Hard Truths for Hardware Startups : Starting Up & Right : Episode 11



Trae Nickelson: Hello and welcome to Starting Up & Right. Conversations with a Startup CFO. I am Trae Nickelson, your Co-host. Joining me on screen, is Ryan Keating, a startup CFO, and your other Co-host. Hey Ryan.

Ryan Keating: Trae, how are you? Good to see you.

Trae: Good to see you too. Doing well here, doing well. Let's jump right in. If you are a founder of a hardware startup, you're in the right place today. We're going to talk about fulfillment and some of the challenges that go into growing a hardware based startup, and some of the things that you may not have thought of at this point. Ryan, we've got a guest today, Dana Madlem, good friend of ours. Set the stage for Dana. Tell us as a CFO and working with a hardware startup, when do you reach out to Dana or when does he reach out to you? How do you guys connect?

Ryan: A good question. Dana and Rush Order have been a great partner to us for 10, maybe 15 years. It's always the same scenario. It's early stage company that wants to start selling products, physical products, and Rush Order comes in and actually fills a need even before we're needed or simultaneously, it's such an amazing solution for what's called a 3PL. Dana will describe that, but it's very straightforward.

A hardware company has product, they need to get that product to a warehouse, so it could be shipped, somebody to handle returns, somebody to manage inventory, somebody to fulfill orders, even customer support. When you find the right mix, and the thing I really love about working with Rush Order is they're really good at early stage companies.

They're really good at getting companies onto platforms and working with Amazon fulfillment and dealing with companies that are coming in from international, wanting to start to sell in the US. We've just enjoyed a great relationship with them for again, well over a decade.

Trae: Good. Let's bring Dana onscreen. Dana, thanks for joining man. Welcome to the show.

Dana Madlem: Hey guys. Thanks Trae, thanks Ryan. Appreciate it.

Trae: How'd Ryan do there? He tried to tee it up for you, but tell us a little bit about yourself and about Rush Order, just the high level pitch, and then we'll start digging into some hard hitting questions.

Dana: Sure. I think Ryan hit the nail on the head with what a 3PL is, and what Rush Order provides. We're a warehousing and order fulfillment. We provide those services globally. We ship across all sales channels, meaning we do e-commerce fulfillment, we ship to major retailers, and practically everything in between. My role at the company is running day-to-day operations worldwide.

Trae: Very good. 3PL, what does that stand for?

Dana: Good question. Third party logistics. Essentially there's you, you're the seller of the product, you have a customer and we're the third party in between that helps facilitate the movement of that product from one to the other.

Trae: Got you. Ryan mentioned the different inflection points where he reaches out to talk to you guys. When should a hardware startup founder reach out to a 3PL?

Dana: I think it's a stock easy answer, which is as soon as possible, not because you're necessarily going to hire a 3PL before it's necessary, but the logistics component and frankly, distribution in general is, for lack of a better description, a really expensive part of running a hardware business. It can also be more complex than most folks realize. Working through, "Hey, here's where we're going to manufacturer, here's where our customers are, here's some of the channels through which we think we're going to reach those customers, here's some uniqueness about the product or the type of customer experience we're trying to create."

Working through those different use cases and understanding what are the cost implications involved, what are some of the things that are possible or feasible, what are some of the things that are not, that maybe you thought would be easy that aren't. Working through those things early on is generally a big help to a lot of startups, I think. We're often engaging with startups maybe a year or even more sometimes before they even have a physical inventory to ship, not just for that reason, then we're essentially donating our time at that point to help out and then see if we can help with their business planning.

Ryan: Even a year before starting to ship the physical product. That's good to know.

Dana: Yes. I think, Ryan, because they're engaging with you commonly at the same time thinking about needing a CFO to help them pro forma for financials, out raising money, the filling in all the numbers of the economics of the business is a big part of where we come in early along with a CFO [unintelligible 00:05:22] as well.

Ryan: I know there's quite a few third-party logistic companies out there. We work with Rush Order a lot because you tend to really understand, or specialize, but really understand early stage companies. What's the landscape look like for third-party logistics for 3PLs? How should a company think about selecting one?

