6 Cash Flow Risks Hardware Scale-ups Need to Watch

Education / 6 Cash Flow Risks Hardware Scale-ups Need to Watch
Engineering Handoff Mentality

Bringing new products to market is difficult.

Only 24% of hardware scale-ups even make it as far as the second round of funding.

And cash flow challenges makes this challenge much greater.

Today, we’re looking at the 6 most common reasons hardware scale-ups who are focused on new product development struggle with cash flow, and what to do about them.


1. High up-front costs

Physical products require a lot of cash up front.

Materials, contracts, parts, assemblies, dies molds — all of this costs.

And it all costs before you even start producing.

The solution

Be ready to tweak your bill of materials to hit a lower per-unit price point or use a material that’s easier to work with / source.

You can always iterate later if a substituted-in component isn’t performing up to snuff.

2. Contract manufacturing costs

Most scaling companies don’t own a factory.

Rather, they partner with a contract manufacturer or CM.

A CM is a great option.

It means that all the highly-specialized skills needed to take product development from an idea to a mass-produced reality are in the hands of a specialist.

Because your engineering manager doesn’t want to be scheduling workers shifts or dealing with 150 new hires.

However, CMs do have some downsides.

  • Most have minimum runs — no more prototyping or 3D printing — so a mistake can be expensive.
  • Most have significant investments up front, consuming a large chunk of cash before they start producing.
  • Long-term contracts are the norm.

The solution

Make sure there’s someone senior on your team who’s worked with contract manufacturers before.

Their experience in sourcing a good CM and building a positive relationship will pay dividends far beyond their salary.

Second, make sure you have a crystal clear way to communicate product data to your CM.

This should be automated, secure, and easy for both parties to access.

There should never be confusion over the latest file, nor should the process of getting core documents to the CM be manual.

That’s a recipe for missed deadlines and a frustrated relationship.

3. Inventory

Unless you’re essentially building to order, you probably need to hold some finished goods in your inventory.

This causes two problems.

  1. It means that you’re renting warehouse space somewhere. That’s more cash tied up somewhere.
  2. It means you’re paying to manufacture goods that are not turning into cash coming in.

The solution

Make sure your margins during product development are calculated based on landed cost, not shipped cost.

This means that shipping, storage, and final-mile distribution are baked into the cost of the product, rather than just the cost to get something from raw material to on the container ship.

4. Payment terms

Hardware scale-ups must deal with rough payment terms on both ends of their value chain.

Suppliers demand cash for materials long before you’re paid by clients.

And on the other end, clients and customers might not pay you for 90 days or more from when the product is delivered.

The result of all this is a cash flow story that looks like this:

product development processes

The solution

First, negotiate the longest payment terms possible for your suppliers, even if it means paying a premium.

The extra breathing room here will keep you solvent for longer.

Second, negotiate rapid payment terms with your clients, even if it means eating into your margins or you have to tack on a better returns/opt-out policy.

Again, this will eat into your margins, but slim margins with growth and cash in the bank is better than fat margins and a long list of creditors.

Slim margins with growth and cash in the bank is better than fat margins and a long list of creditors.

5. Initial scrap rate

New product development is almost always more difficult than it’s projected to be.

On average, they launch about 20% later than they’re supposed to.

And even agile hardware scale-ups can struggle with getting quality products to market.

For instance, John Teel predicts a 10% defect rate for new product development, compared to 1-3% most established companies have.

No manufacturing process is ever perfect and you are guaranteed to have some faulty units. Initially, this may be 10% or more, but as time goes on and you optimize your manufacturing process you should be able to reduce this number to only 1–3%.

However, scaling businesses often build models based on 1-3% right from the start — despite this not being an achievable objective.

And now hardware scale-ups need to actually solve the problem, creating more ECRs, more fixes and edits, and an ever-expanding collection of designs and product data.

The solution

Optimize your engineering change processes to push through improvements as quickly as possible.

The goal is to get your suppliers, CMs and other auxiliary stakeholders adjusted production documents as soon as they’re completed and approved by internal resources. This means:

  • A clear process for ECRs within your engineering team
  • Clarity over what approvals are needed
  • A way to share updated production files to your product development network

6. Growing pains for new product development

Finally, we run into the problem of new product development: there are always some growing pains.

First, scaling hardware companies are moving processes and systems from ad hoc solutions, where speed and rapid innovation are critical, to a world where precision, repeatability, and control are prized.

Shifting requirements mean new processes and systems need to be developed, refined, and deployed.

Shifting requirements mean new processes and systems need to be developed, refined, and deployed.

Second, for some, this will be the first foray into offshore manufacturing.

Unless the product development team includes a seasoned CM professional, this might be the first time they worked across time zones or closely with contract manufacturers.

Solution

As you transform your output from designs and prototypes to production runs and manufactured goods, you also need to transform your underlying processes to match.

This means:

It’s only when these processes are organized correctly can you effectively scale your business and scale production effectively.

Summary

The transition to factory run and full-blown production manufacturing is arguably the most challenge part of new product development.

And tight cash flow doesn’t make this any easier.

High costs, long payment terms, and the growing pains of a major transition mean that it’s an exceptionally risky time for hardware scale-ups.

But by scaling business processes and enabling collaboration between core engineers, business stakeholders, suppliers, and CMs, businesses can set themselves up not only for positive cash flow but long-term business success.

Image credit: Ivan Bandura via Unsplash


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2018-12-12T14:08:27+00:00