-
How Smart, Connected Products Are
Transforming Competition
?
?
Michael E.
Porter
James E.
Heppelmann
FROM THE NOVEMBER
2014 ISSUE
HTTPS:///2014/11/HOW-SMART-CONNECTED-
PRODUCTS-ARE-TRANSFOR
MING-
COMPETITION
Information technology is
revolutionizing products. Once composed solely
of
mechanical and electrical parts,
products have become
complex systems
that combine hardware, sensors, data storage,
microprocessors, software, and connectivity in
myriad ways. These
“smart,
connected
products”—
made
possible
by
vast
improvements
in
processing
power
and
device
miniaturization
and
by
the
network
benefits of
ubiquitous wireless
connectivity
—
have unleashed
a new era of
competition.
Smart,
connected
products
offer
exponentially
expanding
opportunities
for
new
functionality,
far
greater
reliability,
much
higher
product
utilization,
and
capabilities
that
cut
across
and
transcend
traditional
product
boundaries.
The
changing
nature
of
products
is
also
disrupting
value
chains,
forcing companies to
rethink and retool nearly everything they do
internally.
These new types of products
alter industry structure and the nature of
competition,
exposing companies to new
competitive opportunities and threats. They are
reshaping
industry boundaries and
creating entirely new industries. In many
companies, smart,
co
nnected
products will force the fundamental question,
“What business am I in?”
Smart, connected products raise a new
set of strategic choices related to how value is
created and captured, how the
prodigious amount of new (and sensitive) data they
generate is utilized and managed, how
relationships with
traditional
business partners such as channels are redefined,
and what role companies
should play as
industry boundaries are expanded.
The
phrase “internet of things” has arisen to reflect
the growing number
of smart,
connected products and highlight the
new opportunities they can represent. Yet this
phrase is not very helpful in
understanding the phenomenon or its implications.
The
internet, whether involving people
or things, is simply a mechanism for transmitting
information. What makes smart,
connected products fundamentally different is not
the
internet, but the changing nature
of the “things.” It is the expanded capabilities
of smart,
connected products and the
data they generate that are ushering in a new era
of
competition. Companies must look
beyond the technologies themselves to the
competitive transformation taking
place. This article, and a companion piece to be
published soon in HBR, will deconstruct
the smart, connected products revolution and
explore its strategic and operational
implications.
The Third Wave of IT-
Driven Competition
Twice before over
the past 50 years, information technology
radically reshaped
competition and
strategy; we now stand at the brink of a third
transformation. Before the
advent of
modern information technology, products were
mechanical and activities in the
value
chain were performed using manual, paper processes
and verbal communication.
The first
wave of IT, during the 1960s and 1970s, automated
individual activities in the
value
chain, from order processing and bill paying to
computer-aided design and
manufacturing
resource planning. (See
“How
Information Gives You Competitive
A
dvantage,”
by Michael Porter and Victor Millar,
HBR, July 1985.) The productivity of
activities dramatically increased, in
part because huge amounts of new data could be
captured and analyzed in each activity.
This led to the standardization of processes
across
companies
—and raised
a dilemma for companies about how to capture IT’s
operational
benefits while maintaining
distinctive strategies.
The rise of the
internet, with its inexpensive and ubiquitous
connectivity, unleashed the
second wave
of IT-driven transformation, in the 1980s and
1990s (see Michael
Porter’s
“Strategy and the
Internet,”
HBR, March 2001).
This enabled coordination and
integration across individual
activities; with outside suppliers, channels, and
customers;
and across geography. It
allowed firms, for example, to closely integrate
globally
distributed supply chains.
The first two waves gave rise to huge
productivity gains and growth across the economy.
While the value chain was transformed,
however, products themselves were largely
unaffected.
Now, in the
third wave, IT is becoming an integral part of the
product itself. Embedded
sensors,
processors, software, and connectivity in products
(in effect, computers are
being put
inside products), coupled with a product cloud in
which product data is stored
and
analyzed and some applications are run, are
driving dramatic improvements in
product functionality and performance.
