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James Park and his partner Eric Friedman stood out like a couple of sore thumbs.

They were in the middle of a crowd of other entrepreneurs at TechCrunch50, a small conference for startups, held in San Francisco last September.

But unlike most of their peers, the duo weren’t touting a web-based mashup, a new advertising platform or a collection of 3-D avatars for customer service. They sought attention for their hardware company, which was building a fitness gadget called Fitbit that would be part pedometer, part wellness tracker.

"We have three full-time employees and everything else is outsourced," says Park. "But we have a great idea and we have a flexible work force, and we want to build the next big thing in the gadgets business."

Consumer electronics startups are the new frontier for enterprising entrepreneurs. Once thought to be an expensive business skewed in favor of large companies with nearly unlimited access to capital, giant manufacturing facilities and armies of engineers, the business is attracting entrepreneurs who think small and move quickly. And they’re changing the consumer electronics landscape: the Chumby, LiveScribe Pulse Pen, Roku media player and Pure Digital’s Flip camcorder all owe their existence to scrappy, independents, not big corporate R&D departments. In some cases, these gadget startups have led to multimillion-dollar paydays for their founders.

Fueling this change is the explosion of the PC and cellphone industries, which have created an ecosystem of boutique industrial designers, contract manufacturing shops and online retailers that support this new generation of guerrilla hardware entrepreneurs.

Neither Park nor Friedman have experience in consumer electronics. Consummate software geeks, they studied computer science in college. Their last company was the photo-sharing startup Windup Labs that was eventually acquired by CNET. But together they’re creating a consumer hardware company on the cheap. Fitbit has raised just $2.5 million in its first round of venture financing, and the company hopes to start shipping its $100 devices this summer.

"Today with a guy or two, a good idea and about $1.5 million you can get a contract manufacturer in Asia to do your gadget," says Gadi Amit, founder of New Deal Design, a San Francisco-based industrial design firm. "About 10 years ago that would have taken 20 engineers and $10 million."

There are caveats. A cellphone can be tricky for new entrants because it requires extremely sophisticated design, specialized chips and custom software. But smaller, simpler products like the Fitbit are easier, say industry watchers.

For engineers to switch between hardware and software companies isn’t new. But Park and Friedman are different, says Amit. "James is kind of the quintessential profile of the internet entrepreneur," he says. "Now he’s doing hardware and that’s a novelty."

So what are two dot-com era survivors doing in the hardware business?

Chasing the Dream

It’s no secret in Silicon Valley that almost every engineer, venture capitalist or dot-com executive loves gadgets. IT geeks rush to Fry’s and Amazon to get their latest cellphone, e-book reader or personal planetarium. Their homes are filled with gadgets, and showing off gadgets is as much a part of networking and social bonding as drinking beer and exchanging business cards. 

Park and Friedman are no exception. About a year and a half ago, the fitness junkies were casually tossing ideas around a gadget that would track not just physical activities (walking, biking) but could also log sleep patterns. In effect, they wanted device that would produce a complete picture of a user’s physical well being.

And just like that, they decided to build one. "We like gadgets and we like building things so we thought why not make a go of this one?" says Park.

But getting Silicon Valley VCs to fund a consumer electronics hardware startup isn’t easy. "Money flows where money knows," says Jason Krikorian, former founder of Sling Media. Krikorian, together with his brother Blake, founded Sling Media in 2004 and last year sold it to EchoStar Communications for $380 million.

"The consumer electronics space is one that a lot of VCs have a bit of an allergic reaction to," says Krikorian. "VCs see the gadget consumer as hard to predict. And when it comes to the product itself, they see a lot of challenges, from cash requirements to distribution and dealing with retail."

Sling Media ultimately raised $57.5 million in funding from DCM and Mobius Capital, among others. It’s a fair chunk of change but many software startups draw as much. Take the Marc Andreesen-backed social networking site Ning, which has raised about $60 million so far.

Park and Friedman knew the odds were stacked against them as they pitched a gadget company. But they were counting on a new kind of strategy. Instead of asking for millions, they would start low. All they needed was a modest first round to kick off operations.

That’s how they found True Ventures. A venture firm focused on early stage companies, True Ventures has funded companies such as tech blog Gigaom, web-based instant messaging platform Meebo, and online gaming company Hive7.

"We offered a pretty conventional business model," says Park. "We build something and sell it to people at a cost that is higher than what it takes to produce. And we don’t want too much money to get started."

Idea to Execution

Next step in their plan: finding an industrial designer to take their feature set and turn it into a hardware package.

In the last few years, a number of boutique industrial design shops
have sprung up focusing on consumer electronics. Fuseproject founder Yves Behar created the stylish Jawbone headset. MindTribe has helped engineer Pure Digital’s popular Flip Mino
camera.

