The Internet of Things: Impact on M2M, where it’s going, and what to do about it?

Introduction

From RFID in the supply chain to M2M today

The ‘Internet of Things’ first appeared as a marketing term in 1999 when it was applied to improved supply-chain strategies, leveraging the then hot-topics of RFID and the Internet.

Industrial engineers planned to use miniaturised, RFID tags to track many different types of asset, especially relatively low cost ones. However, their dependency on accessible RFID readers constrained their zonal range. This also constrained many such applications to the enterprise sector and within a well-defined geographic footprint.

Modern versions of RFID labelling have expanded the addressable market through barcode and digital watermarking approaches, for example, while mobile has largely removed the zonal constraint. In fact, mobile’s economies of scale have ushered in a relatively low-cost technology building block in the form of radio modules with local processing capability. These modules allow machines and sensors to be monitored and remotely managed over mobile networks. This is essentially the M2M market today.

M2M remained a specialist, enterprise sector application for a long time. It relied on niche, systems integration and hardware development companies, often delivering one-off or small-scale deployments. For many years, growth in the M2M market did not meet expectations for faster adoption, and this is visible in analyst forecasts which repeatedly time-shifted the adoption forecast curve. Figure 1 below, for example, illustrates successive M2M forecasts for the 2005-08 period (before M2M began to take off) as analysts tried to forecast when M2M module shipment volumes would breach the 100m units/year hurdle:

Figure 1: Historical analyst forecasts of annual M2M module shipment volumes

Source: STL Partners, More With Mobile

Although the potential of remote connectivity was recognised, it did not become a high-volume market until the GSMA brought about an alignment of interests, across mobile operators, chip- and module-vendors, and enterprise users by targeting mobile applications in adjacent markets.

The GSMA’s original Embedded Mobile market development campaign made the case that connecting devices and sensors to (Internet) applications would drive significant new use cases and sources of value. However, in order to supply economically viable connected devices, the cost of embedding connectivity had to drop. This meant:

  • Educating the market about new opportunities in order to stimulate latent demand
  • Streamlining design practices to eliminate many layers of implementation costs
  • Promoting adoption in high-volume markets such as automotive, consumer health and smart utilities, for example, to drive economies of scale in the same manner that led to the mass-adoption of mobile phones

The late 2000’s proved to be a turning point for M2M, with the market now achieving scale (c. 189m connections globally as of January 2014) and growing at an impressive rate (c. 40% per annum). 

From M2M to the Internet of Things?

Over the past 5 years, companies such as Cisco, Ericsson and Huawei have begun promoting radically different market visions to those of ‘traditional M2M’. These include the ‘Internet of Everything’ (that’s Cisco), a ‘Networked Society’ with 50 billion cellular devices (that’s Ericsson), and a ‘Cellular IoT’ with 100 billion devices (that’s Huawei).

Figure 2: Ericsson’s Promise: 50 billion connected ‘things’ by 2020

Source: Ericsson

Ericsson’s calculation builds on the idea that there will be 3 billion “middle class consumers”, each with 10 M2M devices, plus personal smartphones, industrial, and enterprise devices. In promoting such visions, the different market evangelists have shifted market terminology away from M2M and towards the Internet of Things (‘IoT’).

The transition towards IoT has also had consequences beyond terminology. Whereas M2M applications were previously associated with internal-to-business, operational improvements, IoT offers far more external market prospects. In other words, connected devices allow a company to interact with its customers beyond its strict operational boundaries. In addition, standalone products can now deliver one or more connected services: for example, a connected bus can report on its mechanical status, for maintenance purposes, as well as its location to deliver a higher quality, transit service.

Another consequence of the rise of IoT relates to the way that projects are evaluated. In the past, M2M applications tended to be justified on RoI criteria. Nowadays, there is a broader, commercial recognition that IoT opens up new avenues of innovation, efficiency gains and alternative sources of revenue: it was this recognition, for example, that drove Google’s $3.2 billion valuation of Nest (see the Connected Home EB).

In contrast to RFID, the M2M market required companies in different parts of the value chain to share a common vision of a lower cost, higher volume future across many different industry verticals. The mobile industry’s success in scaling the M2M market now needs to adjust for an IoT world. Before examining what these changes imply, let us first review the M2M market today, how M2M service providers have adapted their business models and where this positions them for future IoT opportunities.

