Increasing your business while getting ahead of the competition
Should you work for a company that produces such items as heating, ventilation and air conditioners, 3D cardiac imaging machines, seed drills or submersible pumps, chances are that you’re already aware of the rise of the Internet of Things (IoT). All of us in the tech community are constantly excited about any opportunity to tell the rest of you about our cool technology that can run on your machine, vehicle or product. We see the IoT’s potential to not only improve services but also to connect each product to the internet, to collect data from it and, using advanced machine learning technology, to derive predictions from the ongoing analysis of that data.
But if you’re the CEO of an already successful manufacturing company, maybe the questions you’re asking right now are “Why should I care? Isn’t the IoT just the stuff my geeky R&D staff care about? Don’t my products sell just fine without IoT connectivity? How can it possibly be meaningful to my business?”
In this article, I’ll be making the case that with IoT, you can not only double the size of your business but also create a barrier that your competition will find difficult to cross. I’ll cover three basic business models and discuss the organisational implications of IoT, as well as some of the objections you’ll encounter. Now that you’re ready to lead the digital transformation of your company, here’s a roadmap to point you in the right direction.
Out in the physical world, next-gen products are increasingly being powered by software. The new £68,000 Porsche Panamera is controlled by a 100 million lines of code, up from only two million lines in the previous generation. Tesla owners have come to expect new features delivered to their vehicles through software updates, not by a mechanic.
Healthcare machines are also becoming more software-defined. A drug infusion pump may run on more than 200,000 lines of code, an MRI scanner seven million. On construction sites, a modern boom lift has 40 sensors and 3 million lines of code, while on the farm, a combine harvester has over 5 million. We can debate whether size is a worthwhile measure of the value of software but you get the point. Software is starting to define physical machines.
Since machines are now becoming more software-defined, maybe the business models that once applied only to software will start to apply more and more to the world of physical products. Let’s see how well this theory stands up to scrutiny. . .
Business model 1: Product & disconnected services
In the early days of the software industry, we sold them on a CD so, if you wanted to use the newest version, you’d have to go out and buy a copy. As software products became more complex, companies like Oracle moved to a business model where you bought each product (ERP or database) together with a service contract. Over time, this service contract became the largest and most profitable component of many enterprise software product companies. In the year before Oracle bought Sun (when they were still a pure software business) they had revenues of approximately $15bn but only $3bn was product revenue. The remaining $12bn – over 80% of their revenue – was high margin, recurring service contracts.
But what is service? Is it answering the phone nicely from Bangalore? Is it flipping burgers at McDonald’s? No. Service is the delivery of information that is personal and relevant to you. That could be the hotel concierge giving you directions to the best Szechuan Chinese restaurant in town, or your doctor telling you that based on your genome and lifestyle, you should be on a specific medication. Service is personal and relevant information.
I’ve heard many executives of product manufacturing companies say, “Our customers won’t pay for service”. Well of course, if you think that service is just fixing broken things, then your customers will think you should be building a more reliable product. Remember that Oracle service revenue. In 2004, the Oracle Support organisation studied 100m support requests and found that over 99.9% of them had been answered with already known information. Aggregating information for thousands of different uses of the software, even in a disconnected state, represented huge value over the knowledge of a single person in a single location. Real service is not breaking support but rather information about how to maintain or optimise the availability, performance or security of the product.
You might wonder why, in America, General Electric bothers to run ads about the industrial internet during Saturday Night Live commercial breaks. All you need to do is download their 201610-K and look on page 36. Out of $113bn in revenue, GE recognised that $52bn, or nearly half of it, came from service revenue. So imagine if your business could move to 80% service revenue. Not only would you be tens of billions of dollars larger, overall margins could also easily double. And let me remind you this is all being done without connecting your products as IoT devices. If you’re currently the CEO of a power, transportation, construction, agriculture, oil & gas, life science or healthcare machine company, ask yourself this question – how big is your service business?
Business model 2: Product & connected services
If they could connect to their own IoT- enabled products, any business could make the service they provide even more personal and relevant. Many software and hardware product companies already connect to their products to provide assisted services, which help both the manufacturers and users maintain or optimise the security, availability and performance of these products.
Now let’s shift that concept to the world of physical products. If I know both the model number and current configuration of a specific machine as well as the time-series data coming from its hundreds of sensors, then the service I provide can be even more personal and relevant.
I can provide precision assistance for the users who maintain or optimise the performance, availability and security of that machine. If in business model 1 we charge 0.5-1% of product purchase price per month, then in model 2, I could charge an additional 1-2% for an improved service. At scale, these small margins can be significant. Consider a product which sells 4,000 units at $200K each. At just 1% per month, this product could generate $100m of high margin, recurring revenue for the manufacturer.
Business model 3: Product-as-a-service
Once you can tell a human worker how to maintain or optimise the security, availability or performance of a product, the next step is for the manufacturer to take over those responsibilities. Over the last fifteen years, we’ve seen the rise of software-as-a- service companies (SaaS) such as Salesforce, Workday and Blackbaud. In the past seven years, this has also happened with hardware products, as companies such as Amazon, Microsoft and Google provide computational and storage products as a service.
All of these new product-as-a- service (PAAS) companies have changed the pricing models to per transaction, per seat, per instance, per month or per year. We expect to see the same with agricultural, construction, transportation and healthcare machines. Early examples we’re familiar with are Uber and Lyft, which provide transportation-as-a-service, priced per ride. Of course, Uber’s most expensive operating cost is the human labour so, like those of us in high tech software and hardware products, it is looking at replacing the human driver with automation. At some point, the traditional car manufacturers will have to respond and the recent replacement of the Ford CEO is the most visible example of ongoing change. Which brings us to change management and leadership.
The rise of the Chief Services Officer
There are significant organisational changes that must be made if you decide to adopt a strategy of IoT-enabled products. Many senior managers of aviation, construction and healthcare equipment companies focus on the design and production of the physical product, not the software it depends on and certainly not the services that this software can potentially provide.
Consider creating a Chief Services Officer (CSO) as a member of your leadership team and make sure they have a VP of service products and a VP of service sales reporting to them. There will certainly be some internal obstacles to choosing IoT adoption. Local distributors who have relied on one-off, human-powered services and a commission based on selling only physical products are sure to stand in your way. General purpose service companies, facilities managers in the building industry, or outsourcers in the tech industry will also see new business models as a threat and all of them can cause you to delay implementation. But if history is an indicator, by the time your competitors have finally made the transition, it will be too late for you to do so.
The inevitability of change
If you build machines for transportation, power, water, agriculture, construction, oil, gas or healthcare, I hope that you can now see a roadmap that’s based on the experiences of the software industry. Any business can start today with the first model I’ve described. It doesn’t require you be connected to any of your machines but does require you to focus on building service products, marketing and selling these to your customers. While the journey will not be easy, the rewards of having a high margin, recurring revenue, differentiated product will enable you to thrive in the coming decade.
Timothy Chou is the former president of Oracle On Demand, a lecturer at Stanford University and chairman of Lecida, an industrial machine learning company lecida.com