Deep Tech For Deep Minds? Or Deep Pockets?

Thinking Through The History & Evolution of Hard Investing

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People love to talk about the founding myths of venture capital (myself included). The Traitorous Eight, Arthur Rock, Don Valentine. Books like The Power Law by Sebastian Mallaby is a great overview.

But as much awe as these founding stories produce in founders, investors, and operators around the world, they very rarely pay little more than lip service to what these people were building and funding. The short answer? Hardware.

The company the Traitorous Eight left? A semiconductor manufacturer. The company they built when they left? A semiconductor manufacturer.

So while most people think the first great startup was Google, or Facebook, a lot of people rightfully pay respectful homage to the hardware manufacturers of the 50s. But the reality is, it goes back even further than that. Steve Blank has a great presentation on the "secret history of silicon valley." While most people think "Silicon Valley" was just fruit orchards until the emergence of the likes of Fairchild Semiconductor in the 50s, the reality is the tech industry can trace its roots all the way back to the vacuum tubes of early radar development in the early 1900s.

Source: "Secret History" by Steve Blank

Before it was "Cerebral Valley" or "Silicon Valley," it was "Microwave Valley."

Where Have All The Hardware Investors Gone?

So what changed? When I started investing 10 years ago, it was a blanket statement about venture capital: "we're generalists, investing in anything, except of course for things like hardware and biotech."

The simple reason for VC's aversion to hardware over the years was simply the rise of software. As the cost of starting a software company has plummeted, "nothing has reduced hardware costs to the extent open source and AWS did for software."

The more complicated reasons include dependence on physical supply chains, capital intensity and subsequent exacerbated dilution, lower multiples in the public markets, and longer time horizons to reach scale.

The lack of investment in hardware and manufacturing more broadly has, in part, exacerbated the off-shoring of American manufacturing capabilities. After the famous spike in manufacturing during World War II, the US saw a continuous (albeit volatile) rise to manufacturing employment that peaked around 1978. Since then, its been largely downhill.

Source: Bureau of Labor Statistics

That is, until ~2010. Since then, there has been steady increases in manufacturing employment. In 2022, for the first time in a very long time, US manufacturing growth outpaced the rest of the world.

In fact, many people believe the claims of the demise of manufacturing in the US are greatly exaggerated:

"Simply put, the United States remains a manufacturing powerhouse. In 2020 it was the world’s fourth‐​largest steel producer and in 2021 was the second‐​largest automaker and largest aerospace exporter. Accounting for nearly 16 percent of global manufacturing output in 2021—second only to China, which has four times the population of the United States—the US had a greater share than Japan, Germany, and South Korea combined. By itself, the US manufacturing sector would constitute the world’s eighth‐​largest economy."

These same proponents of evaluating manufacturing on its merits point to the different between employment and output:

"Perceptions of US manufacturing decline may also be due to the declining number of Americans who work in factories. From a peak of 19.5 million workers in 1979—22 percent of the nonfarm workforce—manufacturing employment has dropped to approximately 13 million today and just 8.3 percent of nonfarm workers. But employment is not the same as output—far from it. While manufacturing employment has declined by about one‐​third, output is only slightly off its record high. Manufacturing’s value‐​added, meanwhile, last year stood at an all‐​time high."

The Latest VC Double Take

So the reality of the opportunity in manufacturing may be a fraught narrative, when in fact there is still obvious sizable opportunity. Companies like SpaceX and Anduril awoke something in the VC community; you can, in fact, do really well if you make hardware really well.

But more than that, the AI explosion of the last few years shattered everyone's worldview and sent a generation of VCs scrambling to understand what exactly a semiconductor is. GPUs? CPUs? Good thing they had Perplexity to help them figure it out.

The wake up call's loudest voice? Nvidia. As they shot from $27B to $61B in revenue in just one year. From that potential, to the global political threats to TSMC in Taiwan, its spurred some of the most ambitious to go chasing trillions for new chip projects.

Source: Koyfin

The fear, obviously, is how manic VCs have become around hype cycles. Now, hype cycles are something I've written about over and over and over and over again. And I can't help but think its just getting more manic, borderline foaming at the mouth.

One great illustration of the constant whiplash? This DM that Turner Novak got from a VC:

"Yea I spent the past three days making a Gen AI video market map, and this morning my partners emailed me saying we were flying to El Segundo for the week and need the space mapped before we take off tomorrow morning. We triggered a cap call this afternoon and I’m booking a dinner rez each night so we can pull in whatever founders we can find. I signed up for this when we were hanging out on Discord all day and helping pump tokens. I’m exhausted and can’t deal with this anymore."