M2M Today: Geographies, Verticals and New Business Models

Headline: M2M is now an important growth area for MNOs

The M2M market has now evolved into a high volume and highly competitive business, with leading telecoms operators and other service providers (so-called ‘M2M MVNOs’ e.g. KORE, Wyless) providing millions of cellular (and fixed) M2M connections across numerous verticals and applications.

Specifically, 428 MNOs were offering M2M services across 187 countries by January 2014 – 40% of mobile network operators – and providing 189 million cellular connections. The GSMA estimates the number of global connections to be growing by about 40% per annum. Figure 3 below shows that as of Q4 2013 China Mobile was the largest player by connections (32 million), with AT&T second largest but only half the size.

Figure 3: Selected leading service providers by cellular M2M connections, Q4 2013

 

Source: Various, including GSMA and company accounts, STL Partners, More With Mobile

Unsurprisingly, these millions of connections have also translated into material revenues for service providers. Although MNOs typically do not report M2M revenues (and many do not even report connections), Verizon reported $586m in ‘M2M and telematics’ revenues for 2014, growing 47% year-on-year, during its most recent earnings call. Moreover, analysis from the Telco 2.0 Transformation Index also estimates that Vodafone Group generated $420m in revenues from M2M during its 2013/14 March-March financial year.

However, these numbers need to be put in context: whilst $500m growing 40% YoY is encouraging, this still represents only a small percentage of these telcos’ revenues – c. 0.5% in the case of Vodafone, for example.

Figure 4: Vodafone Group enterprise revenues, implied forecast, FY 2012-18

 

Source: Company accounts, STL Partners, More With Mobile

Figure 4 uses data provided by Vodafone during 2013 on the breakdown of its enterprise line of business and grows these at the rates which Vodafone forecasts the market (within its footprint) to grow over the next five years – 20% YoY revenue growth for M2M, for example. Whilst only indicative, Figure 4 demonstrates that telcos need to sustain high levels of growth over the medium- to long-term and offer complementary, value added services if M2M is to have a significant impact on their headline revenues.

To do this, telcos essentially have three ways to refine or change their business model:

  1. Improve their existing M2M operations: e.g. new organisational structures and processes
  2. Move into new areas of M2M: e.g. expansion along the value chain; new verticals/geographies
  3. Explore the Internet of Things: e.g. new service innovation across verticals and including consumer-intensive segments (e.g. the connected home)

To provide further context, the following section examines where M2M has focused to date (geographically and by vertical). This is followed by an analysis of specific telco activities in 1, 2 and 3.

 

  • Executive Summary
  • Introduction
  • From RFID in the supply chain to M2M today
  • From M2M to the Internet of Things?
  • M2M Today: Geographies, Verticals and New Business Models
  • Headline: M2M is now an important growth area for MNOs
  • In-depth: M2M is being driven by specific geographies and verticals
  • New Business Models: Value network innovation and new service offerings
  • The Emerging IoT: Outsiders are raising the opportunity stakes
  • The business models and profitability potentials of M2M and IoT are radically different
  • IoT shifts the focus from devices and connectivity to data and its use in applications
  • New service opportunities drive IoT value chain innovation
  • New entrants recognise the IoT-M2M distinction
  • IoT is not the end-game
  • ‘Digital’ and IoT convergence will drive further innovation and new business models
  • Implications for Operators
  • About STL Partners and Telco 2.0: Change the Game
  • About More With Mobile

 

  • Figure 1: Historical analyst forecasts of annual M2M module shipment volumes
  • Figure 2: Ericsson’s Promise: 50 billion connected ‘things’ by 2020
  • Figure 3: Selected leading service providers by cellular M2M connections, Q4 2013
  • Figure 4: Vodafone Group enterprise revenues, implied forecast, FY 2012-18
  • Figure 5: M2M market penetration vs. growth by geographic region
  • Figure 6: Vodafone Group organisational chart highlighting Telco 2.0 activity areas
  • Figure 7: Vodafone’s central M2M unit is structured across five areas
  • Figure 8: The M2M Value Chain
  • Figure 9: ‘New entrant’ investments outstripped those of M2M incumbents in 2014
  • Figure 10: Characterising the difference between M2M and IoT across six domains
  • Figure 11: New business models to enable cross-silo IoT services
  • Figure 12: ‘Digital’ and IoT convergence

 

Telco-Driven Disruption: Hits & Misses (Part 1)

Introduction

Part of STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing explores the role of telcos in disrupting the digital economy. It analyses a variety of disruptive moves by telcos, some long-standing and well established, others relatively new. It covers telcos’ attempts to reinvent digital commerce in South Korea and Japan, the startling success of mobile money services in east Africa, BT’s huge outlay on sports content, AT&T’s multi-faceted smart home platform, Deutsche Telekom’s investments in online marketplaces and Orange’s innovative Libon communications service.

