Guest post – Harvard’s Prof. Sunil Gupta on Connected Devices

2015: A decisive year for the connected landscape

Sunil Gupta is the Edward W. Carter Professor of Business Administration and Chair of the General Management Program at Harvard Business School. He is also the co-chair of the executive program on Driving Digital and Social Strategy.

In this first of three guest posts, Professor Gupta shares his thoughts on Connected Devices as rumours of Apple’s automotive ambitions swirl following recent hints by a senior executive.

Connected devices will continue to spread both inside and outside the home over the next 12 to 18 months, and as they do, the battle for control of (and revenue from) the ecosystems they inhabit will heat up. The unexploited potential value of these web-connected ecosystems is huge, the world’s largest, most successful technology companies are vying to control it, and the outcome will affect daily life for everyone with an internet connection.

Availability of consumer devices to connect both the home and person has exploded over the past year, finally making mass adoption a real prospect. Remote climate controls, the Apple Watch and other wearable devices, health monitors have all become commonplace. The connected car falls somewhere between the home and person, and has attracted attention for dramatic advances at the prototype stage – most notably Google’s large scale demonstration of fully driverless cars, and senior Apple executives tantalising audiences at this week’s Code conference, indicating its ambitions to go far beyond its launch of CarPlay, already deployed in the Ferrari FF, with Mercedes Benz, Jaguar and with others to follow.

In my view, value in each of these distinct connected ecosystems – the home, the car, and the person – resides not in the individual devices but their connectivity, and the machine-to-machine (‘M2M’) and machine-to-consumer (‘M2C’) interactions that it enables. The more devices in each network, and the more they can be connected to each other to do something useful, the more value there is to be captured.

Home and personal networks evolving fastest, cars will follow

Home will be fastest growing connected device segment in 2015, with sales expected to increase c. 200%. Energy and security devices, two of the most mature categories of home device, will drive this growth as ‘connected’ penetrates the large existing markets for thermostats and burglar alarms.

Wearable tech – or connected person – is opening up whole new categories, and therefore growing at a relatively slow, although absolutely very rapid, rate of 60% p.a. as device-makers work hard to drive adoption of new devices, rather than connection of existing categories. Health and fitness monitoring remains the largest category, and, although substantial, it is by nature a niche market.

Smart watches – a category that definitely does enjoy the universality of the home thermostat – are forecast to be the fastest growing major category of wearable device in 2015, with unit sales to increase +230%, with significant upside likely as the Apple Watch accelerates from limited initial sales to widespread availability.

Connected cars in the literal sense are fast becoming a reality; 22 million vehicles are expected to ship in 2016 with native internet connectivity, an increase of 52% compared to 2014. However the depth of M2C interaction remains constrained by the connected car ecosystem – the limited suite of apps and devices built around the car. Unlocking applications for the connectivity now being built into many cars is the second frontier of growth in this market.

Personal network ruled by the mobile phone

On the person, the mobile phone has emerged as the de facto platform – as the provider of internet connectivity to the ecosystem, and the dominant user interface, most wearable devices must connect with the users’s phone. Competition for the personal connected the platform is therefore part of the wider smartphone platform market, in which Google Android dominates the market by volume, but Apple is entrenched in the highly valuable premium position and has made significant market share gains with the iPhone 6 and Apple Watch.

Despite the large absolute number of devices sold, in my view the small sizeof the personal network – typically two or three nodes – and narrow scope of each device (eg. sensors with a specific purpose, human interfaces) limits the potential for complex M2M interaction to add value, and therefore the value captured by the platform in facilitating this interaction.

Competition in the personal ecosystem is therefore focussed at the level of the device. This currently means the mobile handset, but as Google Glass and Microsoft Hololens have demonstrated, there is no reason this should remain the case as user interfaces advance.

Virgin territory in the home ecosystem

The home ecosystem contrasts with the personal in two important respects: there is no dominant platform, and the value in being that platform is significant.

Both major players – Apple and Google – have recognised that no-one ‘owns’ the home system. There is no operating system for houses; they remain largely unclaimed territory, to be won by the first person to stake their claim. As the range of devices is wider – from proximity sensors to door locks, lights, and window blinds – and the network generally far larger, there is scope for M2M interaction to add value by doing something useful in the building.