Massive amounts of new product-usage data
enable many of those improvements.
Another leap in productivity in the
economy will be unleashed by these new and better
products. In addition, producing them
will reshape the value chain yet again, by
changing
product design, marketing,
manufacturing, and after-sale service and by
creating the need
for new activities
such as product data analytics and security. This
will drive yet another
wave of value-
chain-based productivity improvement. The third
wave of IT-driven
transformation thus
has the potential to be the biggest yet,
triggering even more
innovation,
productivity gains, and economic growth than the
previous two.
Some have suggested that
the internet of things “changes everything,” but
that is a
dangerous oversimplification.
As with the internet itself, smart, connected
products
reflect a whole new set of
technological possibilities that have emerged. But
the rules of
competition and
competitive advantage remain the same. Navigating
the world of smart,
connected products
requires that companies understand these rules
better than ever.
What Are Smart,
Connected Products?
Smart, connected
products have three core elements: physical
components, “smart”
components, and
connectivity components. Smart components amplify
the capabilities
and value of the
physical components, while connectivity amplifies
the capabilities and
value of the smart
components and enables some of them to exist
outside the physical
product itself.
The result is a virtuous cycle of value
improvement.
Some have suggested that
the internet of th
ings “changes
everything,” but that
is a dangerous
oversimplification.
Physical
components comprise the product’s
mechanical and electrical parts. In a car, for
example, these include the engine
block, tires, and batteries.
Smart
components comprise
the sensors, microprocessors, data storage,
controls,
software, and, typically, an
embedded operating system and enhanced user
interface. In a
car, for example, smart
components include the engine control unit,
antilock braking
system, rain-sensing
windshields with automated wipers, and touch
screen displays. In
many products,
software replaces some hardware components or
enables a single
physical device to
perform at a variety of levels.
Connectivity
components
comprise the ports, antennae, and protocols
enabling wired or
wireless connections
with the product. Connectivity takes three forms,
which can be
present together:
One-to-one: An individual product
connects to the user, the manufacturer, or
another product through a port or other
interface
—
for example, when
a car is
hooked up to a diagnostic
machine.
?
One-
to-many: A central system is continuously or
intermittently connected to
many
products simultaneously. For example, many Tesla
automobiles are
connected to a single
manufacturer system that monitors performance and
accomplishes remote service and
upgrades.
?
Many-
to-many: Multiple products connect to many other
types of products and
often also to
external data sources. An array of types of farm
equipment are
connected to one another,
and to geolocation data, to coordinate and
optimize
the farm system. For example,
automated tillers inject nitrogen fertilizer at
precise depths and intervals, and
seeders follow, placing corn seeds directly in the
fertilized soil.
?
Connectivity
serves a dual purpose. First, it allows
information to be exchanged between
the
product and its operating environment, its maker,
its users, and other products and
systems. Second, connectivity enables
some functions of the product to exist outside the
physical device, in what is known as
the
product cloud. For example, in
Bose’s new
Wi-Fi system, a smartphone
application running in the product cloud streams
music to
the system from the internet.
To achieve high levels of functionality, all three
types of
connectivity are necessary.
Smart, connected products are emerging
across all manufacturing sectors. In heavy
machinery, Schindler’s PORT Technology
reduces elevator wait times by as much as
50% by predicting elevator demand
patterns, calculating the fastest time to
destination,
and assigning the
appropriate elevator to move passengers quickly.
In the energy sector,
ABB’s smart grid
technology enables utilities to analyze huge
amounts of real
-time data
across a wide range of generating,
transforming, and distribution equipment
(manufactured by ABB as well as
others), such as changes in the temperature of
transformers and secondary substations.
This alerts utility control centers to possible
overload conditions, allowing
adjustments that can prevent blackouts before they
occur.
In consumer goods, Big Ass
ceiling fans sense and engage automatically when a
person
enters a room, regulate speed on
the basis of temperature and humidity, and
recognize
individual user preferences
and adjust accordingly.
