Shopping for Smart Toys as an Investor

We’ve been looking closely at the smart toy market over the last few months. In this post I’ll share some of what we’ve found and some of what we’re looking for when evaluating investments in the sector.

A growing market

Demand for smart toys is growing from both consumers and educators, with sales projected to triple from $5bn this year to $15.5bn by 2022. The story is the same with venture capital (VC) funding, having increased over tenfold from $50m in 2013 to $600m in 2017.

While to date most VC funding has been concentrated in a dozen strong performers, times are changing. We’ve found numerous promising educational smart toy startups in Europe, and believe that the market is ripe for further growth from new entrants even as we await the first big exit in the space.

The education factor

Prioritizing educational impact makes sense for smart toy companies because it increases demand from parents and creates the potential for enterprise sales to schools. According to a recent study, parents prefer educational toys to video games and TV by a factor of 4:1. The growing premium paid to knowledge economy workers has driven parents and schools to look for STEM aligned toys in particular. Indeed another study suggests parents would pay more for STEM-related smart toys compared to traditional toys, so smart toy startups have some room to factor the cost of their educational content development into their retail prices.

So how do you make a smart toy truly educational but not ‘boring’? Many educators believe that tactile play, which uses physical objects to engage with childrens’ senses, is a crucial component of engagement, particularly at an early age. You can see this in the success of companies like Tangible Play, whose tablet add-on Osmo enables augmented reality interaction with physical objects and has sold successfully to 25,000 schools.

Other ways smart toy companies avoid the “back of the closet” problem: Most incorporate a connected software component that can be refreshed to unlock new features as well as providing data for product iteration. Some, like Reach Robotics develop strong creative intellectual property engaging children in the universe of their MekaMon. Others plug into existing toy universes with proven staying power, eg Tenka Labs, Brixo and Wonder Workshop which are all Lego compatible. Overall, toys which are inherently extensible and enable kids to customise their experience tend to perform better long term.

Be in it for the long haul

Perhaps the best way to avoid the back of the closet as a startup: keep the company alive. The average shelf-life of a traditional consumer toy is between six months and two years, while most successful startups need seven to ten years before they exit by being acquired or going public.

Betting on one ‘flagship product’ in a smart toy startup doesn’t make sense. Companies will need two to three product cycles before their business can provide a healthy return on entrepreneurs’ time and investors’ money. Accordingly, as venture capitalists we try to look beyond the success of the initial launch/Kickstarter campaign to evaluate the expansiveness of the team’s vision, their creative and product development skills as well as their access to distribution for future products in making investment decisions.

Standing out from the crowd

There are now nearly ten well-funded companies selling pre-assembled robots teaching children to code. There are even more which are offering modular robots for the user to assemble and program, and countless numbers of educational apps and video games. Investors and analysts will look harder at product differentiation than they have in the past given the crowded market.

There are now nearly ten well-funded companies selling pre-assembled robots teaching children to code. There are even more which are offering modular robots for the user to assemble and program, and countless numbers of educational apps and video games. Investors and analysts will look harder at product differentiation than they have in the past given the crowded market.

In addition to product, differentiation can come from innovation in technology, creative IP, distribution or business models. Manufacturing prowess is a good example here: hardware is an unforgiving business, gross margins below 75% can quickly burn through revenue needed for growth. It is no coincidence that two of the most well funded smart toy companies, UBTech and Makeblock, are based in Shenzhen, where there is deep expertise in cost effective manufacturing.

Smart toys have great potential to increase market share over the coming years as costs of technology come down and parents search for ways to make their children’s play time more educational. However looking forward to 2018 and beyond smart toy companies have some challenges to negotiate, from thin margins to increasing concerns over security and privacy. Investors are right to be excited about this dynamic new market, however they would do well to keep a clear head and do their due diligence.

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We are the leading European VC focused on EdTech. We invest in companies that help people learn & grow: www.brighteyevc.com

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Brighteye Ventures

Brighteye Ventures

We are the leading European VC focused on EdTech. We invest in companies that help people learn & grow: www.brighteyevc.com

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