Being the platform – becoming the operating system – is the only strategy that can deliver wholesale a meaningful share of the connected world. As Microsoft discovered, it is the ultimate strategic advantage; the neutron bomb of tech. By comparison, competing to rule the ecosystems of applications and hardware device-by-device and app-by-app through product innovation and marketing has all the appeal of trench warfare.

Google’s market penetration strategy was best articulated by Nest Labs founder Tony Faddel in saying ‘People don’t buy platforms. People buy devices.’ By this logic capturing the connected home is a simple volume game; Just as the PC OS and high-definition DVD battles were won by Microsoft and Sony respectively shipping more machines, so Google is betting that a device is the gateway into the home, and that ‘killer app’ devices can establish an installed base that will then gain its own momentum as ‘Works with Nest’ becomes the de facto standard for third party device manufacturers.

Apple, by contrast has stayed out of the device arena instead launching its ‘HomeKit’ platform as an all-purpose unifier of the disparate connected home standards being promoted by competing device-makers. At first sight, the calculation that enough Apple devices are already on home networks to allow them to become the dominant platform seems risky; it rests significantly on what is probably Apple’s least successful consumer product – Apple TV – which will act as the hub for HomeKit devices when the user is away. However the installed base – probably north of 30 million – dwarfs Nest’s, which is probably less than 10 million today. Combined with the low price point of an Apple TV compared to a Nest thermostat, Apple’s strategy may be intelligent, having cost far less to implement than Google’s acquisition of Nest and at the outset penetrated more homes.

At this stage of the game – much like Sony and Panasonic competing with BluRay and HDDVD in 2007 – both players look credible, and while one has an advantage, it appears far from decisive. Moves into the user interface and device ecosystem over the next year or two are likely to decide the eventual victor. Both players will recognise this and dramatically increase resources directed at the connected home.

Car dashboards fiercely contested

Millions of ‘connected cars’ have been sold. But in most cases the scope of connected functionality remains narrow – limited to tasks directly related to driving the car, such as roadside assistance, satellite navigation, vehicle tracking, or (probably the most progressive to date), Tesla’s over-the-air updates for its electric cars.

Due to its long product cycle and inherent risk-aversion, the automotive industry will be slower in opening up to a wide range of M2C applications. However the possible value of the in-car ecosystem is clear; the average American drives for 480 hours each year, representing collectively 152 million man-hours per year potentially available for work, entertainment, shopping or viewing online ads – any activity that can take place over a wireless data connection.

This latent value is apparent to both the auto and tech industries; many major automakers (BMW the leader amongst them with its flagship ConnectedDrive platform) have invested heavily to build connected functionality into their vehicles whilst both Google and Apple are investing substantially to colonise this new territory, and Jeff Williams, Apple’s senior vice president of operations, has recently been quoted as regarding the car as “the ultimate mobile device.”

Will device manufacturers capture the value in connection?

Continuous connection has so dramatically created new categories of devices, and associated revenue streams, that is seems obvious that manufacturers must benefit from it.

However, the huge range of consumer products – from lightswitches to lawnmowers – that face the imperative to get connected dwarfs the new categories of device that connection has created. In these existing applications, where highly-efficient manufacturers of goods ranging from building products to consumer electronics presently compete to earn often wafer-thin net margins, the prospect of connection is viewed with trepidation by some who question whether the investment in connected hardware will support a margin premium, or simply become a functional pre-requisite, increasing functionality and manufacturing complexity, but not a sustainably higher price.

Because of fierce price competition and free-availability of connected technology, manufacturers in high volume, low margin consumer markets will, in my view compete away any ‘connected’ margin premium in the medium term. I would expect that smart OEMs instead use connection as an opportunity to grab market share by getting functionality to market faster, and to build ancillary revenue streams such as remote monitoring or consumable ordering.

In summary

I expect that the next 18 months will be a decisive period in Apple and Google’s tussle for the connected home. A clear winner may not be decided, but it is likely that the winning moves will be made.

Outside the home the entrenched market positions in the smartphone market will result in a fragmented market dominated by the same two tech titans. Winning control of the connected car is a longer game; Apple will attempt to establish its position as early as later this year 2015 but others have yet to make their opening moves.

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Nick Field
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field@livingstonepartners.co.uk