FURTHER READING
Digital Ubiquity
TECHNOLOGY
& OPERATIONS
FEATURE
?
Marco Iansiti
and Karim R. Lakhani
How connections,
sensors, and data are revolutionizing business.
SAVE
SHARE
?
?
?
Why
now? An array of
innovations across the
technology landscape have converged to make smart,
connected
products
technically
and
economically
feasible.
These
include
breakthroughs
in
the
performance,
miniaturization,
and
energy
efficiency
of
sensors
and
batteries;
highly
compact,
low-cost computer processing power and
data storage, which make it feasible to put
computers inside
products; cheap
connectivity
ports
and
ubiquitous,
low-cost wireless
connectivity; tools
that
enable
rapid software development; big
data analytics; and a new IPv6 internet
registration system opening
up 340
trillion trillion trillion potential new internet
addresses for individual devices, with protocols
that support greater security, simplify
handoffs as devices move across networks, and
allow devices to
request addresses
autonomously without the need for IT support.
Smart,
connected
products
require
that
companies
build
an
entirely
new
technology
infrastructure,
consisting
of
a series of
layers known
as a “technology stack” (see the exhibit “The New
Technology
Stack”). This includes
modifie
d hardware, software
applications, and an operating system embedded
in the product itself; network
communications to support connectivity; and a
product cloud (software
running
on
the
manufacturer’s
or
a
third
-party
server)
containing
the
product-data
database,
a
platform for building software
applications, a rules engine and analytics
platform, and smart product
applications
that
are
not
embedded
in
the
product.
Cutting
across
all
the
layers
is
an
identity
and
security structure, a
gateway for accessing external data, and tools
that connect the data from smart,
connected products to other business
systems (for example, ERP and CRM systems).
This
technology
enables
not
only
rapid
product
application
development
and
operation
but
the
collection, analysis,
and sharing of
the potentially huge
amounts of
longitudinal data generated
inside
and outside the products that
has never been available before. Building and
supporting the technology
stack for
smart, connected products requires substantial
investment and a range of
new
skills
—
such
as
software development, systems engineering, data
analytics, and online security
expertise
—
that are
rarely found in manufacturing
companies.
What Can Smart, Connected
Products Do?
Intelligence and
connectivity enable an entirely new set of product
functions and
capabilities, which can
be grouped into four areas: monitoring, control,
optimization, and
autonomy. A product
can potentially incorporate all four (see the
exhibit “Capabilities of
Smart,
Connected Products”). Each capab
ility
is valuable in its own right and also sets
the stage for the next level. For
example, monitoring capabilities are the
foundation for
product control,
optimization, and autonomy. A company must choose
the set of
capabilities that deliver
its customer value and define its competitive
positioning.
Monitoring.
Smart, connected
products enable the comprehensive monitoring of a
product’s
condition, operation, and
external environment through sensors and external
data
sources. Using data, a product can
alert users or others to changes in circumstances
or
performance. Monitoring also allows
companies and customers to track a product’s
operating characteristics and history
and to better understand how the product is
actually
used. This data has important
implications for design (by reducing
overengineering, for
example), market
segmentation (through the analysis of usage
patterns by customer type),
and after-
sale service (by allowing the dispatch of the
right technician with the right part,
thus improving the first-time fix
rate). Monitoring data may also reveal warranty
compliance issues as well as new sales
opportunities, such as the need for additional
product capacity because of high
utilization.
In some cases, such as
medical devices, monitoring is the core element of
value creation.
Medtronic’s digital
blood
-
glucose meter uses a
sensor inserted under the patient’s skin to
measure glucose levels in tissue fluid
and connects wirelessly to a device that alerts
patients and clinicians up to 30
minutes before a patient reaches a threshold
blood-glucose level, enabling
appropriate therapy adjustments.