In each case, this briefing describes the underlying strategy, the implementation and the results, before setting out STL’s key takeaways. The conclusions section outlines the lessons other would-be disruptors can learn from telcos’ attempts to move into new markets and develop new value propositions.

Note, this report is not exhaustive. The examples it covers are intended to be representative. Part 2 of this report will analyse other telcos who have successfully disrupted adjacent markets or created new ones. In particular, it will take a close look at NTT DOCOMO, Japan’s leading mobile operator, which has built up a major revenue stream from new businesses.  DOCOMO reported a 13% year-on-year increase in revenues from its new businesses in the six months to September 30th 2014 to 363 billion Japanese yen (more than US$3 billion). Its target for the full financial year is 770 billion yen (almost US$6.5 billion). Revenues from its Smart Life suite of businesses, which provide consumers with advice, information, security, cloud storage and other lifestyle services, rose 18% to 205 billion yen in the six months to September 30th 2014, while its dmarket content store now has 7.8 million subscribers. In the six months to September 30th, the total value of dmarket transactions rose 30% year-on-year to 34.6 billion yen.

In South Korea, leading telco KT is trying to use smartphone-based apps and services to disrupt the digital commerce market, as are the leading U.K. and U.S. mobile operators through their respective Weve and Softcard joint ventures.  In the Philippines, Smart Communications and Globe Telecom have recast the financial services market by enabling people to send each other money using text messages.

Several major telcos are seeking to use their network infrastructure to change the game in the cloud services market. For example, U.S. telco Verizon has made a major push into cloud services, spending US$1.4 billion to acquire specialist Terremark in 2011. At the same time, Verizon and AT&T are having to respond to an aggressive play by T-Mobile USA to reshape the U.S. telecoms market with its Un-carrier strategy.

Some of these companies and their strategies are covered in other STL Partners reports, including:

Telcos can and do disrupt

In the digital economy, innovative start-ups, such as Spotify, Twitter, Instagram and the four big Internet platforms (Amazon, Apple, Facebook and Google) are generally considered to be the main agents of disruption. Start-ups tend to apply digital technologies in innovative new ways, while the major Internet platforms use their economies of scale and scope to disrupt markets and established businesses. These moves sometimes involve the deployment of new business models that can fundamentally change the modus operandi of entire industries, such as music, publishing and video gaming.

However, these digital natives don’t have a monopoly on disruption. So-called old economy companies do sometimes successfully disrupt either their own sector or adjacent sectors. In some cases, incumbents are actually well placed to drive disruption. As STL Partners has detailed in earlier reports, telcos, in particular, have many of the assets required to disrupt other industries, such as financial services, electronic commerce, healthcare and utilities. As well as owning the underlying infrastructure of the digital economy, telcos have extensive distribution networks and frequent interactions with large numbers of consumers and businesses.

Although established telcos have generally been cautious about pursuing disruption, several have succeeded in creating entirely new value propositions, effectively disrupting either their core business or adjacent industry sectors. In some cases, disruptive moves by telcos have primarily been defensive in that their main objective is to reduce churn in the core business. In other cases, telcos have gone on the offensive, moving into new markets in search of new revenues (see Figure 1).

Figure 1: Representative examples of disruptive plays driven by telcos

Source: STL Partners

 

The next section of this paper explores the disruptive moves in the top right hand corner of Figure 1 – those that have taken telcos into new markets and have had a significant financial impact on their businesses.

Offensive, major financial impact 

A classic disruptive play is to use existing assets and customer relationships to move into an adjacent market, open up a new revenue stream and build a major business. This is what Apple did with the iPhone and what Amazon did with cloud services. Several telcos have also followed this playbook. This section looks at three examples – SK Telecom’s SK Planet, Safaricom’s M-Pesa and KDDI’s au Smart Pass – and what other companies in the digital economy can learn from these largely successful moves. Unlike many disruptive moves by telcos, the three businesses covered in this section have had sufficient impact to properly register on investors’ radar screens. They have moved the needle for their parent’s telcos and given their investors confidence in their ability to innovate.

