The powerful capabilities of smart, connected products
not only reshape competition within an industry,
but they can expand the very definition of the industry
itself. The competitive boundaries of an industry
widen to encompass a set of related products that together
meet a broader underlying need. The function
of one product is optimized with other related products.
For example, integrating smart, connected farm
equipment—such as tractors, tillers, and planters—
can enable better overall equipment performance.
The basis of competition thus shifts from the
functionality of a discrete product to the performance
of the broader product system, in which the
firm is just one actor. The manufacturer can now offer
a package of connected equipment and related
services that optimize overall results. Thus in the
farm example, the industry expands from tractor
manufacturing to farm equipment optimization. In
mining, Joy Global has shifted from optimizing the
performance of individual pieces of mining equipment
to optimizing across the fleet of equipment
deployed in the mine. Industry boundaries expand
from discrete types of mining machines to mining
equipment systems.
Increasingly, however, industry boundaries are
expanding even beyond product systems to systems
of systems—that is, a set of disparate product systems
as well as related external information that can
be coordinated and optimized, such as a smart building,
a smart home, or a smart city. John Deere and
AGCO, for example, are beginning to connect not only
farm machinery but irrigation systems and soil and
nutrient sources with information on weather, crop
prices, and commodity futures to optimize overall
VIDEO For a case s tu d y and
v id e o on h ow Jo y G lo b a l’s
sm a rt, c o n n e c te d m in in g
e q u ipm e n t tra n s fo rm s mine
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in s ig h ts /io t.
N o v em b e r 2 0 14 Harvard Business Review 75
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS
CHARTING THE IMPACT ON COMPETITION
This article is the first
in a two-part series
in which we examine
how smart, connected
products are shifting
competition in many
industries. At the most
fundamental level,
companies must
ask four questions:
1 How does the move
to smart, connected
products affect the
structure of the industry
and industry boundaries?
2 How do smart,
connected products
affect the configuration
of the value chain or
the set of activities
required to compete?
3 What new types of
strategic choices will
smart, connected products
require companies to
make to achieve
competitive advantage?
4 What are the
organizational implications
of embracing these new
types of products and
the challenges that affect
implementation success?
In this article, we examine
the effect o f smart, connected
products on industry
structure and industry
boundaries and discuss the
new strategic choices facing
companies. In part two
(forthcoming), we examine
value chain impacts and
organizational issues.
(Disclosure: PTC does business with more than
2 8,000 companies w orldwide, many o f which
are mentioned in this article.)
farm performance. Smart homes, which involve numerous
product systems including lighting, HVAC,
entertainment, and security, are another example.
Companies whose products and designs have the
greatest impact on total system performance will be
in the best position to drive this process and capture
disproportionate value.
Some companies—like John Deere, AGCO, and
Joy Global—are intentionally seeking to broaden
and redefine their industries. Others may find themselves
threatened by this development, which creates
new competitors, new bases for competition,
and the need for entirely new and broader capabilities.
Companies that fail to adapt may find their traditional
products becoming commoditized or may
themselves be relegated to the role of OEM supplier,
with system integrators in control.
The net effect of smart, connected products on
industry structure will vary across industries, but
some tendencies seem clear. First, rising barriers to
entry, coupled with first-mover advantages stemming
from the early accumulation and analysis of
product usage data, suggests that many industries
may undergo consolidation.
Second, consolidation pressures will be amplified
in industries whose boundaries are expanding. In
such cases, single product manufacturers will have
difficulty competing with multiproduct companies
that can optimize product performance across
broader systems. Third, important new entrants
are likely to emerge, as companies unencumbered
by legacy product definitions and entrenched ways
of competing, and with no historical profit pools to
protect, seize opportunities to leverage the full potential
of smart, connected products to create value.
Some of these strategies will be “productless”—that
is, the system that connects products will be the core
advantage, not the products themselves.
Sm a r t , Co n n e c ted Pro d u c ts and
C om p e titiv e A d v a n ta g e
How can companies achieve sustainable competitive
advantage in a shifting industry structure? The
basic tenets of strategy still apply. To achieve competitive
advantage, a company must be able to differentiate
itself and thus command a price premium,
operate at a lower cost than its rivals, or both. This
allows for superior profitability and growth relative
to the industry average.
The foundation for competitive advantage is operational
effectiveness (OE). OE requires embracing
best practices across the value chain, including upto-
date product technologies, the latest production
equipment, and state-of-the-art sales force methods,
IT solutions, and supply chain management
approaches.
OE is the table stakes of competition. If a company
is not operationally effective and continually embracing
new best practices, it will fall behind rivals in
cost and quality. Yet OE is rarely a source of sustainable
advantage, because competitors will implement
the same best practices and catch up.
To move beyond OE, a company must define a distinctive
strategic positioning. Whereas operational
effectiveness is about doing things well, strategic positioning
is about doing things differently. A company
must choose how it will deliver unique value to the
set of customers it chooses to serve. Strategy requires
making trade-offs: deciding not only what to do but
what not to do.