Monitoring capabilities can span
multiple products across distances. Joy Global, a
leading
mining equipment manufacturer,
monitors operating conditions, safety parameters,
and
predictive service indicators for
entire fleets of equipment far underground. Joy
also
monitors operating parameters
across multiple mines in different countries for
benchmarking purposes.
Control.
Smart, connected
products can be controlled through remote commands
or algorithms
that are built into the
device or reside in the product cloud. Algorithms
are rules that
direct the product to
respond to specified changes in its condition or
environment (for
example, “if pressure
gets too high, shut off the valve” or “when
traffic in a parking
garage reaches a
certain level, turn the overhead lighting on or
off”).
Control through
software embedded in the product or the cloud
allows the
customization of product
performance to a degree that previously was not
cost effective
or often even possible.
The same technology also enables users to control
and
personalize their interaction with
the product in many new ways. For example, users
can
adjust their Philips Lighting hue
lightbulbs via smartphone, turning them on and
off,
programming them to blink red if
an intruder is detected, or dimming them slowly at
night. Doorbot, a smart, connected
doorbell and lock, allows customers to give
visitors
access to the home remotely
after screening them on their smartphones.
Optimization.
The rich flow
of monitoring data from smart, connected products,
coupled with the
capacity to control
product operation, allows companies to optimize
product
performance in numerous ways,
many of which have not been previously possible.
Smart,
connected products can apply
algorithms and analytics to in-use or historical
data to
dramatically improve output,
utilization, and efficiency. In wind turbines, for
instance, a
local microcontroller can
adjust each blade on every revolution to capture
maximum
wind energy. And each turbine
can be adjusted to not only improve its
performance but
minimize its impact on
the efficiency of those nearby.
Real-
time monitoring data on product condition and
product control capability enables
firms to optimize service by performing
preventative maintenance when failure is
imminent and accomplishing repairs
remotely, thereby reducing product downtime and
the need to dispatch repair personnel.
Even when on-site repair is required, advance
information about what is broken, what
parts are needed, and how to accomplish the fix
reduces service costs and improves
first-time fix rates. Diebold, for example,
monitors
many of its automated teller
machines for early signs of trouble. After
assessing a
malfunctioning ATM’s
status, the machine is repaired
remotely if possible, or the
company
deploys a technician who has been given a detailed
diagnosis of the problem, a
recommended
repair process, and, often, the needed parts.
Finally, like many smart,
connected
products, Dieb
old’s ATMs can be updated
when they are due for feature
enhancements. Often these can occur
remotely, via software.
Autonomy.
Monitoring, control, and optimization
capabilities combine to allow smart, connected
products to achieve a previously
unattainable level of autonomy. At the simplest
level is
autonomous product operation
like that of the iRobot Roomba, a vacuum cleaner
that
uses sensors and software to scan
and clean floors in rooms with different layouts.
More-sophisticated products are able to
learn about their environment, self-diagnose
their own service needs, and adapt to
users’ preferences. Autonomy not only can reduce
the need for operators but can improve
safety in dangerous environments and facilitate
operation in remote locations.
Autonomous products can also act in
coordination with other products and systems. The
value of these capabilities can grow
exponentially as more and more products become
connected. For example, the energy
efficiency of the electric grid increases as more
smart
meters are connected, allowing
the utility to gain insight into and respond to
demand
patterns over time.
Ultimately, products can function with
complete autonomy, applying algorithms that
utilize data about their performance
and their
environment
—
including the
activity of
other products in the
system
—
and leveraging their
ability to communicate with other
products. Human operators merely
monitor performance or watch over the fleet or the
system, rather than individual units.
Joy Global’s Longwall Mining System,
for example,
is able to
operate autonomously far underground, overseen by
a mine control center on
the surface.
Equipment is monitored continuously for
performance and faults, and
technicians
are dispatched underground to deal with issues
requiring human intervention.
