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China’s manufacturers are enabling a new model of startup incubation

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The current chronology Silicon Valley hardware startups typically follow is slow and disordered. But that could change with a new incubation model emerging from an unlikely group: China’s global hardware manufacturers (OEMs).

Usually, when launching a hardware business, startups make prototypes, then raise capital so they can fund production. They then often turn to China, where they begin the arduous process of identifying and trying out multiple suppliers, manufacturers, and logistics companies. After a time-consuming and, frankly, painful process of speed-dating, fraught with miscommunication, startups will choose their partners. These relationships are transactional in nature, which means, right from the onset, there is a fundamental misalignment of interests between volume on the supply side and quality, brand equity, and sustainable growth on the startup side. Without pushing large volume, startups are unable to command quality from the supply chain. Eventually a product is produced and brought to market, though it’s not always the intended, original design.

Take Kickstarter campaigns, for example. Of the campaigns that successfully deliver product, only about 15 percent ship on time. Many more never come to mass production. Lily, the drone startup, is notorious for failing to produce after raising $34 million in a crowdfunding campaign. Even VC-backed, well-funded American hardware companies struggle to align their designs with production processes and cost realities. Nest, Pebble, and Jawbone are all examples of Silicon Valley-backed hot brand names that struggled to play the hardware game as prescribed by U.S. VC rhetoric.

Meanwhile, China is well-known for its hardware manufacturing capabilities. More than 90 percent of the world’s electronics move through China at some point during their production processes. This reputation as the world’s assembly line masks two things: China has best-in-class, large-scale industrial production know-how, and Chinese companies have incredible engineering prowess that is reality-based, not theoretical. Many of these manufacturing goliaths are hungry to move beyond their low-margin wheelhouse.

The dawn of something new

This desire of China’s manufacturing goliaths to be more than hired labor gives startups an alternative to the traditional Silicon Valley VC path. By taking their prototypes directly to manufacturers and taking a small seed round from those companies, startups are able to tear down many of the barriers that continually plague Silicon Valley hardware companies. When the supplier has skin in the game, several interests align, as the potential profit-sharing from a startup’s success can be far beyond a nominal manufacturing margin. The supplier now has an incentive to keep production costs low, a disincentive to work with any competitors or abuse the IP, a sense of responsibility to maintain the highest quality controls, and an urgency to bring the product to market as quickly as possible.

Aligning interests with a supply chain partner, startups can leverage the partner to buy up/lease all the production capacity needed at below-market production rates. Startups are creating products that engineers have put together using the best materials and best possible traits of existing products. It’s a combination that has enabled startups to create a completely new and unique model and open up a brand new product segment that didn’t exist before, more quickly than ever before.

This trend is logically more prominent in manufacturing-capital intensive industries. Sunwoda, China’s largest consumer battery pack manufacturer has invested in two prominent Chinese startups, Anker and JieDian, for example. SCUD, the second largest in the battery pack space, has invested in LaiDian and Xiaole. With manufacturing secured and products already on the market, these companies can later turn to VCs for growth money at more advantageous valuations. This is done instead of diluting valuations simply to raise VC money in order to bargain with manufacturers on R&D costs and bridge cash flow gaps on early production runs. Moreover, when the manufacturers are on the startup’s side, they can help optimize costs, mitigate frequent production errors, and extend payment terms on early production. It’s difficult for VCs to match that platform, and these Chinese startups have begun to realize that fact first.

Global startups starting to follow suit

When my company began designing our first product, we sought out our supply chain partners prior to even incorporating. At the inception level, we gave minority equity stakes to SCUD, who I mentioned above, and ESID, a consumer electronics industrial design firm. These supply chain partners became not just suppliers or investors but rather prideful founding members of the team at the initial incorporation stage. They have incubated and guided our supply chain every step of the way, working with us, not for us. In less than 11 months we designed, developed, produced, and shipped 5,000 units of our first product, a sophisticated energy storage system, to 21 countries. We have also shipped a full range of accessories and are in pre-production for a second product launch; and we have hired more than 10 full-time employees. To date, we have yet to raise a round of angel or VC funding.

Gi FlyBike is another exemplary pioneering global startup – an e-bike company founded by a group of Argentinians. After a successful crowdfunding campaign, Gi Flybike took its designs to Yadea Technology Group, the global leader in e-bike manufacturing with nearly two decades of history. The manufacturer sells more than three million e-bikes to five continents, with almost 15 percent global market share. The Gi FlyBike R&D team is currently based inside the Yadea Technology Group manufacturing plant, entering its first mass production stage.

Startups that hatch ready to hit the market

We are at the beginning of a new era of Chinese and Chinese-Western startups that hatch ready to hit the market. The needs of these companies are, and will be, different. They are able to leverage locals in China’s manufacturing centers with strong knowledge of the supply chain as well as experienced founders who know the end markets. They are creating new value in unused capacity, in back-of-envelope sketches and offbeat ideas from some great engineers.

While this OEM incubation model could, and will, be replicated around the world, rich and hungry Chinese OEMs are probably the most ready to engage today. It will be difficult for Western manufacturers to compete with the cost, speed, niche specialization, and production scale of the new China.

There is a new cadence for global hardware companies, and it doesn’t have to start in Silicon Valley with venture capitalists.

Eli Harris is cofounder and CEO of EcoFlow Tech.

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