Smart, connected products are defining a new
standard for operational effectiveness, dramatically
raising the bar in terms of best practices. Every product
company will have to decide how to incorporate
smart, connected capabilities into its products. But
not only the product itself is being affected. As we
discussed earlier, the move to smart, connected
76 Harvard Business Review N o v em b e r 20 14
HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG
products also creates new best practices across the
value chain.
The implications of smart, connected products
for the value chain will be discussed in detail in
the second article in this series (see the sidebar
“Charting the Impact on Competition”). Here we
focus briefly on how smart, connected products
affect product design, service, marketing, human
resources, and security, because these shifting internal
activities often bear directly on strategy choices.
Design. Smart, connected products require a
whole set of new design principles, such as designs
that achieve hardware standardization through
software-based customization, designs that enable
personalization, designs that incorporate the ability
to support ongoing product upgrades, and designs
that enable predictive, enhanced, or remote service.
Expertise in systems engineering and in agile software
development is essential to integrate a product’s
hardware, electronics, software, operating
system, and connectivity components—expertise
that is not well developed in many manufacturing
companies. Product development processes will
also need to accommodate more late-stage and postpurchase
design changes quickly and efficiently.
Companies will need to synchronize the very different
“clock speeds” of hardware and software development;
a software development team might create
as many as to iterations of an application in the time
it takes to generate a single new version of the hardware
on which it runs.
After-sale service. Smart, connected products
offer major improvements in predictive maintenance
and service productivity. New service organizational
structures and delivery processes are required to take
advantage of product data that can reveal existing
and future problems and enable companies to make
timely, and sometimes remote, repairs. Real-time
product usage and performance data allows substantial
reductions in field-service dispatch costs and major
efficiencies in spare-parts inventory control. Early
warnings about impending failure of parts or components
can reduce breakdowns and allow more efficient
service scheduling. Data on product usage and
performance can feed insights back to product design,
so that firms can reduce future product failures and
associated service required. Product usage data can
also be used to validate warranty claims and identify
warranty agreement violations.
Joy Global
Smart, connected mining
machines such as this Joy
Global longwall shearer
autonomously coordinate
with other equipment to
improve mining efficiency.
In some cases, firms can decrease service costs by
replacing physical parts with “software parts.” For example,
glass cockpit LCD displays in modem aircraft,
which can be repaired or upgraded via software, have
replaced electrical and mechanical dials and gauges.
Product usage data also enables firms to better “design
for service”—that is, reduce the complexity or
placement of parts that are prone to failure in order
to simplify repairs. All these opportunities change
the service activities in the value chain substantially.
Marketing. Smart, connected products allow
companies to form new kinds of relationships with
customers, requiring new marketing practices and
skill sets. As companies accumulate and analyze
product usage data, they gain new insights into how
products create value for customers, allowing better
positioning of offerings and more effective communication
of product value to customers. Using data
analytics tools, firms can segment their markets in
more-sophisticated ways, tailor product and service
bundles that deliver greater value to each segment,
and price those bundles to capture more of that
value. This approach works best when products can
be quickly and efficiently tailored at low marginal
cost through software (as opposed to hardware)
variation. For example, whereas John Deere used to
manufacture multiple engines with different levels of
horsepower to serve different customer segments, it
now can modify the horsepower rating on the same
engine using software alone.
Human resources. Smart, connected products
create major new human resource requirements
and challenges. The most urgent of these is the need
to recruit new skill sets, many of which are in high
demand. Engineering departments, traditionally
staffed with mechanical engineers, must add talent
in software development, systems engineering,
product clouds, big data analytics, and other areas.
Security. Smart, connected products create the
need for robust security management to protect the
data flowing to, from, and between products; protect
products against unauthorized use; and secure access
between the product technology stack and other
corporate systems. This will require new authentication
processes, secure storage of product data, protections
against hackers for both product data and
customer data, definition and control of access privileges,
and protections for products themselves from
hackers and unauthorized use.
November 2014 Harvard Business Review 77
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS
Implications for Strategy
The path to competitive advantage ultimately rests
on strategy. Our research reveals that in a smart,
connected world companies face 10 new strategic
choices. Each choice involves trade-offs, and each
must reflect a company’s unique circumstances. The
choices are also interdependent. The company’s entire
set of choices must reinforce one another and
define a coherent and distinctive overall strategic positioning
for the company.
Which set of smart, connected product
capabilities and features should the company
pursue? Smart, connected products dramatically
expand the range of potential product capabilities
and features. Companies may be tempted to add
as many new features as possible, especially given
the often low marginal cost of adding more sensors
and new software applications, and the largely fixed
costs of the product cloud and other infrastructure.
