The Digital Skeptic: It Turns Out Hardware as a Business Is Hard

NEW YORK ( TheStreet) -- Peter Semmelhack will tell anybody who's got the guts to listen that making smart hardware is, well ... hard.

"There is a hype cycle right now where young entrepreneurs now believe that hardware is easy," said the founder and CEO of Bug Labs, the 15-person smart hardware development firm based in Manhattan. "But they don't understand all the gatekeepers they have to deal with: designers, distributors, shipping, inventory, warehousing, customs, certification, software licensing. Hardware is hard."

Semmelhack, over the past few weeks, has been breaking down the realities for me of what it takes to make a living in what is considered by many investors to be the hottest sector in the domestic electronics economy: intelligent gadgets made in small batches by small companies.

Atoms Are the New Bits was the trendy headline in a by-now infamous Wired feature by then editor Chris Anderson.

The theory of this emerging smart, small-lot device economy is -- a la the information revolution -- that a new generation of fabrication tools such as 3-D desktop printers from Brooklyn-based MakerBot, recently acquired by 3-D printing firm Stratasys for $403 million, or Netherlands-founded, New York City-based Shapeways will enable the production of cheaply designed devices, created using open source fast-prototyping electronics such as Arduino and Raspberry Pi and free design tools such as AutoCad 360 from San Rafael, Calif.-based Autodesk ( ADSK). All of which will be funded by newly frictionless crowdfunding platforms such as New York City-based Kickstarter and San Francisco-based Indiegogo.

What makes Semmelhack such a must-know for investors is that the man isn't merely writing about -- or trying to sell products and services into -- this small-batch electronics market.

He's actually done it. And lived to tell the tale.

Starting in 2006, Semmelhack raised $10 million from first-tier investors including Union Square Ventures to launch a line of modular consumer electronics -- basically a smart Lego set of snap-together screens, keyboards, sensors.

He quickly found that "There are so many things that obstruct the path to construction and profits," he said, "that I don't know where to begin."

The first WTF moment
Almost immediately, Semmelhack says the firm had its first WTF moment: Bug Labs could not find vendors for even basic parts, including critical Wi-Fi chips.

"It was like being a software coder and being unable to buy if/then statements," he said.

"A big company like an Apple ( APPL) would come in and completely wipe out the supply of critical parts," Semmelhack explained. Bug Labs was always making due with older gear that offered lower performance. "Our C-level producers would do the molds, and it would look like %^$#," he said. "But we were the low man on the totem pole, so what could we do?"

Next, Bug Labs saw that even if it could get the chips, it could not find the software needed to run them.

The firm always seemed to be reacting to one crisis or another. The financial meltdown in 2008 froze inventory in a factory shuttered by defaulted lender Wachovia. Bug Labs' gear failed a regulatory certification exam when radio frequency parts somehow malfunctioned. And there were endless issues of shipping, lab testing, support and managing inventory.

When I challenged him that tools such as 3-D printers and low-cost chips are supposed to change that core dynamic, he chuckled.

"These tools are cool. We use them. But what you learn is, 3-D printers will never replace manufacturing basics like injection-mold plastics, rapid metal-fab and mass-produced computer chips," he said.

It's the enterprise, stupid
By 2009, Semmelhack realized that Bug Labs was going to have to shed its original shell -- and fast. Its first product run aimed at consumers was a flop. But he noticed small amounts of product sold to early adopters with engineering backgrounds who, of all things, were carrying his Bug Labs gear into the office.

"We began to a see a slow trickle of sales into big operations like the Defense Advanced Research Projects Agency and Accenture ( ACN)," he said. Bug Labs figured out that these large enterprises were buying his kits as development tools for their own products.

"They figured out if you take our parts and have a weekend and pay us for some of our time," he said. "You can have you a product in a few days. That saved them millions. And that turned out to be our business."

Bug Labs sells its hardware modules and support service to operations including Ford ( F), Comcast ( CMCSA), Pitney Bowes ( PBI) and many others. Revenue is growing at 20% or so per year. And there are actually ... gasp, profits.

"Let's be honest. We are hardware. We live in a physical world. Somebody has to step up and improve physical stuff," he said. "But there are so many impediments in moving at the speed you need to, in a world of atoms," he said.

"Most people don't understand just how hard hardware is."

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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