From shitcoin Discord channels to AI wrappers to El Segundo power lifting sessions. And for those of you not in the know (or who perhaps have a healthy relationship with Twitter and dopamine levels in their brain), what's in El Segundo you ask? A lot.

Source: John Coogan

Hard tech, deep tech, frontier tech, hardware, manufacturing — these represent the most recent emerging VC whiplash. And the danger is that complex physical manufacturing, interwoven with global supply chains, and reliant on healthy working capital dynamics… all of those are not great pump and dumps for VCs.

Protecting The Iron Goose

Manufacturing is far from a golden goose. It requires so much time, care, attention, love, and is still a very difficult thing to get working. As some companies try and address the long-tail of 40K machine shops that prop up industries like aerospace and defense, there is a fundamental need for investors to understand what hard tech is, and more importantly what it is not.

It is not your standard venture bet. Delian Asparouhov, who himself is building a space manufacturing company, has described the changing dynamics in traditional venture investing categories, which I've written about before:

"I think that if you look at it over the next decade what types of companies are going to be generating the most returns and have the most impact on society, I think people are going to realize that the falsehood of zero marginal cost of software was actually complete fake news, in that if you have zero marginal cost it also means you have zero moat because it means two Stanford grads can go build the same shitty piece of software and go sell it as well.

I think venture capitalists are starting to awaken to the idea that ultimately what you need to be aiming for is the most long tail of outcomes. And if you look at the top 5 companies in the NASDAQ right now—Apple, Nvidia, Tesla. People are starting to realize that in order to build these long tail outcome companies you actually need to build things that tend to be a little bit more capex expensive and so that tends to mean that its something that is easier done when you have venture capitalist effectively as a co-founder. And so I think you'll see some more of it, mostly because I think the most interesting companies are going to be more capex intensive over the next decade."

The competitive moat of better and better software has deteriorated in large part because the early days of software you had new-age platforms replacing sluggish incumbents. Amazon replacing Borders was a tech-native platform creating a new way of doing something that had been done the same way for hundreds of years.

Today, software companies are competing with incumbents who are themselves cloud-native. They're not slow-moving dinosaurs and, therefore, are harder to replace. That zero marginal cost, to Delian's point, suddenly becomes zero margin.

My fear is that a generation of VCs suddenly shift to a very complex and physical world of company building, and infest it with some very not-meant-for-the-physical-world philosophies of company building. As a result, we need more people thinking about and articulating the dynamics of leverage that need the most focus if more of these hard tech startups are going to be successful, and not fall victim to the over-exuberance of VCs that has infested crypto as a category.

Establishing a Manifesto

I owe credit, both for thinking about this space in general this week, and my eventual conclusion, to a piece that Aaron Slodov, CEO of Atomic Industries, published in Pirate Wires — a “techno-industrialist manifesto."

So instead of restating it, I'll let Aaron conclude for me. I'd encourage everyone to read the full piece, but here's just a taste:

"we need to make manufacturing better, cheaper, and faster through technology. it should be as easy to make physical things as it is to make software. the end.

The marriage of technology and manufacturing could be the salvation for which our nation is searching. The prospect of 4%+ GDP growth does not come from SaaS, banking, real estate, investing, or AI. The opportunity to achieve sustainable GDP expansion comes by way of improved production. Agnostic of debt cycles, we are an industrial society; the idea of a post-industrial economy is a dream cooked up by nihilists. In the pursuit of profits, we have disincentivized trade skills, hollowed out industry, become addicted to services, and enriched our rivals to magnitudes that now threaten our way of life.

The most valuable thing to pursue is also the hardest; rebuilding a modernized US industrial base will take trillions of dollars, but will also extend our prosperity and abundance into the next millennium.

I’ve spent most of my career in technology. I worked at a FAANG company, where I touched IT/ sysops and mechanical engineering (energy and self-driving cars), a smaller tech company doing IT/ sysops, and co-founded (CTO) an AI SaaS startup in market research with two friends. Today, I’m leading Atomic Industries, a company I founded to exascale the American manufacturing sector. With the bottom falling out of tech recently, I feel at ease working on real world challenges, because there’s tremendous value to unlock. The next wave of trillion dollar companies in the coming decades will be in hard tech and/or manufacturing adjacent.

Just like Elon and other founders first built in SaaS, then turned their attention to the world of atoms, techno-industrialists are finding their moment. The last 40 years in tech have created massive last-mover advantage on top of which to build. This technical margin has paved the way for us to transform manufacturing and heavy industry forever."

Check out the full piece on Pirate Wires here.

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