But just because a company can offer many new capabilities
does not mean that their value to customers
exceeds their cost. And when companies get into
a features and capabilities arms race, they end up
blurring strategic differences and creating zero-sum
competition.
How should a company determine which smart,
connected capabilities to offer? First, it must decide
which features will deliver real value to customers
relative to their cost. In residential water heaters,
A.O. Smith has developed capabilities for fault
monitoring and notification, but water heaters are
so long-lived and reliable that few households are
willing to pay enough for these features to justify
their current cost. Consequently, A.O. Smith offers
them as options on only a few models. In commercial
water heaters and boilers, however, adoption of
such capabilities is high and rising. The value of remote
monitoring and operation to commercial customers
that often cannot operate without heat and
hot water is high relative to their cost, and so these
features are becoming standard. Note that the cost
of incorporating smart, connected product features
will tend to fall over time, as is the case in water
heaters and boilers. When deciding what features
to offer, then, companies must continually revisit
the value equation.
Second, the value of features or capabilities
will vary by market segment, and so the selection
of features a company offers will depend on what
segments it chooses to serve. Schneider Electric, for
example, makes building products as well as integrated
building management solutions that gather
volumes of data about energy consumption and
other building performance metrics. For one segment
of customers, Schneider’s solution involves
remote equipment monitoring, alerts, and advisory
services in reducing energy use and other costs. For
the segment of customers that want a fully outsourced
solution, however, Schneider actually takes
over remote control of equipment to minimize energy
consumption on customers’ behalf.
Third, a company should incorporate those capabilities
and features that reinforce its competitive
positioning. A company competing with a high-end
strategy can often reinforce differentiation through
extensive features, while a low-cost competitor may
choose to include only the most basic features that
affect core product performance and that lower
the cost of operation. For example, A.O. Smith’s
Lochinvar boiler unit, which competes using a
highly differentiated strategy, has made extensive
smart, connected product features standard on its
core products. In contrast, Rolex, the luxury watch
maker, has decided that smart, connected capabilities
are not an area in which it will compete.
_ How much functionality should be embedded
in the product and how much in
the cloud? Once a company has decided which capabilities
to offer, it must decide whether the enabling
technology for each feature should be embedded
in the product (raising the cost of every product),
delivered through the product cloud, or both. In addition
to cost, a number of factors should be taken
into consideration.
Response time. A feature that requires quick response
times, such as a safety shutdown in a nuclear
power plant, requires that the software be embedded
in the physical product. This also reduces the
risk that lost or degraded connectivity slows down
response.
Automation. Products that are fully automated,
such as antilock brakes, usually require that greater
functionality be embedded into the device.
Network availability, reliability, and security.
Embedding software in the product minimizes dependence
on network availability and the amount
of data that must flow from the product to cloudbased
applications, lowering the risk that sensitive
Tesla
A Tesla vehicle in need of
repairs can autonomously
call for a corrective software
download, or, if necessary,
send a notification to the
customer with an invitation
for a valet to pick up the
car and deliver it to a Tesla
facility.
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HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG
or confidential data will be compromised during
transmission.
L o c a tio n o f p r o d u c t u s e . Companies that operate
products in remote or hazardous locations can
mitigate the associated dangers and costs by hosting
functionality in the product cloud. As discussed
above, Thermo Fisher’s chemical analyzers, used in
hazardous or toxic environments, have cloud-based
capabilities and connectivity that enable the instantaneous
transmission of contamination data and allow
the immediate initiation of mitigation efforts.
N a tu r e o f u s e r in te r fa c e . If the product’s user
interface is complex and is changed frequently, the
interface may be best located in the cloud. The cloud
offers the ability to deliver a much richer user experience
and potentially to take advantage of an existing,
familiar, and robust user interface like a smartphone.
F req u en c y o f s e rv ic e o r p ro d u c t u p g ra d e s . Cloudbased
applications and interfaces allow companies
to make product changes and upgrades easily and
automatically.
Home audio equipment maker Sonos, a smart,
connected products pioneer, takes advantage of
cloud-based capability to “reinvent home audio for
the digital age,” putting a premium on convenience,
variety of music, and ease of use. The company’s
wireless systems place both the music source and
the user interface in the cloud, enabling Sonos to
simplify its products’ physical design: The portable
device, which is controlled from a smartphone, contains
only the amplifier and speaker. With this offering,
Sonos attempted to disrupt the home audio market.
The trade-off? Wireless streamed audio systems
do not deliver the level of sound quality that true
audiophiles demand. Competitors such as Bose will
make different choices and trade-offs to secure their
competitive differentiation.
We believe that as smart, connected products
evolve, more human-machine interface capabilities
may well move out of the product and into the cloud.
However, the complexity facing users in operating
these interfaces will increase. User interfaces may often
overshoot in complexity, and user backlash may
drive firms to restore simpler, easy-to-use interfaces
for common functions, including on/off controls.