SK Planet – an ambitious mobile commerce play

Owned by SK Telecom, SK Planet is a major broker in South Korea’s world-leading mobile commerce market. It has developed several two-sided online services that are similar in some respects to those offered by Google. SK Planet operates the T Map, a turn-by-turn navigation service, the T Store Android app store, the Smart Wallet payment, loyalty and couponing service, the OK Cashbag loyalty marketing programme and the 11th St online marketplace.


Strategy

Taking advantage of South Koreans’ appetite for new technologies, SK Telecom is using its home market as a test bed for mobile commerce solutions that could be deployed more widely. As well as seeking to generate revenues from enabling payments, advertising, loyalty, couponing and other forms of direct marketing in South Korea, it is aiming to become a leading mobile commerce player in other markets in Asia and North America.

SK Telecom’s approach has been to launch services early and then refine these services in response to feedback from the Korean market. It launched a mobile couponing service, for example, as early as 2008. To reduce the impact of corporate bureaucracy, in 2011, SK Telecom placed its digital commerce activities into a separate company, called SK Planet. The new entity has since focused on the development of a two-sided platform that aims to provide consumers with convenient shopping channels and merchants and brands with a wide range of marketing solutions both online and in the bricks and mortar arena. Although its services are over-the-top, in the sense that they don’t require consumers to use SK Telecom, SK Planet continues to work closely with SK Telecom – its sole owner.

Downstream, SK Planet is trying to differentiate itself by putting consumers’ interests first, giving them considerable control and transparency over the digital marketing they receive. Upstream, SK Planet is putting a lot of emphasis on helping traditional bricks and mortars stores go digital and reverse so-called showrooming, so that consumers research products online, but actually buy them from bricks and mortar retailers.

SK Planet CEO Jinwoo So talks about enabling “Next Commerce” by which he means the seamless integration of online and bricks and mortar commerce.  “Just as Amazon became the global leader in e-commerce by revolutionizing the industry, SK Planet aims to
become the global ‘Next Commerce’ leader in the offline market by driving mobile innovation that will eventually
break down the walls which separate the online and offline worlds,” he says.

Estimating the offline commerce market in South Korea is worth 230 trillion won (more than 210 US billion dollars), SK Planet is aggressively adapting its existing digital commerce platforms, which are underpinned by SK Telecom’s network assets, for mobile commerce. It is also making extensive use of the big data generated by its existing platforms to hone its offerings.

At the 2014 Mobile World Congress, SK Planet CEO Jinwoo So outlined how SK Planet has worked closely with SK Telecom to develop algorithms that use customer data to predict churn and provide personalized recommendations and offers. “We combined the traditional data mining with text mining,” he said. “How people create the search criteria or the sites they visit, we came up with a very unique formula, which gives up much two times better performance than before. … In 11th street, we have achieved almost three times better performance by applying our recommendation engine, which we developed. Now we are trying to prove the ROI for marketing budgets for brands and merchants.”

 

  • Introduction
  • Executive Summary
  • Telcos can and do disrupt
  • Offensive, major financial impact (Strategy, Implementation, Results)
  • SK Planet – an ambitious mobile commerce play
  • M-Pesa – reinventing financial services
  • KDDI au Smart Pass – curating online commerce
  • Offensive, limited financial impact (Strategy, Implementation, Results)
  • Deutsche Telekom’s start-stop Scout 24 investments
  • AT&T Digital Life – slow burn for the smart home
  • Defensive, major financial impact (Strategy, Implementation, Results)
  • BT Sport and BT Wi-Fi – High perceived value
  • Defensive, minor financial impact (Strategy, Implementation, Results)
  • Orange Libon – disrupting the disruptors
  • Conclusions
  • STL Partners and Telco 2.0: Change the Game

 

  • Figure 1: Representative examples of disruptive plays driven by telcos
  • Figure 2: SK Planet’s Syrup Wallet stores loyalty cards, coupons and payment cards
  • Figure 3: Shopkick enables US retailers to interact with customers in store
  • Figure 4: SK Planet is an increasingly important part of SK Telecom’s business
  • Figure 5: The flywheel effect: how upstream partners can increase relevance
  • Figure 6: M-Pesa continues to grow in Kenya seven years after launch
  • Figure 7: Vodacom Tanzania has made it easy to register for M-Pesa
  • Figure 8: KDDI’s revenues and profits from value added services grow steadily
  • Figure 9: au Smart Pass is bolstering KDDI’s ARPU
  • Figure 10: Immobilienscout24 has seen a steady increase in traffic
  • Figure 11: AT&T Digital Life gives consumers remote control over their homes
  • Figure 12:  Investors value BT Sport’s contribution
  • Figure 13: BT Sport has driven broadband net-adds, but at considerable expense
  • Figure 14: Orange’s multi-faceted positioning of Libon in the App Store