Dana: Yes, sure. There are literally hundreds of 3PLs in the US alone, who knows how many worldwide, but it is a very large, very fragmented market for sure. The barrier to entry can be relatively low. A couple of guys in a garage and some boxes and tape could conceivably call themselves a 3PL. It goes all the way up to multi-billion dollar companies in terms of top-line revenue and everything in between. A lot of times, each of these 3PLs have some specialization, whether it's geographic or product-specific.

For example, shipping apparel is very different than shipping pharmaceuticals and very different than shipping consumer electronics. Even within consumer electronics, maybe headphones are going to be very different than medical devices. Lots of 3PLs have lots of different degrees of specialization.

Ryan: Dana, let me ask this. I understand there's different types of 3PLs that specialize in, say, pharmaceuticals versus consumer electronics, very different probably in how they're set up, how their facilities are for refrigeration, et cetera. How about size? I'm coming from a standpoint of working with startups. An example is, say, a lot of times our startups will begin with QuickBooks Online as their accounting system, but eventually, the complexity or size of their business pulls them into, say, a NetSuite or something even larger. Do you see that? How does a 3PL work with that as a company gets larger and more complex?

Dana: Yes, I think that's very analogous. For your typical startup that's just getting off the ground, the unfortunate reality is you actually have a huge variety of choices. Very large 3PLs will claim they can work with startups. Very small 3PLs obviously will claim they work with startups and they do. They probably do quite well. The challenge is then what happens in year two, year three as you start to grow and really scale, can that small 3PL scale with you or on the front end that first year, can that big 3PL really give you the time, attention, effort and provide the level of flexibility maybe that you need because again, something unique in your business model, which is typically why you started the startup in the first place, right? Can they accommodate those things?

We tend to focus on being usually the first or second 3PL that a startup would hire. We can definitely do that early stage, provide hands-on account management, et cetera, and then provide scale. We can do that into maybe it's thousands of orders a day, something like that, maybe a little bit more than that. For example, we're not going to go pitch our services to Apple tomorrow or Samsung. There's a whole another level then of scale. If you have ambitions of being that big than the other 3PLs that can service that kind of volume as well, including some of those really big guys out there.

Trae: Yes, it strikes me that both Keating and Rush Order serve the same market here. This very early stage all the way up to a certain degree where they outgrow you guys, but you service them for a good long time and get it rolling in those early stages startups.

Dana: I think we find too that rarely do clients outgrow us. Usually, there's an acquisition or some sort of exit that happens before that and then the acquiring company might be one of those larger companies that already has a larger 3PL and they say, "Rush who?" Then it's hopefully time to move on to the next startup and we'll wash, rinse, repeat again, but that's usually what happens.

Trae: Yes, that makes good sense.

Ryan: We see that outcome as well sometimes with our services, sure. All right. Now, I do want to ask, just in terms of selecting the 3PL, where have you seen companies make mistakes or the wrong fit that they have to undo later? How should they think about that selection process?

Dana: Yes, first off, that word fit is really, really critical. I think startups should think about hiring a 3PL, almost like looking for a partner in marriage. It is a really really important part of your business. It's probably as strategic of a relationship as your contract manufacturer believe it or not, it's pretty close at least in many cases and so I think it's really important to take it seriously look very carefully.

Carefully in that context is generally defined as what is this 3PL good at? Who are their other clients? What niche or what vertical and what geographies do they focus in? What is their culture? What is their style of work like and does that mesh with what you as an entrepreneur trying to build as a business.

Along the way of course, you can get into a lot of the tactical details like, "Hey we think there's a possibility we're going to need to do flash firmware on the devices in the warehouse at some point, is that a capability that the 3PL has, have they done it before or can they demonstrate it happening on the warehouse floor." Some of those little technical details can get really important as well.

I think as part of that I would strongly recommend if you're to hire a 3PL, 100% visit the facility, tour it, meet the people, watch orders go down the line, see how they flow through the process. Can you envision your products in that type of packaging, on those types of lines, being handled in such a way and is it going to work for your business?

