When I decided to move into consulting work, focusing on cleantech, I took a bit of time to assess why I am passionate about this work, and what draws me to it. When I distilled my thoughts, some trends emerged, and I was able to come up with four maxims that keep me engaged and excited about the industry:
The Future Is Hardware
If It Doesn’t Scale, It Doesn’t Matter
The Brains Are Draining
The Climate Is In Crisis
Each of those statements is fairly cryptic in isolation, so I wanted to share a bit more about each one. In this article, I’ll cover the first two. In a later article, I’ll cover the last two.
The Future Is Hardware
In the 1967 movie The Graduate, Dustin Hoffman’s character gets pulled aside at a graduation party by Mr. McGuire, who only wants to tell him one word – plastics.
“There’s a great future in plastics. Think about it,” he tells him.
That one tip was better than anything that Jim Cramer has ever shouted at the screen. Today, olefins production and downstream plastics manufacture is a multi-$100B per year industry. If I could channel Mr. McGuire more than fifty years later, I would say that there’s a great future in hardware. Think about it.
I know this take will get panned by all the folks that believe software is where it’s at. I can’t disagree that software has had a really good run of it the past few decades. And there will continue to be an awesome future in software. Google Search is one of the highest margin, perennial businesses ever created. You can’t argue against software’s dominance.
But unless something changes in the near future, we live in a physical world that requires physical inputs. We need to farm the food that we eat, produce the chemicals and materials that we use to make things, and make copper coils spin in inventive ways to produce electricity.
Hardware is generally hidden from view. You’re likely reading this on a smartphone, tablet, or laptop. You’ve got some appliances at your house. You’ll fill up or plug in your car. But that’s about it. The average person doesn’t interact with hardware that often. One of those things breaks? You’re going to call someone to fix it, or more-increasingly, decide to toss it and replace it.
While everyone has been fawning over OpenAI’s ChatGPT and the rise of useful digital assistants, Nvidia has blown the doors off of their market cap. OpenAI is estimated to be worth $80B from its most recent funding round. At the time of writing this, Nvidia, the market leader for GPU chips to train AI models, is worth $2.2T. Hardware wins.
Amazon has become one of the largest retailers in the US by delivering items directly to our homes, usually within 24-48 hours of order placement. (A personal addiction only second to smartphones.) But if you take a look at their annual reporting, Amazon posted an operating income of -$2.8B (yes, a loss) for the North American segment of their online sales business in 2022. Amazon Web Services (AWS), the segment that operates data centers for cloud computing (read, hardware) had an operating income of $22.8B for the same reporting period. The tides improved in 2023 for the North American retail segment, but AWS was still more than 70% of Amazon’s operating income for that year. Hardware wins again.
We need to build things that create things, because we consume things. Trends will ebb and flow in software – social, mobile, crypto, AI, etc. Markets will rise and fall. But the need for hardware will always be there, and it will scale with the ever-increasing population. We need clean air to breathe, clean water to drink, and electrons to power the devices that we hold dear.
If you need one more example, we had supply chains break down for a few months at the beginning of the Covid-19 pandemic and we (collectively, as a society) almost ran out of toilet paper.
Hardware is not going anywhere, anytime soon.
If It Doesn’t Scale, It Doesn’t Matter
The economics of commodities are brutal. Fake it ‘till you make it doesn’t exist. There is no freemium model for electricity production. Margins on commodity prices are reduced to their market-rate minimums too rapidly. Those initially-high average selling prices (ASPs) that you see in other segments (I’m looking squarely at you, Apple Vision Pro) can’t happen sustainably in commodities.
This puts startups in the difficult position of facing off against Mike Tyson in their first televised appearance. If you get knocked out in that first fight, you’re relegated to a case study at a top graduate school.
Utility companies, petrochemical players, and retailers have found some limited success in selling “green” alternatives at a premium. Some utilities will allow customers to pay higher rates, to subsidize renewable grid projects, but the offerings aren't consistent, and this isn’t something that everyone can afford. (It’s basically philanthropy, without the tax break, for the consumer.) Amazon can score some marketing points by lowering the life cycle analysis of their Prime transportation fleet, by driving electric vans from Rivian. Niche applications exist, but there are not that many of them.
The new kids on the block have to compete with the incumbents – who are already at scale. Sustainable aviation fuels (SAFs) have to compete with refineries that have been optimizing their processes for over 100 years. And in a high-volume business like fuels, fractions of a penny advantage can make markets.
So the game is rigged, right? Why play, if it’s so hard to win?
Fortunately, there are a couple programs, both public and private, that can help new technologies cross the so-called “valley of death” for new technology adoption. The Department of Energy (DOE) has a loan guarantee program, which helped keep Tesla afloat while building out their Fremont facility. Breakthrough Energy Catalyst (part of BEV) is a private group that also provides project financing for new technologies.
These vehicles provide advantaged or guaranteed financing, at costs of capital that would otherwise be inaccessible for these risky companies. This helps alleviate some of the CapEx or depreciation risks at scale.
There are some tax incentives that address the bottom-line, variable or OpEx costs that a company incurs, such as the Section 45Q carbon sequestration tax credit. These tax credits are great in the short term, but they can't be relied on to build a sustainable business. One election cycle can throw a business into turmoil, if they rely on these. I saw a lot of that happening in the early 2010's.
To better address the OpEx costs, companies have to get cost-conscious earlier in the development cycle. In Walter Issacson’s biography of Elon Musk, there were two passages that exemplified this value engineering:
At SpaceX, the team sorted the bill-of-materials of a rocket by cost, and starting at the top, had to justify why each piece cost as much as it did. Poor justifications required rework.
At Tesla, Elon would stand on the manufacturing floor, watching the motions of the line workers, to determine how to make each step in the process more efficient. He would routinely do this until 2-3AM, sleep on the roof of the factory in a tent, and wake up a few hours later to start anew.
These snapshots are not common within the industry at large. I’ve been doing this work for over 15 years now, and the only times that I can recall being told to strictly watch costs is when runway is running low. Otherwise, time is the only non-renewable resource – allocate resources and capital to make schedules happen and milestones appear in the rear-view mirror.
Being a student of the organization’s COGS model, and optimizing cash cost through process simplification, waste minimization, energy efficiency, and process reliability needs to happen during the development cycle. Teams need to get excited about that value engineering journey during development. It sets an organization up for success, and makes the transition into profitability much easier.
Any new manufacturing process in the cleantech space is going to have to compete with incumbents from day one. The processes are going to have to scale gracefully, and a lot of time and effort needs to go into the design process to ensure that the economics of scaling are well-understood. The best tech in the world can’t compete, if it can’t scale enough to make a difference.
–
A link to the second part of this article will appear here when it is published.
Images above are hallucinations based on this text, brought to you by DALL-E 3.