^ Should the company pursue an open or
^ closed system? Smart, connected products
involve multiple types of functionality and services,
and are often systems encompassing multiple
products. A closed system approach aims to have
customers purchase the entire smart, connected
product system from a single manufacturer. Key
interfaces are proprietary, and only chosen parties
gain access. The operating data that GE gathers
from its aircraft engines, for example, is available
only to the airlines operating the engines. An open
system, by contrast, enables the end customer to assemble
the parts of the solution—both the products
involved and the platform that ties the system together—
from different companies. Here, the interfaces
enabling access to each part of the system are
open or standardized, allowing outside players to
create new applications.
Closed systems create competitive advantage by
allowing a company to control and optimize the design
of all parts of the system relative to one another.
The company maintains control over technology and
data as well as the direction of development of the
product and the product cloud. Producers of system
components are restricted from accessing a closed
system or are required to license the right to integrate
their products into it. A closed approach may result
in one manufacturer’s system becoming the de facto
industry standard, enabling this company to capture
the maximum value.
A closed approach requires significant investment
and works best when a single manufacturer
has a dominant position in the industry that can be
leveraged to control the supply of all parts of the
smart, connected product system. If either Philips
Healthcare or GE Healthcare were the dominant
manufacturer of medical imaging equipment, for
example, it could drive a closed approach in which
it could sell medical imaging management systems
that included only its own or partners’ equipment to
hospitals. However, neither company has the clout
to restrict hospitals’ choice of other manufacturers’
equipment, so both companies’ imaging system platforms
interface with other manufacturers’ machines.
A fully open system enables any entity to participate
in and interface with the system. When Philips
Lighting introduced the hue smart, connected
lightbulb, for example, it included a basic smartphone
application that allowed users to control
the color and intensity of individual bulbs. Philips
also published the application programming interface,
which led independent software developers to
quickly release dozens of applications that extended
the utility of the hue bulbs, boosting sales. The open
Wind
Turbine
When smart wind turbines
are networked, software
can adjust the blades
on each one to minimize
impact on the efficiency
of turbines nearby.
November 2014 Harvard Business Review 79
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS
Babolat
Babolat’s Play Pure Drive
product system puts
sensors and connectivity
in the tennis racket handle,
allowing users to track and
analyze ball speed, spin,
and impact location to
improve their game.
approach enables a faster rate of applications development
and system innovation as multiple entities
contribute. It can also result in a de facto industry
standard, but one from which no company gains a
proprietary benefit.
While a closed system is possible for individual
product systems, it is often impractical for systems
of systems. Whirlpool, for example, realizes that its
strong position in home appliances will not be sufficient
to become the leader in the “connected home,”
which includes not only connected appliances but
also automated lighting, HVAC, entertainment, and
security. Therefore, Whirlpool designs its appliances
to be readily connectable to the variety of home automation
systems on the market, seeking to retain
proprietary control only over its product features. A
hybrid approach, in which a subset of functionality
is open but the company controls access to full capabilities,
occurs in industries like medical devices,
where manufacturers support an industry standard
interface but offer greater functionality only to customers.
Over time, closed approaches become more
challenging as technology spreads and customers
resist limits on choice.
Should the company develop the full set
of smart, connected product capabilities
and infrastructure internally or outsource to
vendors and partners? Developing the technology
stack for smart, connected products requires
significant investment in specialized skills, technologies,
and infrastructure that have not been typically
present in manufacturing companies. Many of these
skills are scarce and in high demand.
A company must choose which layers of technology
to develop and maintain in-house and which
to outsource to suppliers and partners. In utilizing
outside partners, it must decide whether to pursue
custom development of tailored solutions or license
off-the-shelf, best-of-breed solutions at each level.
Our research suggests that the most successful companies
choose a judicious combination of both.
Companies that develop smart, connected products
in-house internalize key skills and infrastructure
and retain greater control over features, functionality,
and product data. They may also capture
first-mover advantages and the ability to influence
the direction of technology development. The company
gets on its own, steeper learning curve, which
can help maintain its competitive advantage. For
example, while software skills are not well developed
in most manufacturing companies, Jefflmmelt
recently said that “every industrial company will become
a software company.” The nature of technology
for smart, connected products makes it clear
why that might well be true and why building internal
software capability is crucial.
Early pioneers AGCO and Deere have both taken a
largely in-house route to develop smart farm equipment
solutions for those reasons. GE has created a
major software development center to build in-house
capabilities it sees as strategic across business units.
However, as with the two previous IT waves, the
difficulty, skills, time, and cost involved in building
the entire technology stack for smart, connected
products is formidable and leads to specialization at
each layer. Just as Intel has specialized in microprocessors
and Oracle in databases, new firms that specialize
in components of the smart, connected products
technology stack are already emerging, and their
technology investments are amortized over many
thousands of customers. Early movers that choose
in-house development can overestimate their ability
to stay ahead and end up slowing down their development
time line.