 

Connected Car: Key Trends, Players and Battlegrounds

Introduction: Putting the Car in Context

A growing mythology around M2M and the Internet of Things

The ‘Internet of Things’, which is sometimes used interchangeably with ‘machine-to-machine’ communication (M2M), is not a new idea: as a term, it was coined by Kevin Ashton as early as 1999. Although initially focused on industrial applications, such as the use of RFID for tagging items in the supply chain, usage of the term has now evolved to more broadly describe the embedding of sensors, connectivity and (to varying degrees) intelligence into traditionally ‘dumb’ environments. Figure 1 below outlines some of the service areas potentially disrupted, enabled or enhanced by the Internet of Things (IoT):

Figure 1: Selected Internet of Things service areas

Source: STL Partners

To put the IoT in context, one can conceive of the Internet as having experienced three key generations to date. The first generation dates back to the 1970s, which involved ARPANET and the interconnection of various military, government and educational institutions around the United States. The second, beginning in the 1990s, can be thought of as the ‘AOL phase’, with email and web browsing becoming mainstream. Today’s generation is dominated by ‘mobile’ and ‘social’, with the two inextricably linked. The fourth generation will be signified by the arrival of the Internet of Things, in which the majority of internet traffic is generated by ‘things’ rather than humans.

The enormous growth of networks, cheaper connectivity, proliferation of smart devices, more efficient wireless protocols (e.g. ZigBee) and various government incentives/regulations have led many to confidently predict that the fourth generation of the Internet – the Internet of Things – will soon be upon us. Visions include the “Internet of Everything” (Cisco) or a “connected future” with 50 billion connected devices by 2020 (Ericsson). Similarly rapid growth is also forecasted by the MIT Technology Review, as detailed below:

Figure 2: Representative connected devices forecast, 2010-20

Source: MIT Technology Review

This optimism is reflected in broader market excitement, which has been intensified by such headline-grabbing announcements as Google’s $3.2bn acquisition of Nest Labs (discussed in depth in the Connected Home EB) and Apple’s recently announced Watch. Data extracted from Google Trends (Figure 3) shows that the popularity of ‘Internet of Things’ as a search term has increased fivefold since 2012:

Figure 3: The popularity of ‘Internet of Things’ as a search term on Google since 2004

Source: Google Trends

However, the IoT to date has predominantly been a case study in hype vs. reality. Technologists have argued for more than a decade about when the army of connected devices will arrive, as well as what we should be calling this phenomenon, and with this a mythology has grown around the Internet of Things: widespread disruption was promised, but it has not yet materialised. To many consumers the IoT can sound all too far-fetched: do I really need a refrigerator with a web browser?

Yet for every ‘killer app’ that wasn’t we are now seeing inroads being made elsewhere. Smart meters are being deployed in large numbers around the world, wearable technology is rapidly increasing in popularity, and many are hailing the connected car as the ‘next big thing’. Looking at the connected car, for example, 2013 saw a dramatic increase in the amount of VC funding it received:

Figure 4: Connected car VC activity, 2010-13

Source: CB Insights Venture Capital Database

The Internet of Things is potentially an important phenomenon for all, but it is of particular relevance to mobile network operators (MNOs) and network equipment providers. Beyond providing cellular connectivity to many of these devices, the theory is that MNOs can expand across the value chain and generate material and sustainable new revenues as their core business continues to decline (for more, see the ‘M2M 2.0: New Approaches Needed’ Executive Briefing).

Nevertheless, the temptation is always to focus on the grandiose but less well-defined opportunities of the future (e.g. smart grids, smart cities) rather than the less expansive but more easily monetised ones of today. It is easy to forget that MNOs have been active to varying degrees in this space for some time: for example, O2 UK had a surprisingly large business serving fleet operators with the 9.6Kbps Mobitex data network for much of the 2000s. To further substantiate this context, we will address three initial questions:

  1. Is there a difference between M2M and the Internet of Things?
  2. Which geographies are currently seeing the most traction?
  3. Which verticals are currently seeing the most traction?