Ryan: You made an interesting comment there if I can ask me, when most people probably think of warehousing and shipping products, it's taking a box, putting a label on it and sending it out the door but you said actually adding firmware. You have the capability or 3PLs have the capability of working with the electronics and adding actual updates and software?

Dana: Yes we do a lot of it, either on the front end when inventory arrives. Maybe it's just a designed portion of the process where we need to load firmware software on a product. Sometimes that's less high tech and maybe it's just adding components or accessories or quick start guides or other simple things, but a lot of times it is loading software firmware, other times it happens as a fire drill.

It might be, "Hey, we've noticed that users are really struggling with the setup and configuration of the device. If only we could get this new firmware on the device before we ship, we'd enable a much better customer experience." We end up going through a little bit of a fire drill, pulling all the units off the shelf flashing them and then putting them back on the shelf and getting ready for outbound fulfillment to customers.

Then there's a third component which is the reverse logistics piece which is items coming back, generally these tend to be in our case fairly high value products and maybe there's value we can recoup there in terms of maybe a cosmetic inspection, firmware flash, functional test a little bit of cleanup, repackaging and make those available as warranty replacements or the VIP or PR samples those types of things as well recoup some value.

Trae: Keating and Rush Order have developed a pretty symbiotic relationship, I know that Dana there've been occasions where you've sent some work over to Ryan, you need to talk to Ryan. Ryan you've had startups come through the door you need to go talk to Dana or Rush Order what are those two, Dana when do you know or what do you see on your end and you need to go talk to Keating and vice versa Ryan what do you see on your end when they need to reach out to Dana. I'm just curious about some common scenarios I guess.

Dana: We spend a lot of time early on in the onboarding process working with clients on how do we get orders, ship them out, how do we notify customers with tracking numbers and things that your shipments are on the way, and then how do we get the financial reporting booked back into the client accounting system. We see a lot of interesting approaches and interesting tools and we tend to see a lot of-- We've been in business for 30+ years, see methodologies that work and those that don't.

There are oftentimes when a client might say, "Well we've got these spreadsheets and we've got this person," or "Hey we're on Quickbooks Online but we're scaling quickly and maybe need something more robust." There's usually a dialogue between us and our client about accounting systems and accounting expertise on staff that oftentimes leads to an introduction to Ryan and the team.

Trae: I know Ryan it probably comes up pretty often when you're doing a financial model for someone with some hardware startup aspirations right?

Ryan: Yes it's very similar a trigger just the opposite direction. We'll have clients that come to us and they've thought a lot about what they're going to sell and what their bomb is and how many units they want to sell, and how much they're going to spend on marketing and advertising and salespeople. When you get down to it and you ask them about this piece of shipping and fulfillment and returns, it's a detail that they haven't really put into place. As Dana mentioned earlier you should be thinking about this even up to a year before you ship. It's not really on their list of-- They don't know most of the time, they don't know how early they should be thinking about this or how important it is.

I remember a great example that Dana gave me quite a while ago and that talking to someone like Rush Order early on can even help influence the size of the packaging and that impacts like how many you can fit on a pallet. If you do it the right way, you can get so much more economies in shipping. Even talking to Rush Order that early in the process, which again is when you're a founder and you're trying to bring a product to market, you're trying to build it. You're trying to show somebody that there's a market, you're trying to raise money to build more.

The shipping and fulfillment is a little bit down your list of priorities and it shouldn't be. What we'll do is we'll make it top of mind and say, "You got to start these conversations. You've got to get engaged with this now." As Dana said, it's an important relationship and not one to be at the very end saying, "Oh, okay, we're going to go live on Amazon tomorrow. We should probably have somebody who's going to help us send these products out."

We'll see that quite a bit with early-stage companies. It just hasn't hit their radar yet just because they haven't been through it. We're there to help them understand and prioritize what they need to think about.

Trae: Guys, I know we've hit on it here so far, but are there, what are some commonly overlooked or underestimated aspects of fulfillment that need to be on my mind as a startup founder, some things I'm not thinking of?