But outsourcing can create new costs, as suppliers
and partners demand a larger share of the value created.
Companies that rely on partners also compromise
their ability to differentiate going forward, and
their ability to build and retain the in-house expertise
required to set overall product design strategy, manage
innovation, and choose vendors well.
In making these build-versus-buy choices, companies
should identify those technology layers that
offer the greatest opportunities for product insight,
future innovation, and competitive advantage, and
outsource those that will become commoditized or
advance too quickly. For example, most companies
should strive to maintain solid internal capabilities
in areas such as device design, the user interface,
systems engineering, data analytics, and rapid product
application development.
These choices will evolve over time. In the early
stages of smart, connected products technology, the
number of capable and robust suppliers has been limited,
and so companies have been faced with the imperative
of in-house or custom development. Already,
however, best-of-breed vendors with turnkey connectivity
solutions and product clouds, secure highperformance
application platforms, and ready-to-use
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HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG
data analytics are emerging. This makes it increasingly
challenging for in-house efforts to keep up and
can turn an early lead into a disadvantage.
_ What data must the company capture,
** secure, and analyze to maximize the
value of its offering? Product data is fundamental
to value creation and competitive advantage in
smart, connected products. But collecting data requires
sensors, which add cost to the product, as
does transmitting, storing, securing, and analyzing
this data. Companies may also need to obtain rights
to the data, adding complexity and cost. To determine
which types of data provide sufficient value
relative to cost, the firm must consider questions
such as: How does each type of data create tangible
value for functionality? For efficiency in the value
chain? Will the data help the company understand
and improve how the broader product system is performing
over time? How often does the data need to
be collected to optimize its usefulness, and how
long should it be retained?
Companies must also consider the product integrity,
security, or privacy risks for each type of data
and the associated cost. The less sensitive data a
company collects, the lower the risk of breaches and
transmission disruptions. When security requirements
are high, companies will need capabilities to
protect the data and limit transmission risk by storing
data in the product itself. (We will discuss security
more extensively in part two of this series.)
The types of data a company chooses to collect
and analyze also depend on its positioning. If the
company’s strategy is focused on leading in product
performance or minimizing service cost, it must
usually capture extensive “immediate value” data
that can be leveraged in real time. This is especially
important for complex, expensive products for
which downtime is costly, such as wind turbines or
jet engines.
For companies seeking leadership in the product
system, there is a need to invest in capturing and analyzing
more-extensive data across multiple products
and the external environment, even for products the
company does not produce. For example a smart,
connected product system might need to capture
traffic data, weather conditions, and fuel prices at
different locations for an entire fleet of vehicles.
Different strategies involve different data-capture
choices. Nest, which aims to lead in energy efficiency
and energy cost, gathers extensive data on both
product usage and peak demand across the energy
grid. This has enabled the Rush Hour Rewards program,
which raises residential customers’ air conditioning
thermostat temperature to reduce energy
use during peak demand periods and precools a
home before peak demand begins. By partnering
with energy providers, securing the data they provide,
and integrating it with customer data, Nest
enables customers to earn discounts or credits from
their energy provider and to use less energy when
everyone else is using more.
How does the company manage ownership
and access rights to its product
data? As a company chooses which data to gather
and analyze, it must determine how to secure rights
to the data and manage data access. The key is who
actually owns the data. The manufacturer may own
the product, but product usage data potentially belongs
to the customer. For example, who is the rightful
owner of the data streaming from a smart, connected
aircraft engine—the engine supplier, the
airframe manufacturer, or the airline that owns and
operates the planes?
There is a range of options for establishing data
rights for smart, connected products. Companies
may pursue outright ownership of product data, or
seek joint ownership. There are also various levels of
usage rights, including NDAs, the right to share the
data, or the right to sell it. Firms must determine their
approach to transparency in data collection and use.
Rights to data can be laid out in an explicit agreement
or buried in small print or hard-to-understand boilerplate
documents. Although we are seeing the early
stages of a movement toward more transparency in
data gathering across industries, data disclosure and
ownership standards often have yet to be established.
Another option for handling data rights and access
includes the establishment of a data-sharing
framework with component suppliers for providing
information about the component’s condition and
performance but not about its location. Limiting suppliers’
access to data, however, could reduce potential
benefits if the supplier lacks a full understanding
of how products are being used, slowing innovation.
Customers and users want a say in these choices.
Some customers today are much more willing than
others to share data on their product use. For example,
part of Fitbit’s value proposition is its ability
Medtronic
Medtronic’s implanted
digital blood glucose meter
connects wirelessly to a
monitoring and display
device and can alert
patients to trends in glucose
levels requiring attention.
Ralph
Lauren
Ralph Lauren’s Polo Tech
Shirt, available in 2015,
streams distance covered,
calories burned, movement
intensity, heart rate, and
other data to the wearer’s
mobile device.
