Keurig accidentally created the perfect business model
for hardware startups
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It’s no secret that investors don’t like hardware businesses.
Despite the eternal frustration of startup founders, investor
distaste in physical product businesses is actually entirely
logical. It’s nearly impossible to build a venture-scale business
by selling dumb plastic parts at a 30% gross margin.
But the connected, vertically integrated hardware products of
today are very different than their dumb counterparts of
yesterday. The difference is simple yet profound: it enables
hardware businesses to operate with financials that mimic their
SaaS brethren. Somewhat surprisingly, the most notable
example of this type of business model was pioneered by
Keurig, a company few people think of as a hardware business.
At Bolt, we believe this is one of the pillar business models of
the next generation of hardware businesses, which is why our
portfolio has a growing group of companies that follow this
paradigm.
█ Background
The core Keurig system is quite simple: a machine (the brewer)
and a proprietary system for packaging single-serve coffee (KCups). Like many great hardware inventions, the original Keurig
machine was invented in a dorm room and grew slowly. The two
founders built prototypes but struggled to gain mass-market
adoption until 1996 when Green Mountain Coffee made a large
strategic investment in Keurig. With a stroke of brilliance, they
later acquired Keurig as a way to efficiently distribute higher
margin coffee.
Keurig is one of most successful hardware companies of the
past few decades. Except they’re not a hardware company. The
vast majority of their revenue comes from coffee. In fact, 228M
pounds of coffee per year, or more than 1.25 pounds for every
coffee drinking adult in the US. Of the $4.7B in revenue in 2014,
only $580M was from hardware sales. That’s less than 15%.
Yet, without Keurig’s crucial piece of hardware, the booming
business would likely cease to exist.
█ No more razors, no more blades
When discussing Keurig, nearly every single person will
inevitably bring up the famed “razors and blades” business
model pioneered by Gillette. The general gist is: sell a cheap
“freebie” product (a razor) that requires continuous and highmargin replenishment to function (the blades). This is why a
razor with a blade costs $7 but each blade after that costs $4
and why an inkjet printer costs $60 but each set of ink costs $40
or more.
Keurig is profoundly psychologically different from razors and
blades.
█ To Keurig or not to Keurig
Some might think there’s a fine line between Keurig-like
business models and razor-like business models. Here are a
few examples to test the boundary:
Nearly everyone buying “replacements” has a negative
association with these purchases. Think of your emotion the last
time you purchased a set of ink cartridges. Unless you have a
weird obsession with ink, I’ll bet it was a feeling of frustration
and being ripped off. I imagine a used car salesmen with slickedback hair trying to convince me I should buy two sets “just in
case I run out.” Yuck.
Keurig on the other hand is always a positive buying experience.
This primarily comes from the simple fact that you’re not buying
replacements, you’re buying the thing you actually want to
consume; the brewer is just a mechanism for delivery.
■ Kindle e-reader and a digital book.
When you open the box for a Kindle, you’re excited to own a new piece of technology. But the real magic of the product
experience comes when you purchase and read your first book. The device melts away from the experience and becomes
an invisible facilitator for the act of reading.
Verdict: Keurig for books (not razors and blades) Cost of consumable: 15% of device
■ Brita water filtration system and spare filter
The Brita water filtration system starts off as a complete product, but over time the filter wears out requiring you to replace it
in order to get back to peak performance. Buying replacement filters, which are nearly half the cost of a full Brita system,
feels like a nuisance.
Verdict: Razors and blades Cost of consumable: 40% of device
■ Game console and game (Playstation 4 and Grand Theft Auto 4)
Like the Kindle, game consoles aren’t very useful on their own. This is completely acceptable to consumers as the entire
psychological experience of using a game console hinges on the games themselves, rather than the delivery system (the
console).
Verdict: Keurig for games Cost of consumable: 12% of device
█ Cost
A curious pattern emerges when looking at the handful of
products on the market that follow these two business models.
The relative cost of Keurig-like consumables to Keurig machines
is much lower than the cost of razor blades to razors.
Keurig cost of consumable: 1% of device
Razor cost of consumable: 57% of device
In addition to the focus of the product (as discussed above), the
price difference drives the negative psychological associations
consumers have with razors-and-blades business models.
█ Why it matters
So who really cares? Plenty of companies have built big
businesses by selling hardware at a 30% gross margin. Why
can’t you just run a Kickstarter and sell a ton of units through
Best Buy when to scale up? You can, you’re just entering into a
game of diminishing returns with an extremely slim chance of
winning in the long-run.
revenue will be drastically larger than current revenue. If you’re
in a traditional hardware business, future revenue is confined to
cyclic product sales. This roughly means you get one shot at
revenue with each customer per product development cycle:
each sale must be painfully acquired by building a new product
every 18 months or so.
Recurring revenue matters because it fundamentally changes
your business. There are good reasons investors are averse to
hardware but love software. One of the leading reasons
revolves around future revenue. Investors pay huge premiums
to own stock in companies betting on the likelihood that future
.
The Keurig model combines the best of both worlds: hardwarelike customer acquisition and software-like recurring revenue.
Revenue vs cost over time for traditional hardware businesses
and SaaS businesses is shown below
Customer acquisition costs are often lower in hardware than in
many SaaS businesses. This fundamentally comes from the
psychological comfort we humans have from spending money
on hardware ($120 for a coffee machine without thinking to hard)
vs software ($120 for SaaS products is a difficult decision that
very few average consumers make). For the inevitable customer
acquisition cost that businesses do wind up paying, hardware
companies recover that cost very quickly (usually in a few
months at the point of sale) vs SaaS businesses (usually a year
or more amortized over the usage of the product/service).
Check out this post for more detail.
Keurig for X style model of revenue and cost over time. Each
product development cycle is additive to constantly growing
recurring consumables revenue.
functions, you’re adding necessarily highly-efficient, vertically
integrated distribution system. Not a walk in park by any stretch
of the imagination.
This is where the brilliance of the Keurig model shines. The
initial sale of a $120 Keurig brewer isn’t that difficult or costly.
Keurig doesn’t spend a lot on marketing or advertising and the
product isn’t complex to manufacture or service. In my rough
estimation, the BOM for a brewer is around $40, giving Keurig
about a 25% gross margin on the product. Time from PO to FOB
is likely less than 2 months, yet high-margin K-cup sales start
immediately and continue for years. Keurig spends less than
$0.015 on each K-cup and charges 100% more per unit than
bagged, ground coffee. Yet few people complain about this cost.
Our bet is once these businesses are built, they’re next to
impossible to dislodge and their customers become devoted to
their products and consumables.
There aren’t too many businesses that are built around this
model, but there will be. In the past year, Bolt has made
investments in Kuvée, Petnet, and Sutro (with a few more in the
works), all of which follow the Keurig business model. Make no
mistake: these products and businesses are exceptionally hard
to build. Not only are you building hardware, firmware, backend, front-end, mobile, operations, sales, and marketing