Latest / Hardware Startups with Fexingo: Devices, Robotics, and Manufacturing Tech Companies / Why Hardware Startups Are Adopting Subscription Models
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- Lucas: So hardware startups have traditionally operated on a pretty simple financial model: build a device, sell it for a margin, and hope the customer buys the next version in a few years. But increasingly, we're seeing founders flip that script entirely by adding a subscription layer on top of the physical product. Luna: You mean like hardware as a service? Where you're not just selling a box, you're selling ongoing access to features or data? Lucas: Exactly. And one of the cleanest examples I've seen is August Home, the smart lock company. They launched back in 2013 with a Wi-Fi enabled deadbolt that you could control from your phone. The core functionality was free — unlock and lock from the app. But they quickly realized that if they could charge a monthly fee for features like remote access, activity logs, and integration with other smart home systems, they could dramatically increase the lifetime value of each customer. Luna: And did that work? I remember some pushback from early adopters who felt like they'd already paid for the hardware. Lucas: There was definitely an initial backlash. Early August lock owners expected those features to be included forever. But August framed it as a 'premium subscription' — about $5 a month or $50 a year — and they added enough new features over time that a significant portion of users opted in. By 2017, they had over 100,000 paying subscribers. And that recurring revenue gave them predictable cash flow, which is extremely rare in hardware. Luna: So the hardware itself becomes the customer acquisition cost, and the subscription is where you actually make money. That flips the traditional gross margin narrative on its head. Lucas: Right. In a traditional hardware model, you might have a 40% gross margin on the device sale, but your customer acquisition cost eats into that heavily. With a subscription, you might sell the hardware at cost or even a slight loss, but if the customer stays for two or three years, you've made far more than you would have on a single sale. Luna: And that changes how you think about product design. If you're designing for a subscription, you need a reason for the customer to keep paying — which means software updates, cloud services, or consumables. Lucas: Exactly. August's subscription included things like video recording from their doorbell camera, cloud storage, and advanced notifications. Those are software features, but they depend on the hardware being connected and reliable. So the hardware has to be built with that ecosystem in mind from the start. Luna: I've seen other categories do this too. Peloton obviously, but also startups like Owlet for baby monitoring, and even some industrial sensor companies. It's almost becoming table stakes for connected hardware. Lucas: And it's not just consumer products. In industrial hardware, companies like Samsara — which makes IoT sensors for fleet management — charge a subscription for their software platform. The hardware is almost incidental; it's the data and analytics that drive the recurring revenue. Luna: That makes sense for B2B. But for startups, what's the practical advice? Should they build the subscription from day one, or launch with free features and add the paywall later? Lucas: That's the million-dollar question. And I think the answer depends on your customer's expectations. If you're selling a lock or a light bulb, people expect a one-time purchase. Trying to charge a subscription upfront can kill your conversion. August's approach — give the core functionality for free, then charge for premium — seems to work well. Luna: But you have to be careful not to bait and switch. If you launch with a feature that's free and then later put it behind a paywall, you'll anger your early adopters. Lucas: Exactly. August learned that lesson. They originally had remote access as a free feature, then moved it to the subscription. That caused a lot of negative press. So now, many startups are upfront about what's free and what's paid from the beginning, even if the paid features aren't available until later. Luna: And there's the financial side too. Hardware subscription models affect your revenue recognition and how you raise capital. Investors often value recurring revenue more highly than one-time sales because it's predictable. But the upfront hardware costs can be brutal on cash flow. Lucas: That's a key tension. If you're selling hardware at cost, you're not generating any gross profit on the unit. You need to have enough cash to manufacture thousands of units before you see any subscription revenue. That's why a lot of hardware startups use crowdfunding or pre-sales to fund the initial production run. Luna: And if the subscription doesn't stick — if customers churn after a few months — you're in a worse position than if you'd just sold the hardware at a margin. Lucas: Right. So the unit economics have to work. You need to know your customer acquisition cost, your expected lifetime value, and your churn rate. For hardware, the upfront cost is so high that even a 5% monthly churn can be disastrous. That's why many hardware subscription companies focus on high-engagement products where the customer uses the device daily — like a lock, a thermostat, or a fitness tracker. Luna: Let's talk about a specific example where the subscription model is the entire business. There's a company called Tonal, the smart home gym. They sell the hardware for a few thousand dollars, but you have to pay a monthly membership to access the workout programs and tracking. The hardware is almost useless without the subscription. Lucas: That's a different approach — the subscription is essential, not optional. And Tonal's numbers are impressive. They reportedly have over 100,000 subscribers and very low churn, partly because the hardware is expensive and integrates deeply with the software. Once