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Commoditization and Leverage

When a technology product is brought to market, it is typically the result of several partners working together.  For instance, an Android phone is the result of companies like HTC or Samsung productizing Google’s underlying mobile operating system platform and partnering with mobile carriers such as AT&T and Verizon who use their networks and stores to proliferate product sales to end users.

Android now accounts for the majority of the sales for the smart phone market, but the various Android hardware companies combined have far less profitability compared to Apple. Where Apple has been able to improve their strong financial fundamentals and profitability along with their legendary revenue growth, the Android smart phone vendors in general have seen their gross margins become increasingly under pressure.

So, the question is how can Apple protect their profitability and financial fundamentals when Android hardware vendors cannot?  It is because embedded in Apple’s business strategy is great leverage and protection against commoditization.

First, let’s take a deeper look at the Android world.  Android has evolved into a powerful technology platform.  Unfortunately, for the hardware companies, none of them own the platform.  As a hardware vendor, this is a big problem because if everyone has access to the same technology, there is by definition no competitive advantage.  And the result is inevitable commoditization — where gross margins become pressured as competitors are forced to compete on price.

When hardware vendors become commoditized, the balance of power shifts to the sales enablers.  In this case, Android hardware vendors become increasingly at the mercy of their carrier partners.  From a carrier point of view, hardware commoditization is great as it provides leverage to pit hardware vendors against each other and allows the carriers to differentiate themselves on the basis of their own value, such as network quality.  It also allows the carrier to “own” the end user relationship.  “Owning” the end-user relationship can be powerful as it creates long-term brand loyalty.

In sharp contrast, what Apple has been able to do in the smart phone market is remarkable.  Not only have they been able to own their technology platform and create significant competitive advantage, they have also succeeded in “owning” the end user through great brand marketing and use of their stores.  Correspondingly, they have commoditized the carriers.  Apple’s strategy has not only allowed them to maintain incredible profitability in the smart phone market, but by controlling the end-user relationship, they have also built a tremendously loyal user base they can leverage for future new technology market introductions.

On a side note — Recently, after watching Prometheus, I went back and watched the original Alien movie.  At one point, the crew of the ship turns to the Android Ash for an explanation for what the Alien is.  In which he says:

Ash: “You still don’t understand what you’re dealing with, do you? A Perfect Organism.”

Google has Android, but Apple just might be the Alien.  In terms of defensibility and leverage, the business model is perfection.

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Bootstrapping Strategies Part 2: “Fatigue Makes Cowards of Us All” — Vince Lombardi

My fitness trainer often shouts this phrase to me whenever I am beginning to hit the wall during workouts (Terry Canon, respect).  The motivation of the phrase is simple – when we get tired or when we are faced with adversity; our mental strength and concentration are put to the test.  And those that have the resiliency to fight through adversity and stay focused on goals will have a significant competitive advantage over those that cannot.

In 2005, Ubiquiti would launch its first product called “SuperRange” – essentially a super-charged Wi-Fi module for long-distance outdoor wireless applications.

Because the product had incredible demand from a niche market of independent operators and distributors that served them, we were able to secure customer payment upfront to fund manufacturing and instantly became a profitable business with cash flow.  The appeal of our “SuperRange” module was that it performed better over long-distances compared with the standard commodity Wi-Fi modules being sold in volume.  Although we charged a cost premium for our module compared with the existing commodity one being used at the time, the operators had no problem paying the premium as they saw it had a great overall cost/performance improvement in their systems.

However, there were 2 disastrous variables working in the background that would inevitably be fatal to my initial business strategy:

  1. Our $35 manufacturing cost was representative of our economies of scale in 1,000’s of quantities.  In contrast, the popular commodity modules had a $20 resale price were coming from Asia in 1,000,000’s of quantities.  Interestingly, there was no significant intrinsic design or manufacturing cost premium in our enhanced design compared to the commonly sold commodity module.  We were just completely outmatched with our competitors from a manufacturing volume/cost leverage standpoint.
  2. Our improvements were simple HW design additions that could easily be copied

You can imagine what happened next.  The commodity Wi-Fi module manufactures soon noticed our growing business and gross margins and said “Hey, this is a great idea; we can manufacture a premium module design and take over their market”  Within months, they copied our HW design and clones started appearing in our sales channels at below our manufacturing costs.

Overnight, growth slowed, customers turned on us saying we had no business selling such over-priced hardware, and I found myself in an impossible position to compete; I was contemplating shutting the doors and moving on with my life.

The irony is that the majority of people who had chimed in with an educated business opinion on my initial strategy told me this would happen.  And it played out exactly like they said it would.  But, I didn’t listen; and I learned a very painful lesson that would cause me to question myself.  As it turns out, it would become the stage for the best opportunity I could wish for.

We shouldn’t look at being handed adversity in life as a bad thing; if you are up for it, then it really becomes an opportunity to find out what you are made of.  And if you can develop the ability to step up and conquer even the most hopeless of challenges, you certainly will gain an attribute that will give you a significant competitive advantage over your peers.  Instead of letting adversity get the best of me, this would mark the first inflection point in Ubiquiti’s growth.   I would quickly meet adversity head-on, recalibrate, and adopt a new strategy that would define an Industry.

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Bootstrapping Strategies Part 1: The Compromise between Today and Tomorrow

Perhaps something of an oddity amongst publicly traded tech companies, Ubiquiti Networks was bootstrapped with no operational funding from inception up to the IPO.  For a software company, this path is challenging enough.  But, Ubiquiti makes hardware.  And with making hardware comes the additional financial burden of funding larger and larger manufacturing expenses as the business grows. People often ask me how we were able to pull this off.   Over the course of the next several weeks, I will introduce a set of bootstrapping strategies, which I hope will give insight into things I did well and things I maybe did not do so well in leading Ubiquiti from my apartment through our IPO.

