlled experiences

Expanding deeper into the depths of hardware allows tech firms to create more consistent and controlled experiences for their end users.

Apple as an example creates such a consistent and clear branding message across all their devices. This even bleeds into in-store experiences.

When using the iPhone, Macbook Pro, or other Apple devices, people understand iOS will inherently run on these devices, creating a cemented expectation. When compared to, for example Android on Samsung devices, Apple has an inherit advantage over Google that goes beyond the physical hardware. Using the iPhone as a platform, Apple is able to create a consistent and controlled experience for iOS users.

The recent Note 7 recall is projected to cost Samsung over $5 billion. Although the recalled phones don’t create poor PR for Android, the recall gives users an opportunity to buy a non-Android device thus hurting Google’s market share for operating systems in the mobile market. Analysts suggest Apple could pick up an additional eight million users before year-end.

With the newly released Google Pixel, which Google is more invested in compared to the Nexus brand, Google is able to better mitigate against the previous risks they faced in the mobile market.

A final thought

The proverbial pendulum is swinging back, and as software gets crowded, additional value needs to be created to remain competitive through other means. Investing in hardware can prove to be the growth catalyst needed for mature software companies seeking an edge.

Hardware commoditization doesn’t mean there’s no value, it means it shouldn’t be the primary value - it can still be used to augment growth for existing software.

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