6
November 2014 Harvard Business Review 8i
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG
to share via social media the personal fitness information
it collects. But not every customer wants to
share this data. Likewise, cautious drivers may be
willing to share data on their driving habits with insurance
or rental car companies as a way to lower
premiums or fees, but others may resist. Firms will
need to provide a clear value proposition to customers
to encourage them to share usage or other
data. As consumers become more aware of the value
that data generates across the value chain, they will
become more active and demanding participants
in decisions about what data is collected, how it is
used, and who benefits.
Today it’s common to see “click through” agreements
giving broad consent to collect product data
the first time a smart, connected product is used.
This consent allows companies to indiscriminately
collect product data and use it with few constraints.
In time we expect that more-stringent contractual
frameworks and mechanisms governing those rights
will emerge to define and protect intellectual property
associated with smart, connected product data.
It behooves companies to get ahead of this trend, especially
on the product data they truly need to collect
in order to drive value.
Careful stewardship of data will also be essential,
especially in highly regulated industries such as medical
devices. Regulatory standards for data access
and security are already in place in many such fields.
Biotronik has created infrastructure that allows it to
securely gather patient information, such as arrhythmia
events or pacemaker battery status, and share it
only with a specified audience—the patient’s physician.
Regardless of the industry, however, stewardship
of data will be an essential capability, and data
breaches will lead to serious consequences regardless
of who is at fault. Ongoing security risk is part of
the business case for which data to collect and how
to manage it.
— Should the company fully or partially dis-
‘ intermediate distribution channels or
service networks? Smart, connected products enable
firms to maintain direct and deep customer relationships,
which can reduce the need for distribution
channel partners. Companies can also diagnose
product performance problems and failures and
sometimes make repairs remotely, reducing reliance
on service partners. By minimizing the role of the
middlemen, companies can potentially capture new
revenue and boost margins. They can also improve
their knowledge of customer needs, strengthen
brand awareness, and boost loyalty by educating
customers more directly about product value.
Tesla, for example, has disrupted the status quo
in the automotive industry by selling its cars directly
to consumers rather than through a traditional
dealer network. This has simplified the firm’s pricing-
consumers pay full sticker price, avoiding the
haggling common at dealerships—greatly improving
customer satisfaction. By eliminating third-party
involvement in repairs, Tesla captures revenue and
deepens its relationship with customers. The firm
transmits software upgrades to its cars, continually
improving the customer experience and giving drivers
the equivalent of the “new car smell” with each
update. When monitoring detects that a Tesla vehicle
is due for repairs, the car either autonomously
calls for a remote repair via software or sends a notification
to the customer with an invitation to request
that a valet deliver it to the Tesla facility. The firm
was recently rated number one in customer satisfaction
by Consumer Reports.
While disintermediation has definite advantages,
some level of physical proximity to customers is still
required and desirable in most industries. Customers
must take delivery of and sometimes install a physical
product, and some types of service visits are still
necessary. In addition, customers may have strong
relationships with resellers and channels that offer
them a broader product line and deep and local fieldbased
expertise. When manufacturers diminish the
role of valuable channel partners, they risk losing
them to competitors whose strategy is to embrace
partners. Also, assuming roles formerly handled by
partners—such as direct selling or service—can be
challenging, involving high start-up costs and major
new investments in value chain functions such as
sales, logistics, inventory, and infrastructure.
The choice of whether or not to disintermediate
a channel or service partner will depend in large
part on the type of partner network the firm manages.
Do partners simply distribute products, or are
they critical to delivering training and service in the
field? What percentage of partner activities can be
replaced through smart, connected product capabilities?
Do customers understand the value of eliminating
the middleman? Do customers understand
that traditional relationships with established channels
are no longer necessary and involve extra cost?
82 Harvard Business Review No v emb e r 2014
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG
MISTAKES TO AVOID
Smart, connected products offer a rich new set of
value creation and growth opportunities. However,
efforts to seize those opportunities will not be
without challenges. Some of the greatest strategic
risks include the following:
Adding functionality th a t customers don’t want to pay for. Just because a
feature is now possible does not mean there is a clear value proposition for
the customer. Adding enhanced capabilities and options can reach the point
o f diminishing returns, due to the cost and complexity o f use.
Underestimating security and privacy risks. Smart, connected products
open major new gateways to corporate systems and data, requiring
stepped-up network security, device and sensor security, and information
encryption.
Failing to anticipate new competitive threats. New competitors offering
products with smart, connected capabilities (such as connectivity and
embedded software) or performance- or service-based business models can
emerge quickly and reshape competition and industry boundaries.
Waiting too long to get started. Moving slowly enables competitors and
new entrants to gain a foothold, begin capturing and analyzing data, and
s ta rt moving up the learning curve.