These are now addressed in turn…

 

  • Executive Summary
  • Introduction: Putting the Car in Context
  • A growing mythology around M2M and the Internet of Things
  • The Internet of Things: a vision of what M2M can become
  • M2M today: driven by specific geographies and verticals
  • Background: History and Growth Drivers
  • History: from luxury models to mass market deployment
  • Growth drivers: macroeconomics, regulation, technology and the ‘connected consumer’
  • Ecosystem: Services and Value Chain
  • Service areas: data flows vs. consumer value proposition
  • Value chain: increasingly complex with two key battlegrounds
  • Markets: Key Geographies Today
  • Conclusions

 

  • Figure 1: Selected Internet of Things service areas
  • Figure 2: Representative connected devices forecast, 2010-20
  • Figure 3: The popularity of ‘Internet of Things’ as a search term on Google since 2004
  • Figure 4: Connected car VC activity, 2010-13
  • Figure 5: Candidate differences between M2M and the Internet of Things
  • Figure 6: Selected leading MNOs by M2M connections globally
  • Figure 7: M2M market maturity vs. growth by geographic region
  • Figure 8: Global M2M connections by vertical, 2013-20
  • Figure 9: Global passenger car profit by geography, 2007-12
  • Figure 10: A connected car services framework
  • Figure 11: Ericsson’s vision of the connected car’s integration with the IoT
  • Figure 12: The emerging connected car value chain
  • Figure 13: Different sources of in-car connectivity
  • Figure 14: New passenger car sales vs. consumer electronics spending by market
  • Figure 15: Index of digital content spending (aggregate and per capita), 2013
  • Figure 16: OEM embedded modem shipments by region, 2014-20
  • Figure 17: Telco 2.0™ ‘two-sided’ telecoms business model

Connected Home: Telcos vs Google (Nest, Apple, Samsung, +…)

Introduction 

On January 13th 2014, Google announced its acquisition of Nest Labs for $3.2bn in cash consideration. Nest Labs, or ‘Nest’ for short, is a home automation company founded in 2010 and based in California which manufactures ‘smart’ thermostats and smoke/carbon monoxide detectors. Prior to this announcement, Google already had an approximately 12% equity stake in Nest following its Series B funding round in 2011.

Google is known as a prolific investor and acquirer of companies: during 2012 and 2013 it spent $17bn on acquisitions alone, which was more than Apple, Microsoft, Facebook and Yahoo combined (at $13bn) . Google has even been known to average one acquisition per week for extended periods of time. Nest, however, was not just any acquisition. For one, whilst the details of the acquisition were being ironed out Nest was separately in the process of raising a new round of investment which implicitly valued it at c. $2bn. Google, therefore, appears to have paid a premium of over 50%.

This analysis can be extended by examining the transaction under three different, but complementary, lights.

Google + Nest: why it’s an interesting and important deal

  • Firstly, looking at Nest’s market capitalisation relative to its established competitors suggests that its long-run growth prospects are seen to be very strong

At the time of the acquisition, estimates placed Nest as selling 100k of its flagship product (the ‘Nest Thermostat’) per month . With each thermostat retailing at c. $250 each, this put its revenue at approximately $300m per annum. Now, looking at the ratio of Nest’s market capitalisation to revenue compared to two of its established competitors (Lennox and Honeywell) tells an interesting story:

Figure 1: Nest vs. competitors’ market capitalisation to revenue

 

Source: Company accounts, Morgan Stanley

Such a disparity suggests that Nest’s long-run growth prospects, in terms of both revenue and free cash flow, are believed to be substantially higher than the industry average. 
  • Secondly, looking at Google’s own market capitalisation suggests that the capital markets see considerable value in (and synergies from) its acquisition of Nest

Prior to the deal’s announcement, Google’s share price was oscillating around the $560 mark. Following the acquisition, Google’s share price began averaging closer to $580. On the day of the announcement itself, Google’s share price increased from $561 to $574 which, crucially, reflected a $9bn increase in market capitalisation . In other words, the value placed on Google by the capital markets increased by nearly 300% of the deal’s value. This is shown in Figure 2 below:

Figure 2: Google’s share price pre- and post-Nest acquisition

 

Source: Google Finance

This implies that the capital markets either see Google as being well positioned to add unique value to Nest, Nest as being able to strongly complement Google’s existing activities, or both.

