By Yuliya Chernova 

American startups, especially consumer-hardware makers, are facing difficult choices as they cope with escalating trade tensions.

The U.S. government has been implementing wave after wave of tariffs on Chinese goods since last summer. During a new round in May, President Trump threatened to impose duties on potentially all imports from China.

Venture-backed companies, including makers of educational robots, at-home health devices and electronic scooters, have seen significant cost increases as many rely heavily on Chinese manufacturers.

"It's all cost, friction, and additional overhead," Brad Feld, partner at Boulder, Colo. venture firm Foundry Group, and an investor in numerous hardware startups, told WSJ Pro.

Startups are responding by increasing prices, changing their sales strategy, and evaluating new production locations.

"It's forcing us to raise our prices and, ultimately, it'll force us to sell fewer units, which means lower revenue," said Paul Berberian, chief executive of Sphero Inc., known for its programmable rolling robot toys, which are made in China.

One of Sphero's products -- app-enabled musical rings called Specdrums -- was slapped with an import tariff last year. The company increased the price to $64.99 from the planned $49, and decided to drop a cheaper version that was in development, Mr. Berberian said.

"We sell to kids. It seems kind of bad to tax kids," Mr. Berberian said.

Big companies are switching manufacturing locations or reallocating resources to other products and revenue sources. Apple Inc., for instance, is asking suppliers to study shifting final assembly of some products out of China as it considers diversifying its supply chain, The Wall Street Journal reported.

Startups don't typically have that luxury.

"There's no Plan B," said Nisan Lerea, co-founder and chief executive of Wazer Inc., a startup that sells precision-cutting tools which it makes in the Brooklyn Navy Yard using Chinese parts. "We need to stay the course because we are not going to say, 'Oh, now I'll do something differently, the company doesn't have the scope."

Wazer was forced to increase its price for its desktop waterjet, passing on its costs to the American manufacturers that buy its product, Mr. Lerea said.

Even without extra costs, hardware startups face high failure rates. Several well-funded venture-backed companies, such as robotics startups Anki Inc. and Jibo Inc., have gone out of business in the past few months for reasons other than tariffs. But costs stemming from tariffs are straining companies that already operate on low margins.

"Incremental tariffs are not something that we modeled into our business model," said Kal Vepuri, founder and CEO of Hero Health Inc., a New York maker of electronic-medication dispensers for home use. Hero Health raised $12 million in Series A funding last year before seeing tariff-related cost increases on many of the components it imports from China.

Bad timing

Tariffs are hitting a broad swath of venture portfolios, in part because firms have been ramping up investments in hardware startups such as Bird Rides Inc., which imports scooters from China. Venture-backed consumer electronics startups in the U.S., raised about $19.39 billion in capital in the past five years, according to Dow Jones VentureSource.

The U.S. in May raised tariffs on $200 billion worth of Chinese goods to 25% from 10%, increasing the toll on more businesses.

Robotics Inc., which has a few dozen employees, found out that its programmable robot, Misty II, would be subject to a 25% tariff after some of its customers had already preordered the robot for $1,699 via a crowdfunding campaign. Misty decided against changing the price for those customers, and will be delivering it for less than its cost, said Tim Enwall, founder and head of Misty Robotics.

"That alone will cost us half a month's payroll," Mr. Enwall said.

New customers would have to pay $2,400 if they preorder, making these robots less competitive on pricing.

"All that means is that the Japanese and the French robots are more affordable," Mr. Enwall said.

Hardware startups also are considering shifting production out of China. But it comes at a cost that most early-stage startups can't afford, said David Pakman, partner at venture firm Venrock.

Primarily, the U.S. isn't a suitable location for many of these companies seeking a low-cost location. Prohibitive costs and a lack of manufacturing facilities for low-volume electronics make shifting production to the U.S. untenable, Mr. Enwall said.

In the case of Hero Health Inc., the maker of the pill dispenser that displays a "Made in U.S.A." label on its website, its executives are considering a plan to move the assembly from California to China, Mr. Vepuri said. The current tariff regime is such that while Hero's components are taxed extra, the Hero machine itself could be imported without an additional duty, at least for now, Mr. Vepuri said.

As the trade talks remain in limbo, entrepreneurs are increasingly fretful.

"I don't know if our company could survive in a full-on tariff regime," Sphero's Mr. Berberian said.

Write to Yuliya Chernova at yuliya.chernova@wsj.com

(END) Dow Jones Newswires

June 21, 2019 12:37 ET (16:37 GMT)

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