Overestimating internal capabilities. The shift to smart, connected
products w ill demand new technologies, skills, and processes throughout
the value chain (for example, big data analytics, systems engineering, and
software application development). A realistic assessment about which
capabilities should be developed in-house and which should be developed
by new partners is crucial.
g Should th e com p an y change its business
mo del? Manufacturers have traditionally focused
on producing a physical good and capturing
value by transferring ownership of the good to the
customer through a sales transaction. The owner is
then responsible for the costs of servicing the product
and other costs of use, while bearing the risks of
downtime and other product failures and defects not
covered by warranties.
Smart, connected products allow the radical alteration
of this long-standing business model. The
manufacturer, through access to product data and
the ability to anticipate, reduce, and repair failures,
has an unprecedented ability to affect product performance
and optimize service. This opens up a
spectrum of new business models for capturing
value, from a version of the traditional ownership
model where the customer benefits from the new
service efficiencies to the product-as-a-service
model in which the manufacturer retains ownership
and takes full responsibility for the costs of product
operation and service in return for an ongoing
charge. Customers pay as they go, not up front. Here,
the value of product performance improvements
that reduce operating cost (such as better energy efficiency)
and service efficiencies are captured by the
manufacturer.
Smart, connected products create a dilemma for
manufacturers, particularly those that make complex,
long-lived products for which parts and service
generate significant revenue and often disproportionate
profit. Whirlpool, for example, currently has
a healthy business selling spare parts and service
contracts—a model that can dull incentives to make
products more reliable, more durable, and easier to
fix. If, instead, Whirlpool moved to a product-as-aservice
model, in which it maintained ownership of
the product and the customer simply paid for the use
of the machine, the economic incentives would be
turned upside down.
The profitability of product-as-a-service models
depends on the pricing and terms of contracts, which
are a function of bargaining power. Product-as-aservice
models can increase buyers’ power, because
customers may be able to switch after the contract
period (if the product is not embedded as with an elevator),
unlike with perpetual ownership.
Product sharing, a variation of the product-as-aservice
model, focuses on more efficient utilization
of products that are used intermittently. Customers
pay for the use of the product (such as cars or bikes)
when they need it, and the company (such as Zipcar
or Hubway) is responsible for everything else.
Product sharing is spreading to non-mobile products
such as houses.
Companies can also pursue hybrid models between
the extremes of product-as-a-service and conventional
ownership, such as product sales bundled
with warranty or service contracts, or product sales
bundled with performance-based contracts. Service
contracts allow the manufacturer to keep service inhouse
and capture more of the value from service
efficiencies. In a performance-based contract, the
manufacturer sells the product along with a contract
that promises that the product will perform to certain
specifications (such as percentage of uptime).
Here, ownership is transferred, but the manufacturer
maintains responsibility and bears the risk of
product performance.
8 4 Harvard Business Review N o v em b e r 2014
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG
q Should the company enter new businesses
- * by monetizing its product d ata through
selling it to outside parties? Companies may find
that the data they accumulate from smart, connected
products is valuable to entities besides traditional
customers. Companies may also discover that they
can capture additional data, beyond what they need
to optimize product value, that is valuable to other
entities. In either case, this may lead to new services
or even new businesses.
Data about the performance of a product’s components,
for example, could be valuable to suppliers
of those components. Data about driving conditions
or delays gathered by a fleet of vehicles could be valuable
to other drivers, to the operators of logistical
systems, or to road repair crews. Data about driving
characteristics could be valuable to fleet operators or
insurance companies.
Again, in choosing how to capture new value from
product data, companies must consider the likely reaction
of core customers. While some of them may not
care how their data is used, others may feel strongly
about data privacy and reuse. Companies will need to
identify mechanisms to provide valuable data to third
parties without alienating customers. For example, a
company might not sell individual customer data but
rather blinded or aggregate data on purchasing patterns,
driving habits, or energy usage.
Should the company expand its scope?
Smart, connected products not only transform
existing products but often broaden industry boundaries.
Products that have been separate and distinct
can become parts of optimized systems of related
products, or components of systems of systems.
Shifting boundaries mean that companies that have
been industry leaders for decades may find themselves
playing more of a supporting role in a broader
landscape.
The emergence of product systems and systems
of systems raises at least two types of strategic
choices about company scope. The first is w hether
a company should expand into related products or
other parts of the system of systems. The second is
whether a company should seek to provide the platform
that connects the related products and information,
even if it does not make or control all the parts.
Companies may be tempted to enter into related
products in order to capture the big opportunity,
but entry into related products always involves risk
and the need for new capabilities. Companies must
identify a clear value proposition before entering.
Expanding product scope will be most attractive
where there are major performance improvement
opportunities through co-designing the related
products to optimize the system. Alternatively, if
optimization is not dependent on individual product
designs, a company may be better off sticking to
its knitting and providing open connectivity to related
products produced by others. Success is less a
function of traditional product design than systems
engineering.
Companies whose products (and associated technological
capabilities) are central to overall product
system operation and performance, such as Joy
Global’s mining machines, will be in the best position
to enter related products and integrate the system.