  • Thirdly, viewing the Nest acquisition in the context of Google’s historic and recent M&A activity shows both its own specific financial significance and the changing face of Google’s acquisitions more generally

At $3.2bn, the acquisition of Nest represents Google’s second largest acquisition of all time. The largest was its purchase of Motorola Mobility in 2011 for $12.5bn, but Google has since reached a deal to sell the majority of its assets (excluding its patent portfolio) to Lenovo for $2.9bn. In other words, Nest is soon to become Google’s largest active, inorganic investment. Google’s ten largest acquisitions, as well as some smaller but important ones, are shown in Figure 3 below:

Figure 3: Selected acquisitions by Google, 2003-14

Source: Various

Beyond its size, the Nest acquisition also continues Google’s recent trend of acquiring companies seemingly less directly related to its core business. For example, it has been investing in artificial intelligence (DeepMind Technologies), robotics (Boston Dynamics, Industrial Perception, Redwood Robotics) and satellite imagery (Skybox Imaging).

Three questions raised by Google’s acquisition of Nest

George Geis, a professor at UCLA, claims that Google develops a series of metrics at an early stage which it later uses to judge whether or not the acquisition has been successful. He further claims that, according to these metrics, Google on average rates two-thirds of its acquisitions as successful. This positive track record, combined with the sheer size of the Nest deal, suggests that the obvious question here is also an important one:

  • What is Nest’s business model? Why did Google spend $3.2bn on Nest?

Nest’s products, the Nest Thermostat and the Nest Protect (smoke/carbon monoxide detector), sit within the relatively young space referred to as the ‘connected home’, which is defined and discussed in more detail here. One natural question following the Nest deal is whether Google’s high-profile involvement and backing of a (leading) company in the connected home space will accelerate its adoption. This suggests the following, more general, question:

  • What does the Nest acquisition mean for the broader connected home market?

Finally, there is a question to be asked around the implications of this deal for Telcos and their partners. Many Telcos are now active in this space, but they are not alone: internet players (e.g. Google and Apple), big technology companies (e.g. Samsung), utilities (e.g. British Gas) and security companies (e.g. ADT) are all increasing their involvement too. With different strategies being adopted by different players, the following question follows naturally:

  • What does the Nest acquisition mean for telcos?

 

  • Executive Summary
  • Introduction
  • Google + Nest: why it’s an interesting and important deal
  • Three questions raised by Google’s acquisition of Nest
  • Understanding Nest and Connected Homes
  • Nest: reinventing everyday objects to make them ‘smart’
  • Nest’s future: more products, more markets
  • A general framework for connected home services
  • Nest’s business model, and how Google plans to get a return on its $3.2bn investment 
  • Domain #1: Revenue from selling Nest devices is of only limited importance to Google
  • Domain #2: Energy demand response is a potentially lucrative opportunity in the connected home
  • Domain #3: Data for advertising is important, but primarily within Google’s broader IoT ambitions
  • Domain #4: Google also sees Nest as partial insurance against IoT-driven disruption
  • Domain #5: Google is pushing into the IoT to enhance its advertising business and explore new monetisation models
  • Implications for Telcos and the Connected Home
  • The connected home is happening now, but customer experience must not be overlooked
  • Telcos can employ a variety of monetisation strategies in the connected home
  • Conclusions

 

  • Figure 1: Nest vs. competitors’ market capitalisation relative to revenue
  • Figure 2: Google’s share price, pre- and post-Nest acquisition
  • Figure 3: Selected acquisitions by Google, 2003-14
  • Figure 4: The Nest Thermostat and Protect
  • Figure 5: Consumer Electronics vs. Electricity Spending by Market
  • Figure 6: A connected home services framework
  • Figure 7: Nest and Google Summary Motivation Matrix
  • Figure 8: Nest hardware revenue and free cash flow forecasts, 2014-23
  • Figure 9: PJM West Wholesale Electricity Prices, 2013
  • Figure 10: Cooling profile during a Rush Hour Rewards episode
  • Figure 11: Nest is attempting to position itself at the centre of the connected home
  • Figure 12: US smartphone market share by operating system (OS), 2005-13
  • Figure 13: Google revenue breakdown, 2013
  • Figure 14: Google – Generic IoT Strategy Map
  • Figure 15: Connected device forecasts, 2010-20
  • Figure 16: Connected home timeline, 1999-Present
  • Figure 17: OnFuture EMEA 2014: The recent surge in interest in the connected home is due to?
  • Figure 18: A spectrum of connected home strategies between B2C and B2B2C (examples)
  • Figure 19: Building, buying or partnering in the connected home (examples)
  • Figure 20: Telco 2.0™ ‘two-sided’ telecoms business model

The Great Compression: surviving the ‘Digital Hunger Gap’

Introduction

The Silicon Valley Brainstorm took place on 19-20 March 2013, at the Intercontinental Hotel, San Francisco.

