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1 Pebble Technology Corp In early September 2014, Pebble Technology Corp. chief executive officer Eric Migicovsky sat with his senior executive team to discuss numerous issues. Pebble Technology manufactured one of the first Smartwatches on the market (see below). The team met in the boardroom of the company’s head office in Palo Alto, California. Migicovsky, a Canadian from Vancouver, had started Pebble while studying at the University of Waterloo’s System Design Engineering programme in 2009. They were meeting the day after Apple formally announced its iWatch. Various rumours put the launch date of the new product from late 2014 to early 2015. Eric was convinced that Pebble had the best smartwatch on the market. This was backed up by numerous independent reviews. However, his time in Waterloo had made him acutely aware of the potential danger of the iWatch. After all, the iPhone had nearly put Blackberry out of business. The Pebble team were wondering whether the iWatch would become a category killer in the way that the iPhone and iPad had done. Smart Watches (wearable technology) Smart watches are part of the wearable technology segment of the technology industry. As smart phones saturate the market (in 2014, 65 per cent of all mobile devices sold globally were ‘smart’), manufacturers and dreamers were trying to determine the next big thing. Many believed that wearable technology would generate massive sales. One researcher suggested that shipments of wearable technology would rise to 485 million units by 2018 from less than 2 million units in 2012. Gartner research, the respected technology market research firm, estimated the market size to be $20 billion by 2020. In addition to smart watches, items in the wearable technology sector included fitness trackers (eg FitBit, Striiv, and Nabu); digital clothing that lights up when a call is received; health care (heart rate or diabetes monitors); and, most notably, Google Glass. As one might expect, a smart watch is worn around the wrist and tells the time. What makes it smart is its ability to use Bluetooth to link with a cellphone, generally using the Android or iOS (Apple) operating systems. Therefore a smartwatch can notify the wearer of incoming calls or meeting times; display text messages and updates from social media accounts; track physical activity (eg step counts and bicycling speed and distance); or stock market notifications. The business model for smart watches is similar to that of the smart phone, in that the manufacturer builds the watch, installs a certain number of applications on the watch at the factory, and provides an infrastructure for 2 others to build apps that will work on the watch. As with smart phones, most apps are developed by third parties and some are free of charge while others cost a dollar or two. Smartwatches aren’t meant to replace phones, they are meant to save time and make checking of notifications more convenient. The first smartwatches came to market in 2010. Early Development of the Company While at Waterloo, Migicovsky had begun work on a smartwatch. He was interested in a device that he could glance at to receive messages while riding his bike to class, rather than having to stop and pull out his phone every time a message or call came in. Early success led to his acceptance to participate in the well-regarded Y-Combinator business accelerator programme in Silicon Valley in 2011. Y-Combinator brings together a number of aspiring entrepreneurs with promising ideas, gives them $120,000 to develop their products and mentors the participants and their companies to help raise the next round of capital. Some notable companies to come out of the programme were Reddit, Dropbox and airbnb. At the end of his 90 day stay, Migicovsky raised approximately $375,000 by selling common shares to three notable venture capitalists acting as business angels (see Appendix A), and Pebble Technology was born. 2009 - 2013 On completion of Y-Combinator, Migiscovsky decided to stay in Silicon Valley. Working out of his two-bedroom apartment in Palo Alto, CA, he used the $375,000 that had been invested to begin to put together a small team to commercialise his watch design. The company launched its first product in late 2010: the inPulse smart watch that linked to Blackberry devices only. They sold just 1500 units (approx. $200,000 total sales) of the initial inPulse production run, partly because of the plummeting interest in Blackberry phones. The company introduced a version that connected to Android devices in late 2011. However, too many of these watches were built and remained unsold, draining cash from the company. At the same time as selling the inPulse, the team was working on the development of a second generation watch to be called the Pebble. With funds rapidly diminishing and no interest from the various venture capitalists that he had contacted, Migicovsky had to turn to an unconventional source of money – Kickstarter, one of the largest crowd-funding operations. See Appendix A. In April 2012, Pebble launched a Kickstarter campaign with a goal of raising $100,000 in 35 days. The first 500 contributors of $115 or more would receive a Pebble smartwatch when available. Those who contributed later in the campaign wouldn’t receive a free watch, but would 3 receive a discount on the price of the Pebble depending on the amount of the contribution. The campaign was an incredible success. Pebble blasted through its goal just six hours after going live and had raised over $4.5 million in the first week. By the end of the campaign, Pebble had received pledges from 68,929 people and raised $10.3 million (an average of $149 per person) – a record for Kickstarter at the time. With the funding from the Kickstarter campaign Pebble was able to complete product development, make arrangements with contract manufacturers, and make plans for a marketing and promotion campaign. Pebble Features When it launched in 2013, reviews of the Pebble were largely positive. Most thought that Pebble was the best smartwatch on the market. It was lightweight; the screen could be viewed in bright sunlight as well as complete darkness; it had an industry-leading battery life (up to seven days); and a customizable watch face. One of its main advantages over the