Addressing Climate Change: Hardware + Software, i.e. a System Company
If you googled “We are a hardware company” at the end of 2022 you would get 228,000 results. If you tried “We are a software company”, it would be 10x more (2.3 million). See screenshots below (taken on 11-Dec-2022).1
Why is that? What is so much favourable about a software company than a hardware one? Why do founders want to build the former, but not so much the latter?
Well, in the world of VC investing (and hence building companies from founders’ perspective), it is almost a no brainer. Software is much more easily scalable, takes shorter time and resources to generate revenue, has less risks involved on the way to hitting product market fit, has negligible inventory or supply chain risk, hence allows for much faster iteration and affordable pivots if necessary, etc. It also typically has a better margin profile from a unit economics perspective.
And more likely than not, a software company benefits from recurring revenues assuming the model has been successfully transformed into software as a service (SaaS) model (vs. licensing model). Such SaaS businesses get rewarded in the market and enjoy higher valuation multiples at scale. All of this eventually converts into more investment dollars when combined with the factors outlined above. (p.s. Adobe is a good example of this from a few years ago as outlined in this article published by McKinsey. During 2010 to 2018, share of subscription revenue for Adobe grew from 10% to 88% while its price-to-sales multiple increased from 4.1 to 12.2)2.
Certain sectors are more suitable for software-only business models (e.g. e-commerce, financial services, etc.). For others however, a software-only business would not suffice to address the real pain points and the needs of the industry at large. A great example of is of course climate-tech. There are certainly great software-only businesses in the areas of carbon footprint measurement, consumer analytics, supply-chain intelligence, corporate ESG management, etc.
However, what we have ahead of us is an uphill battle to meet net-zero targets by 2030 and 2050. According to a recent report published by the Rhodium Group, CO2 emissions in the US increased two years in a row in 2021 and in 20223. US is currently off track to meet its targets for 2030 (see the chart below).
Software alone will not help us make it to the other side. We have to build significant amount of renewables power generation, expand the footprint of electric vehicle (EV) charging infrastructure, increase the capacity of electrolysers, decentralize the electricity network to contribute to reducing energy losses, build large-scale carbon removal projects, equip new homes / retrofit projects with energy efficiency measures and so on and so forth.
On the flip side, all of this new ‘hardware’ can work to its full potential only when integrated with a purpose-built software. It is because we must collect and interpret real-time data, have the ability to share it with all internal and external nodes, equip the hardware with predictive maintenance capabilities, optimize its performance in different working conditions and model / analyse future scenarios to repeat the cycle of collecting, interpreting and building. In addition, the right approach to building hardware is to keep in mind platform and scalability, the two concepts that are inherent to software.
What is the solution here then? How can we address the climate-change in the most effective way? My take is that it certainly helps building and investing in more of those “system companies”. What is a system company? Is there a such thing? I checked with ChatGPT. In fact, to my surprise, it didn’t include climate-tech among the sectors in its initial response, but then chose to do so when I followed up.
A systems company is a company that designs, manufactures, and sells integrated systems. An integrated system is made up of multiple components that work together to perform a specific function or set of functions. These components can include hardware, software, and services, and are tailored to meet the specific needs of the company's customers. Systems companies often have expertise in coordinating the various components and ensuring that they work together effectively and efficiently. Examples of systems companies are those that make aerospace and defense systems, automation and control systems, transportation systems, and climate-tech systems. These companies may design and build the hardware, develop the software and provide services like installation, maintenance, and support.
An example is from the 2023 edition of Energy Technology Perspectives (a flagship research published by the International Energy Agency). As shown on the below table, hardware + solutions would improve efficiency, reduce costs and accelerate innovation across clean energy supply chains.
We need to act yesterday to tackle the climate-change, which is one of the largest existential threats to the Earth and humanity. We have a better chance if we work towards bringing fully integrated hardware and software solutions, i.e. systems to life at scale.
For some reason, the counter seems to have reset in 2023. If you try today, the gap is still huge, but with less number of results (Happy for anyone, who is familiar with how Google shows search count, to shed light on this).
https://www.mckinsey.com/industries/technology-media-and-telecommunications/our-insights/hardwares-business-model-shift-finding-a-new-path-forward?cid=eml-web
https://rhg.com/research/us-greenhouse-gas-emissions-2022/