Manufacturers that produce less system-critical
machines, such as the trucks that move the material
extracted from underground, will have less capability
and credibility in customers’ eyes to take on a
broader system provider role.
The choice of whether or not to develop the technology
platform that connects a product system or
system of systems depends on some related questions.
The first is whether the company can assemble
the necessary IT skills and technology, which are
quite different from those required in product design
and manufacturing. Another key question is where
system optimization takes place. “Inside product”
optimization involves integrating individual product
designs so that products work better together.
“Outside product” optimization takes place through
the algorithms that connect products and other information,
where products themselves are modular.
Inside product optimization creates the strongest
rationale for expanding into related products and offering
a proprietary platform. Outside product optimization
favors an open platform, and the platform
may be offered by a company that does not produce
products at all.
Carrier Corporation offers an example of these
choices. It has a 100-year history of innovation in the
design of a full range of HVAC equipment such as furnaces,
air conditioners, heat pumps, humidifiers, and
ventilators. Carrier optimizes its HVAC product system
performance by integrating individual designs
across products, and its smart Infinity heating and
cooling system platform connects them. However,
HVAC is part of a broader home automation system.
Sonos
The company’s wireless
music systems place the
user interface in the cloud,
enabling users to control
the portable device from
a smartphone.
Philips
Lighting
Users can control Philips
Lighting hue lightbulbs via
smartphone, turning them
on and off, programming
them to blink if they detect
an intruder, or dimming
them slowly at night.
86 Harvard Business Review November 2014
SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG
Smart, connected products will give rise to the next era of
IT-driven productivity growth at a time when the impact
of earlier waves of IT has largely played itself out.
Carrier has not entered other product areas within
home automation because of the need for very different
capabilities. Rather, its Infinity platform provides
interfaces to allow the HVAC product family to
be integrated into the system of systems.
Finally, as smart, connected products expand
industry scope and the boundaries of competition,
many companies will need to rethink their corporate
purpose. The focus is shifting to the broader
need companies meet, rather than their traditional
product definition. For example, Trane has moved
from seeing itself as an HVAC equipment producer to
a company that makes high-performance buildings
better for everyone inside. As products continue to
communicate and collaborate in networks, which
are expanding both in number and diversity, many
companies will have to reexamine their core mission
and value proposition.
A company must make a clear choice in each of
these dimensions of strategy but ensure that each
choice is consistent with and reinforces the others.
For example, a company pursuing product system
leadership will enter related product categories, pursue
inside product design integration, capture extensive
product usage data, and develop more intensive
internal capabilities across the technology stack. In
contrast, a company that focuses on a single part of
a product system will need to become best-of-breed
in terms of features and functionality and provide
transparent and open interfaces so that its product
can be readily integrated into and becomes a valuable
part of other companies’ systems and platforms.
Ultimately, competitive success will arise not by imitating
rivals but by defining a distinctive value proposition
that the company can realistically achieve.
The Larger O p p o r tu n ity
Smart, connected products are changing how value
is created for customers, how companies compete,
and the boundaries of competition itself. These
shifts will affect virtually every industry, directly or
indirectly. But smart, connected products will have
a broader impact even than this. They will affect the
trajectory of the overall economy, giving rise to the
next era of IT-driven productivity growth for companies,
their customers, and the global economy at
a time when the impact of earlier waves of IT has
largely played itself out and productivity growth has
slowed down.
This third wave of IT not only will create step
function improvements in product capability and
performance but will radically improve our ability to
meet many business and human needs. Across many
fields, products will be far more efficient, effective,
safe, reliable, and more fully utilized, while conserving
scarce natural resources such as energy, water,
and raw materials.
This opportunity to drive rapid innovation and
economic growth, and with it a return to prosperity
growth, comes none too soon. The past decade has
been characterized by internal cost reduction, cautious
investment, higher corporate profitability, rising
M&A, and muted innovation across large parts
of the economy. This path has resulted in slower job
growth, slower improvements in wages and living
standards for the average citizen, a diminished sense
of economic opportunity, doubts about capitalism,
and reduced public support for business.
The era of smart, connected products can change
this trajectory, provided that companies move aggressively
to embrace the opportunity. Business and
government together will need to equip workers
across all groups with the skills to participate, and
agree on the rules and regulations needed to set standards,
enable innovation, protect data, and overcome
efforts to block progress (such as auto dealers’
political opposition to Tesla).
The United States stands to lead and benefit
disproportionately in a smart, connected products
world, given America’s strengths in the core underlying
technologies, many of the skills required,
and key supporting industries. If this new wave of
technology allows the U.S. to reinvigorate its capacity
as a technology leader in the global economy, it
will breathe new life into the American dream while
contributing to a better world. 0
HBR R e p rin t R1411C
8 8 Harvard Business Review N o v em b e r 2014
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