Dana: I think from my end and what we see here, two things, one is complexity. I think it's well-documented and well-published. Most hardware startup founders are well aware of the difficulty of building a hardware product for the first time and the delays and the challenges there. I think what's less often as, as public or as well advertised is the fact that that complexity does not end after the product is manufactured.

For some startups, for example, thinking about selling globally the challenges with international shipping, for example, while it sounds like a commoditized part of the business model, it is not. Along with that are some of the surprises, I would say underestimated costs that come with selling and shipping hardware whether domestically or internationally as well.

Ryan mentioned a point about how many boxes can fit on the pallet. There's actually no end to the long tail of optimization that can happen in terms of thinking about costs and then planning accordingly and making sure that there's a profit margin to be preserved at the end of the day. As a result of some of these, what seem like very small decisions that in fact turn out to be very consequential for the business.

Ryan: I can appreciate that. I know in working with you with some of our clients and one of the things that was really underestimated or not even considered is returns. The cost of returns and dealing with returns, especially, we tend to see in startups people pushing the cutting edge of engineering. Coming out with new things or, and trying to pack so much into a small footprint that the manufacturing is complicated. Just because it's built, once it's in the hands of the consumers, seeing those returns come back is something that I never see in a financial forecast, an estimate of cost of returns that will make sure people consider.

How much do you see that when you're working with startups, how much are returns factored into their cost or do you see as a cost element?

Dana: It's a huge driver, especially in high-tech products. High-tech products by definition tend to be pretty complex and complex things have points of failure that are sometimes not anticipated. It comes in the way of hard cost, meaning, refunds and return shipping costs and things that are measurable but are often underestimated for sure. If somebody plans for a 5% return rate, and there's a big difference between 5% and 15% or 25%. Of course, we have a lot of horror stories, which hopefully you as a founder don't become one of, but the surprises with the return ratios are one thing.

The other thing is the unanticipated. We call it like a soft cost of returns, which is the customer service and support function. Somebody has to be there to answer those emails. Somebody has to be there to answer those live chat sessions, building knowledge bases answering questions on social media and that infrastructure tends to be I would say underfunded very frequently and it leads to two problems.

One is it leads to a higher cost number one, but number two-- Higher cost unexpected. Number two, it leads to a really poor customer experience when it's like, "Well, we can't afford to talk to customers on the phone. We can't afford live chat. We're just going to stick to email. Oh, by the way, we're going to offshore it and do it in some really cheap way." Now we've got a customer experience that doesn't quite match the supposedly premium experience of the product we're selling. That becomes a real big pain point as far as returns go as well.

Ryan: Speaking of customer support, that is something that Rush Order does, right?

Dana: That's right. For decades we bolted on a customer support solution, but by virtue of the fact that we believe that fulfillment is really all about delivering a customer experience. If somebody has a question about an order or a question about the configuration or setup of the product that, that belongs in the fulfillment discussion, that's part of the order fulfillment experience. We do offer a 24/7 customer support solution as well for end user-facing customer support.

Ryan: That's a big value. Especially, for a startup. The idea of not having to necessarily staff or train customer support, but to rely on a partner that's touching the product already. Is that pretty common in 3 PLs, or is that somewhat unique to Rush Order?

Dana: Very unique to Rush Order. We got there by a series of accidents and mostly being really bad at saying no to clients years ago, decades ago, in terms of helping to develop solutions for their needs. Now, it's a pretty, pretty rare combination, especially for high-tech startups. It's definitely very rare.

Trae: Well, Dana, speaking of how the scope of the services you guys provide I've always liked hearing about the design process packaging and how that affects even all the way down to the product and what's included in the package. Tell me an interesting story about a few examples of where you guys have really dug into the design process with a startup and helped them optimize, or--?

Dana: Yes. I think anytime you're talking about logistics or order fulfillment, it comes down to weight and dimensions. Weight might seem obvious for shipping costs. Dimensions are also really critical both for how many units you can fit on a pallet, how many units you can get into an ocean container or on an airplane over to your 3PL. Also then on the outbound to customers.