Part of the New Digital Economics Executive Brainstorm & Innovation Series, it built on output from previous events in Singapore, Dubai, London and New York, and new market research and analysis, and focused on new business models and growth opportunities in digital commerce, content and the Internet of Things.

Summary Analysis: ‘The Great Compression’

In the next 10 years, many industries face the ‘Great Compression’ in which, in addition to the pressures of ongoing global economic uncertainty, there is also a major digital transformation that is destroying traditional value and moving it ‘disruptively’ to new areas and geographies, albeit at diminished levels.

In previous analyses (e.g. Dealing with the ‘Disruptors’: Google, Apple, Facebook, Microsoft/Skype and Amazon) we have shown how key technology players in particular compete with different objectives in different parts of the digital value chain. Figure 1 below shows via crossed dollar signs (‘New Non-Profit’) the areas in which companies are competing without the primary intention of driving profits, which means that traditional competitors in those areas can expect ‘disruptive’ competition from new business models.

Figure 1 – Digital disruption
Digital disruption occurring in many industries Mar 2013

Source: STL Partners ‘Dealing with the ‘Disruptors’: Google, Apple, Facebook, Microsoft/Skype and Amazon’

 

The Digital Hunger Gap

For the incumbent industry players we call the near-term results of this disruption ‘The Digital Hunger Gap’ – the widening deficit between past and projected revenues. Chris Barraclough, Chief Strategist STL Partners presented the classic Music Industry case study of the ‘Hunger Gap’ effects of digital disruption.

Figure 2 – The Music Industry’s ‘Hunger Gap’
The Music Industry's ‘Hunger Gap’ Mar 2013

Source: STL Partners

 

In a vote, 95% of participants agreed that something similar would happen in other industries.

Chris then presented our initial analysis of the ‘Hunger Gap’ for telcos (to be published in full shortly), and asked the participants where they thought the telco industry would be relative to its 2012 position in 2020.

Figure 3 – Participants’ views on forecasts for the telecoms industry
Participants' views on forecasts for the telecoms industry Mar 2013

Source: Silicon Valley 2013 Participants / STL Partners

 

As can be seen, participants’ views were widely spread, with a slight bias towards a more pessimistic outlook than that presented of a recovery to 2012 levels.

Chris argued that as the ‘hunger gap’ widens, and before new revenues are developed, there will be massive consolidation and cost-reduction among incumbent players, and opportunities for innovation in services, but the chances of success in the latter are very low and require a portfolio approach and either deep pockets, exceptional insight, or considerable good fortune.

Richard Kramer, Managing Partner of Arete Research, also presented a deflationary outlook for all but the leading consumer technology players in the handset and tablet arena.

Participants then voted on which areas needed the most significant changes in their business – and existing managements’ ‘mindset’ was voted as the top priority.

Figure 4 – ‘Mindset’ is the biggest barrier to transformation
'Mindset' is the biggest barrier to transformation Mar 2013

Source: Silicon Valley 2013 Participants / STL Partners

 

It is also notable that all categories averaged 3.0 or over – or needing ‘Significant Change’. This points to a significant transformation across all industries.

Content:

  • Opportunities
  • Telco 2.0 Strategies
  • Big Data and Personal Data
  • Digital Commerce
  • Digital Entertainment
  • Mobile Advertising & Marketing
  • The Internet of Things
  • Outlook by Industry
  • Next Steps

 

  • Figure 1 – Digital disruption
  • Figure 2 – The Music Industry’s ‘Hunger Gap’
  • Figure 3 – Participants’ views on forecasts for the telecoms industry
  • Figure 4 – ‘Mindset’ is the biggest barrier to transformation
  • Figure 5 – The ‘Telco 2.0’ opportunities for CSPs
  • Figure 6 – The impact of ‘Software Defined Networks’ (SDN)
  • Figure 7 – Will ‘Personal Data’ be more useful than ‘Big Data’?
  • Figure 8 – STL Partners’ ‘Wheel of Digital Commerce’
  • Figure 9 – Who will in ‘SoMoLo’?
  • Figure 10 – Significant changes in viewing habits
  • Figure 11 – Transformation needed in the advertising industry
  • Figure 12 – Growth projections for M2M ‘mobile’ (e.g. 3G/4G) connected devices