In sharp contrast to Ubiquiti’s bootstrapped beginnings, venture capital backed companies are often supported by experienced, savvy investors with operational backgrounds, strategic mindsets, and a commitment to establishing expensive, but necessary infrastructure within their companies (including forming an experience board, hiring corporate lawyers, hiring experienced management, planning a public relations campaign, and creating an IP portfolio).  The assumption is this infrastructure will one day be imperative to protecting the company’s standing.  And, it took my own learning experiences to realize something — they are right.  VC’s are playing for tomorrow.

As a bootstrapping entrepreneur perhaps the biggest challenge is how to balance playing for today vs. playing for tomorrow.  When you are starting, there is no money or time to really look at tomorrow; you can easily get caught in the moment as you are scrapping with everything you have trying to survive today.

When I left my job at Apple in 2005 to dedicate myself to Ubiquiti, my only thought was “if this doesn’t work out, I am screwed.”  It was March of 2005 and my $600/month studio apartment lease down the street from Apple HQ was coming up for renewal.  Instead of committing to another year, I moved my futon and my HW lab into an economical $650/month office surrounded by bail bonds shops across the street from the San Jose Courthouse where I would make my home for the next several months.   Although there was sufficient capital from upfront customer down payments to fund the first manufacturing builds, I was locked in survival mode and entirely focused on how I was going to setup manufacturing, make the shipment lead-times, support initial customers, come up with new product designs, and build the Ubiquiti brand.

Ubiquiti's first office, 2005
Ubiquiti’s First Office, 2005

I had no real advisors, no board members, no corporate lawyers, no accounting, and no IP strategy.  I was completely winging it and was playing to survive another day.  I really did not always see the importance of living for tomorrow until much later on in the company timeline.  One of the biggest regrets I have today is that I did not make the transition earlier.

But to be fair, if Ubiquiti would have ended up as a failure and shut its doors early, playing for tomorrow would have become irrelevant.  Therefore, the best strategy is to incrementally increase your “insurance” as the value of your company increases and resources become more available.

Here are 3 areas of important “insurance” early-stage bootstrappers should look at:

Relationship Contracts:  At this point, you just got in the game.  You might have hired some contractors, partnered with another company, or signed up your first distributor.  No matter what the nature of the relationship is — an employee, friend, contractor, vendor, distributor, partner, etc. – EVERY ONE should be under a contract that protects the company’s best interest.  Get these signed once, filed and out of the way.  It is your most critical insurance.  Unfortunately, a lawyer should be engaged to create these contracts (I will talk about how to handle lawyers in a later post).  For now, remember when dealing with lawyers -– they work for YOU and you should always run them “closed-loop” with a specific scope of deliverables and defined project fee determined up-front.

Initial IP (start with Trademarks):  By now, you might be starting to produce product and generate some profits.  In order to protect against unfair competition as your product sales grow, you should start looking at some IP investment.  If funding a patent portfolio is still out of reach, start with provisional patents and  trademarks.  Trademarks also can provide powerful insurance against unfair competition at good economics.   They are important to have in the regions where a product is sold, but also IMPERATIVE to have in the region of manufacturing.  There are trademark consultants, patent agents, and online resources that can assist in economically registering trademarks and provisional patents.

Bookkeeping / Tax Accounting:  As you start to file corporate tax returns, it is important that you have an expert not only making sure you stay within the law, but someone who knows how to take full advantage of tax credits and strategies.  When I was starting Ubiquiti in the early years, even though it was incredibly profitable, cash flow was challenging as funds were constantly being reinvested into larger manufacturing volumes.  In this case, the timing of the re-investment and the tax obligations created severe cash flow challenges.  An experienced corporate tax accountant can find tax strategies that align with bootstrapping; including in this case for instance, tax payment deferral.  Proper book-keeping with as much transparency as possible is also important as your company grows as it will play a major role in facilitating future funding opportunities and maximizing your company’s perceived valuation.

Keep in mind, that this is just the beginning of the infrastructure you will have to commit to as the company matures.  But, hopefully by that time, you will have found a good advisor that can help to fill in the more advanced pieces.

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New Office

Ubiquiti’s Silicon Valley branch moved to a larger facility in San Jose last month.  Attached are photos showing the property after our design build out.

We had some specific goals we wanted to achieve with the design:

1.      Build an engineer’s dream work environment.  It’s a sleek, modern look where no expense was spared for our lab areas and developer team offices.  Interesting fact — one of our own developers put on his interior design hat and came up with the entire concept.  As you can see, there were many unique approaches including extensive use of frameless glass, polished concrete, stainless steel columns, beam lighting, and Wink whiteboard walls. John Tso is the man!

2.     Optimize developer team efficiency, and productivity.  Technology platforms teams (such as UniFi and AirVision) now have their own team offices where developers can work together collaboratively.  In a way, this new office is very analogous to a technology incubator where we have independent software teams working on unique platforms while each leveraging Ubiquiti’s existing IP, branding, operations, and hardware engineering resources

I really regret not making this upgrade sooner… I have a feeling that the additional overhead costs of an inspiring work environment are more than offset by the intangible value of having very happy engineers and in turn, having their productivity boosted.    Additionally, this new office has already made a difference in recruiting new top engineering talent!

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Why I created this Blog

Hi everyone; thanks for visiting. My goal is to make this site a platform to discuss a variety of topics ranging from the future of technology to random things that I just find cool.  One focus of the site will also be dedicated to sharing some insights from my own career experience in an effort to support the next generation of technical entrepreneurs building and leading companies to compete in the global marketplace.

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