Park and Friedman turned to Gadi Amit and his team at New Deal Design.
A former vice-president of design at Frog Design, one of the largest
and most well-known design companies, Amit broke away in 2000 to start
his own firm. Amit and his team of 15 engineers specialize in consumer
electronics startups. New Deal Design’s clients include Dell, Netgear,
Sling Media and electric-car service station company Better Place. 

Increasingly, says Amit, more entrepreneurs are looking towards
hardware for their next big idea. "Everyone can’t be the next Michael
Dell or Steve Jobs," he says. "But relatively speaking, there is still
a higher chance of success in consumer hardware than in yet another
social networking app."

Within two weeks Amit and his team drew the high level sketches for
Fitbit. In four months, they had the final renderings. Now it would be
up to the contract manufacturers to create the prototypes.

Building on an Idea

Electronics factories in China and Taiwan have changed manufacturing
in the same way that hundreds of software body shops in Bangalore have
reshaped the software world, by offering cheap, competitive and
high-quality labor.

"Five years ago, contract manufacturers would just be manufacturing
houses, nothing more," says Amit. "They would have major difficulties
with refinement of handheld products, difficulties working with colors,
materials and finishes, problems integrating hardware and software."

Now they are are sophisticated enough to create high-gloss products
on the cheap, he says. As compared to even five years ago, contract
manufacturers now are comfortable enough working with small volume
orders and startups. "The back end of manufacturing is relatively easy,"
says Amit. "But you still need a product manager and a lot of flights
to China."

In the last six months, Park has visited Singapore and Indonesia about
four times to meet with Fitbit’s contract manufacturers. Still, he
says, it has been a fairly smooth ride. "There are still differences,
especially with the nuances of the language — we have to be extremely
detailed in our communication and can’t just assume they understand
some things," he says. "But they seem to be pretty familiar in dealing
with Western companies."

With the first few prototypes in hand, Fibit has started wooing some retail buyers.

The rise of online buying, especially for electronics, has changed
the game for them. Old big-box stores such as CompUSA and Circuit City
have given way to online retail shops such as Amazon and Buy.com. And
the shift has brought with it changed attitudes. Online retailers have
lower joint marketing demands and lower margin requirements, so
products can be priced cheaper.

Products now get distributed from two or three central locations,
which means smaller firms need fewer distribution points. "All this
helps companies get to market with less cash," says Krikorian.

But that’s just half of the story, says Jim Marggraff, CEO of
LiveScribe. To go beyond the enthusiast market, consumer electronics
products still need to get on retail shelves. And that means old-fashioned retailers like Target, Wal-Mart and Best Buy still hold
considerable power. "For something really new, there is a huge
credibility boost associated from being on retail shelves," says
Marggraff.

When the LiveScribe pen first appeared on shelves on Target, it
exploded into consumer consciousness in a way direct retail couldn’t
have accomplished, he says. "We had lots of impulse buys from Target,"
says Marggraff. "Being on their shelves made our product feel real."

Retail sales and distribution still remain the biggest challenges
for consumer electronics startups, says Tim Twerdahl, vice president of
consumer products for Roku. For example, products have much higher
return rates through retail than when selling direct. Manufacturers
also have to pay a big premium to the retailers for shelf space, and
are often held hostage to big box stores’ timelines when it comes to
launching new products. "All this can become quite expensive for a
small company," says Twerdahl.

For Fitbit, that’s something to worry about later. They have
more pressing problems. Fitbit, which was scheduled to launch in
spring, has been delayed to summer. "We have some electrical and
mechanical bugs that we have to resolve," says Park. And that can be a
tricky business. Every bug fix requires a new prototype and it can take
up to two weeks to produce a new unit. The costs can add up quickly,
since every new Fitbit prototype can take $3,000 to $5,000 to create.
"We have to be very aggressive about testing," says Park. "Every time
we need to make a decision about what can wait for later revisions."

But if Fitbit’s founders can get their product out to market, they
hope to leverage the worldwide community of gadget blogs and online
forums to carry it forward. Hardware-obsessed gadget heads offer
powerful word-of-mouth marketing and they can turn unknown
products into mainstream hits inexpensively, says Krikorian, pointing
to Sling’s strategy of courting bloggers and online enthusiasts.

If Fitbit can carve a successful niche for itself, there could be a
pot of gold at the end of the rainbow. Last week Cisco acquired Pure
Digital, makers of the Flip video camera, for $590 million.

"An acquisition in consumer electronics is not like winning a
lottery," says Park, ever hopeful. "If you build a good business with
strong cash flows, there are enough big companies out there interested
in you."

Photos: Jon Snyder/Wired.com

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