Reshaping
Industry Structure
To understand the
effects of smart, connected products on industry
competition and
profitability, we must
examine their impact on industry structure. In any
industry,
competition is driven by five
competitive forces: the bargaining power of
buyers, the
nature and intensity of the
rivalry among existing competitors, the threat of
new entrants,
the threat of substitute
products or services, and the bargaining power of
suppliers. The
composition and strength
of these forces collectively determine the nature
of industry
competition and the average
profitability for incumbent competitors. Industry
structure
changes when new technology,
customer needs, or other factors shift these five
forces.
Smart, connected products will
substantially affect structure in many industries,
as did
the previous wave of internet-
enabled IT. The effects will be greatest in
manufacturing
industries.
The Five Forces That Shape Industry
Competition
Smart, connected products
will have a transformative effect on industry
structure.
The five forces
that shape competition
provide the
framework
necessary for understanding
the significance of these changes.
Bargaining power of buyers.
Smart, connected products dramatically
expand opportunities for product differentiation,
moving competition away from price
alone. Knowing how customers actually use the
products enhances a company’s ability
to segment customers, customize products, set
prices to better capture value, and
extend value-added services. Smart, connected
products also allow companies to
develop much closer customer relationships.
Through
capturing rich historical and
product-
usage data, buyers’ costs of
switching to a new
supplier increase.
In addition, smart, connected products allow firms
to reduce their
dependency on
distribution or service partners, or even
disintermediate them, thereby
capturing
more profit. All of this serves to mitigate or
reduce buyers’ bargaining power.
GE Aviation, for example, is now able
to provide more services to end users
directly
—
a
move
that improves its power relative to its immediate
customers, the airframe
manufacturers.
Information gathered from hundreds of engine
sensors, for example,
allows GE and
airlines to optimize engine performance by
identifying discrepancies
between
expected and actual performance. GE’s
analysis of fuel-use data, for example,
allowed the Italian airline Alitalia to
identify changes to its flight procedures, such as
the
position of wing flaps during
landing, that reduced fuel use. GE’s deep
relationship with
the airlines serves
to improve differentiation with them while
improving its clout with
airframe
manufacturers.
However, smart,
connected products can increase buyer power by
giving buyers a better
understanding of
true product performance, allowing them to play
one manufacturer off
another. Buyers
may also find that having access to product usage
data can decrease their
reliance on the
manufacturer for advice and support. Finally,
compared with ownership
models,
“product as a service” business models or
product
-sharing services (discussed
below) can increase buyers’ power by
reducing the cost of switching to a new
manufacturer.
Rivalry among
competitors.
Smart, connected products
have the potential to shift rivalry, opening up
numerous new
avenues for
differentiation and value-added services. These
products also enable firms to
tailor
offerings to more-specific segments of the market,
and even customize products
for
individual customers, further enhancing
differentiation and price realization.
Smart, connected products also create
opportunities to broaden the value proposition
beyond products per se, to include
valuable data and enhanced service offerings.
Babolat,
for example, has produced
tennis rackets and related equipment for 140
years. With its
new Babolat Play Pure
Drive system, which puts sensors and connectivity
in the racket
handle, the company now
offers a service to help players improve their
game through the
tracking and analysis
of ball speed, spin, and impact location,
delivered through a
smartphone
application.
Offsetting this shift in
rivalry away from price is the migration of the
cost structure of
smart, connected
products toward higher fixed costs and lower
variable costs. This
results from the
higher upfront costs of software development,
more-complex product
design, and high
fixed costs of developing the technology stack,
including reliable
connectivity, robust
data storage, analytics, and security (see again
the exhibit “The New
Technology
Stack”). Industries with high fixed cost
structures are vulnerable to price
pressure as firms seek to spread their
fixed costs across a larger number of units sold.
The huge expansion of capabilities in
smart, connected products may also tempt
companies to get into a feature and
function arms race with rivals and give away too
much of the improved product
performance, a dynamic that escalates costs and
erodes
industry profitability.
Finally, rivalry among competitors can
also increase as smart, connected products
become part of broader product systems,
a trend we will discuss further. For example,
manufacturers of home lighting,
audiovisual entertainment equipment, and climate
control systems have not historically
competed with one another. Yet each is now vying
for a place in the emerging “connected
home” that integrates and adds
intell
igence to a
wide array
of products in the home.