We've had clients design products that are fully packaged in a box or an envelope to a customer weigh 17 ounces which is just over a pound. That costs a couple dollars per unit more than had the product been designed one ounce lighter. Similar again in Europe, when you get into half a kilo or a full kilo of a product and other parts of the world too. Same with dimensions.

I think a lot of startups often don't understand how shipping carrier is actually billed, where they're billing for the greater of a very unique, arbitrary, dimensional weight calculation, or the actual weight. Centimeters or inches in box size and design, again, can lead to dollars per order difference in shipping costs. That's been a big pain point over the years that again, when we're able to even sometimes 30 or 60 minutes early on to a year before the product design process add some input, it can make a big difference.

Trae: It'll make a huge difference. The earlier the better and get that sorted out, include it in the design. Dana, we're sitting here still remote for the most part. You're transitioning back to the office. Shipping in that last mile of shipping and COVID and how have recent events affected you guys as far as clientele, client base, your own operations, your own philosophies, any big changes?

Dana: Yes and no. Interestingly, I'm sitting in my office at our headquarters and I've worked every day during the pandemic from my office and supported the folks in the warehouse floors around the world that we operate we've been in person every day. Just like your grocery store workers or other frontline workers, these folks have been onsite and in the office and they don't know what remote work is actually. Include myself in that to some degree.

In that way it hasn't changed, what has changed of course is safety protocols. I think going back to the conversation about finding a really strong mutual fit with the 3PL, that's a big part of it. I think you want to look at that and say how have 3PLs navigated this or ones you were evaluating at least. Have they had downtime? Have they shut the doors of the warehouse? Those types of things. We've been extremely fortunate, knock on wood, fingers crossed.

Obviously, instituted a lot of different protocols and business continuity plans to ensure that we can keep the orders flowing out the door. It has absorbed instrument, a very large proportion of my time, the last year and a half managing our operations. On top of that obviously, the order volume on the ground. E-commerce was already on an upswing before COVID and we all know it's well documented that it's continuing to accelerate and we expect that to continue. At least we hope it does and we're working hard to stay caught up with the volume. Sure.

Ryan: Dana in addition to COVID, which has been more of a recent hurdle that you've dealt with, Rush Order has been around, I think you said for 30 years, is that right? I'm curious, how has even kind of like the onset you've seen a lot, so like the emergence of Amazon and similar platforms, how has that impacted your business?

Dana: Yes, we actually view Amazon as complementary to the business. We think of Amazon in whatever flavor, our client chooses to work with Amazon as another sales channel. There are times just to draw an analogous example, where we're taking a bunch of units, putting them on pallets, and maybe we're shipping your product to Target or Walmart or Best Buy or whoever it may be your Bed Bath & Beyond and on and on and on. There are times when we take those pallets and we ship them off to Amazon and then Amazon does the last mile fulfillment to the customer for those sales on amazon.com.

Sometimes that means Amazon is purchasing the product from our client. Sometimes that means they're using FBA fulfillment by Amazon to compliment a Rush Order and so, again, we're just shipping into FBA and we're replenishing FBA so that they can do the last mile fulfillment. That would be no different than if we were shipping to any other type of channel partner online or offline type of a retailer. Again, Amazon has made things more complex and they become an 800-pound gorilla in the market for sure but just another channel partner in our view and complementary to the business.


Trae: All right, guys. Well, let's wrap it up. That was great. Dana, thanks for joining. One last question for you . I like to follow it up. Friends, family, weekends, what do you do when you're not in the office there, moving things around?

Dana: Oh, that's really a question. Haven't been a lot of days off in the last year and a half, but when I do have them, I [unintelligible 00:27:05] with family, little running, bike riding, trying to stay active. [inaudible 00:27:11]

Trae: Pretty good. Well, thanks for joining me. It's been educational Ryan. Thank you, man.

Ryan: Yes, I enjoyed it. Thanks, Dana. I really appreciated coming on. It was an interesting conversation. I think people will find it very useful, so, and thanks, Trae.

Dana: Once again, appreciate it.

Trae: See you next time.

Ryan: All right. Take care.