competition (see below) was that the Pebble used its own simple notification based operating system to deliver messages to the screen. The screen itself was a 3.2cm rectangle with a lightweight e-paper LCD display. By early 2014, there were more than 1000 apps available for the Pebble. These included notifications for calls, emails, text messages; remote controls for devices such as the NEST home heating control system; GPS directions; and, stock prices among others. Manufacturing Migicovsky had produced his first smartwatches using components taken from smartphones and linking them to the software he had written. They were assembled by high school students in Waterloo. However, he would not be able to achieve his goal of selling millions of smartwatches using this approach. As with most items in the mobile communications industry, smartwatches are designed and developed at head office, but the actual manufacturing is done by contract manufacturers in China or Taiwan. For example, almost all iPhones are manufactured by Foxconn in Taiwan. During the summer of 2012, Migicovsky made numerous trips to China to interview potential contract manufacturers. In January 2013, the selected manufacturer, Foxlink Group, began shipping 15,000 watches per week. In the electronics industry, most companies try to sell their products at twice their manufacturing cost. When new products are launched, they typically carry a premium price as early adopters care less about price than having the newest toy. Prices then fall as the market broadens and 4 manufacturing costs decline. Typical gross margins for a consumer electronics company range from 25% to 45%, depending on the channel of distribution. If the company sells a product from its own website, it will charge the same as the price in a retail store and capture the extra margin. Marketing and Distribution Unlike smartphones which were usually bought by mobile operators such as Rogers, Telus or Bell, and then resold to consumers with a service contract, smartwatches followed a more conventional distribution model. The end user purchases a smartwatch from an electronics retailer (bricks and mortar) or online – directly from the company or a site such as Amazon.com. Traditional retailers typically work on a gross margin of 35 per cent; so if a watch retails for $100, the watch manufacturer receives $65. Amazon works on the same premise, but its gross margin is much lower – it may pay $65 to the manufacturer, but sell the product for $85. If sold directly from a company’s web-site, consumers would pay close to full retail price, and the company would keep the extra gross margin. For example: Sales through traditional retailers Retail Selling price of watch $100.00 Amount Pebble receives from retailer $65.00 (approximately) Amount Pebble sends to manufacturer $36.00 to $48.00 (approximately) Gross profit per watch $17.00 to $29.00 (approximately) Sales directly through manufacturer’s web-site Retail Selling price of watch $100.00 Amount Pebble sends to manufacturer $36.00 to $48.00 (approximately) Gross profit per watch $52.00 to $64.00 (approximately) Pebble had a third line of distribution: its Kickstarter campaign. As noted 500 people who pledged $115 received one of the first watches for free and thousands of others received discounts on the price. These discounts would eat into the Company’s gross profit margin in the first year of sales. Pebble signed its first bricks and mortar distribution agreement with Best Buy in July 2013. By the summer of 2014 the Pebble smartwatch was widely available at retailers both in and outside of North America. When announced, the Pebble had a suggested retail price of $199, but this 5 price had dropped first to approximately $150 in late 2013 and then to approximately $100 by summer of 2014. A premium version of the watch (launched in mid-2014), the Pebble Steel had a suggested retail price of $250. The Pebble Steel had a steel, not plastic casing and premium wrist strap. Otherwise, the innards and functionality were identical to the Pebble. From launch in 2013 to August 2014, Pebble had sold approximately 500,000 smartwatches. Competition Competitors in the smartwatch market ranged from tiny five man Montreal based Neptune, to global giants such as Samsung, Sony, and Motorola. In addition, in late 2014 all competitors were waiting for the launch of the iWatch from Apple. Manufacturer Device(s) Operating System Functions / Features Suggested Retail Launch Date Samsung Gear Android – links only with Samsung phones Camera, voice activation, call notification, other apps available $100 $125+ Sony Smartwatch Android No camera $150 - $350 Motorola (owned by Google to 01/14) Moto 360 Android Round face, no fitness or camera apps $250+ Neptune PINE Android $350+ Apple iWatch iOS – links only with Apple products Unknown $350+ Winter/ Spring 2015 Samsung was the market leader in smart watches with Pebble a strong second. Samsung’s lead was partially attributable to its bundling a ‘free’ smartwatch with certain phones as a promotional effort. All competitors were hustling to encourage the development of apps that would make their devices more attractive to consumers. 2014 As is often the case with new technology companies, spending outpaced revenues by a wide margin. Working capital requirements for mass production, the addition of staff, marketing budgets, and future product development all constituted a significant ‘cash burn’ at Pebble. The company’s staff was up to 100 from five in only two years – most had been in the technology industry for a number of years and hence received very good salaries. Pebble had nearly run through the $10 million in Kickstarter money when it turned to venture capital financing. Charles River Ventures, one of Silicon Valley’s most experienced venture capitalists, with 40 years of venture investing experience came on board with an investment of $15 million. In 6 exchange, it received a large minority stake in the Company. This money was vital in getting the Pebble Steel to market and to fund development of future watches. However, Pebble continued to spend more money each month than it received in sales, despite the success of the Pebble. 7 Appendix A Angel Investors An angel investor is a wealthy individual who invests his or her own money into a number of small ventures.