you've invested in the wall-mounted unit, you're less likely to cancel the membership. Luna: So the hardware itself acts as a lock-in. That's smart, but it also means the initial sale is harder because the customer is committing to both a large upfront cost and a recurring fee. Lucas: Exactly. Tonal's sales cycle is longer, and they spend heavily on marketing. But the lifetime value is much higher than a traditional gym equipment company. They're essentially selling a gym membership with a hardware initiation fee. Luna: And that model is spreading to other categories. I've seen it in pet feeders, air purifiers, even coffee machines. The hardware is cheap or even free, and you pay for the pods or filters on a recurring basis. Lucas: That's the classic razor and blades model, but with a digital twist. Keurig did it with coffee pods, but now startups are doing it with software-enabled consumables. For example, a company called Litter Robot makes a self-cleaning litter box that costs $500, but you also need to buy their proprietary litter trays. That's not exactly a subscription, but it's recurring revenue tied to the hardware. Luna: Before we go deeper, I want to mention something. A lot of listeners have asked how we keep this show ad-free and independent. The honest answer is that a small group of listeners chips in monthly through buy me a coffee dot com slash fexingo. That support is what makes it possible to produce these deep dives without sponsors telling us what to cover. Lucas: Yeah, and we really appreciate that. It gives us the freedom to focus on the topics that matter to founders and operators, not just the ones that have a big marketing budget. So if you get value from the show, that's the way to keep it going. Luna: Alright, back to hardware subscriptions. One challenge I want to dig into is how you handle returns and refurbishment when the hardware is tied to a subscription. If a customer cancels, do you want the device back? Lucas: That's a great point. In the traditional model, the customer owns the device, so returns are rare. But if you're leasing or financing the hardware through the subscription, you might want it back to refurbish and resell. That adds a whole logistics layer. August didn't do that — customers kept the lock. But some industrial IoT startups require the hardware to be returned if the subscription lapses. Luna: And that changes the unit economics again. You have to account for the cost of retrieval, refurbishment, and re-deployment. That can eat into the margin if churn is high. Lucas: Exactly. So the decision to require hardware return depends on the value of the device and the likelihood of reuse. For a $500 sensor, it might be worth it. For a $50 smart plug, probably not. Luna: Let's talk about financing. How do hardware startups fund the upfront manufacturing cost when they're relying on subscription revenue? Lucas: It's tough. Traditional debt financing is harder because there's no immediate revenue stream to service the debt. Many startups use venture capital to cover the initial production runs, but that dilutes the founders. Another option is revenue-based financing, where a lender provides capital in exchange for a percentage of future subscription revenue. That's becoming more common for hardware as a service companies. Luna: And some startups are using crowdfunding not just for validation but actually as a way to pre-sell the hardware and collect the cash upfront, even if the subscription starts later. Lucas: Right. Crowdfunding essentially converts future customers into today's investors. But then you have the added pressure of delivering on time, which is notoriously hard in hardware. Luna: So the subscription model adds complexity, but it also aligns incentives. If your customer is paying monthly, you have a strong incentive to keep the software updated and the device working well. That can lead to better products overall. Lucas: I agree. The traditional model where you ship a device and then walk away often leads to neglected firmware and poor user experience. With a subscription, you're constantly earning your revenue. That forces you to invest in the ongoing product experience. Luna: And for the customer, it lowers the upfront cost. They might be able to afford a $500 device if it's $50 a month with no money down. That can expand your addressable market significantly. Lucas: Yeah, but there's a flip side. The total cost of ownership over a few years can be much higher than a one-time purchase. So the customer has to see ongoing value. If the device is a set-it-and-forget-it product, like a smart thermostat, the subscription might feel like a tax rather than a benefit. Luna: That's why products that deliver continuous value — like fitness coaching, security monitoring, or data analytics — work best for subscriptions. If the value is only at the point of sale, a subscription won't stick. Lucas: So what's the takeaway for a hardware startup founder listening right now? I'd say: first, make sure your product inherently delivers ongoing value that can be unlocked through software or services. Second, be transparent about what's free and what's paid from day one. And third, model your unit economics carefully — know your churn, your customer acquisition cost, and your gross margin on both hardware and subscription. Luna: And don't underestimate the operational complexity. Adding a subscription means you need billing infrastructure, customer support for cancellations, and possibly a logistics chain for returns. That's a different skill set than just designing and selling hardware. Lucas: Absolutely. But if you get it right, you build a more resilient business with predictable revenue. And in the hardware world, where margins are thin and competition is fierce, that predictability can be the difference between surviving and thriving. Luna: And maybe the next big hardware startup won't be known for its device, but for the recurring relationship it builds with its customers. Lucas: That's a good note to end on. Thanks for listening.