Threat of new
entrants.
New entrants in a smart,
connected world face significant new obstacles,
starting with
the high fixed costs of
more-complex product design, embedded technology,
and
multiple layers of
new
IT infrastructure. For example, Thermo Fisher’s
TruDefender FTi
chemical analyzer added
connectivity to a product that already had smart
functionality, to
enable chemical
analysis from hazardous environments to be
transmitted to users and
mitigation to
begin without having to wait for the machine and
personnel to be
decontaminated. Thermo
Fisher needed to build a complete product cloud to
securely
capture, analyze, and store
product data and distribute it both internally and
to customers,
a substantial
undertaking.
Smart, connected products
ultimately can function with complete autonomy.
Human operators merely monitor
performance or watch over the fleet or the
system, rather than over individual
units.
Broadening product definitions
can raise barriers to entrants even higher.
Biotronik, a
medical device company,
initially manufactured stand-alone pacemakers,
insulin pumps,
and other devices. Now
it offers smart, connected devices, such as a home
health-monitoring system that includes
a data processing center that allows physicians to
remotely monitor their patients’
devices and clinical status.
Barriers to entry also rise when agile
incumbents capture critical first-mover advantages
by collecting and accumulating product
data and using it to improve products and
services and to redefine after-sale
service. Smart, connected products can also
increase
buyer loyalty and switching
costs, further raising barriers to entry.
Barriers to entry go down, however,
when smart, connected products leapfrog or
invalidate the strengths and assets of
incumbents. Moreover, incumbents may hesitate to
fully embrace the capabilities of
smart, connected products, preferring to protect
hardware-based strengths and profitable
legacy parts and service businesses. This opens
the door
to new competitors,
such as the “productless” OnFarm, which is
successfully
competing with traditional
agricultural equipment makers to provide services
to farmers
through collecting data on
multiple types of farm equipment to help growers
make better
decisions, avoiding the
need to be an equipment manufacturer at all. In
home automation,
Crestron, an
integration solution provider, offers complex,
dedicated home systems with
rich user
interfaces. Product companies are also facing
challenges from other
nontraditional
competitors like Apple, which recently launched a
simpler,
smartphone-based approach to
managing the connected home.
Threat of
substitutes.
Smart, connected products
can offer superior performance, customization, and
customer
value relative to traditional
substitute products, reducing substitution threats
and
improving industry growth and
profitability. However, in many industries smart,
connected products create new types of
substitution threats, such as wider product
capabilities that subsume
c
onventional products. For example,
Fitbit’s wearable fitness
device, which
captures multiple types of health-related data
including activity levels and
sleep
patterns, is a substitute for conventional devices
such as running watches and
pedometers.
New business models enabled by smart,
connected products can create a substitute for
product ownership, reducing overall
demand for a product. Product-as-a-service
business
models, for example, allow
users to have full access to a product but pay
only for the
amount of product they
use.
ESSENTIAL BACKGROUND
The Five Competitive Forces That Shape
Strategy
COMPETITIVE
STRATEGY
FEATURE
?
Michael E.
Porter
They determine the long-run
profitability of any industry.
SAVE
SHARE
?
?
?
A
variation of product-as-a-service is the shared-
usage model. Zipcar, for example,
provides customers with real-time
access to vehicles when and where they need them.
This substitutes for car ownership and
has led traditional automakers to enter the
car-sharing market with offerings such
as RelayRides from GM, DriveNow from BMW,
and Dash from Toyota.
Another example is shared bike systems,
which are springing up in more and more cities.
A smartphone application shows the
location of docking stations where bikes can be
picked up and returned, and users are
monitored and charged for the amount of time
they use the bikes. Clearly, shared
usage will reduce the need for urban residents to
own
bikes, but it may encourage more
residents to use bikes since they do not have to
buy
and store them. Convenient shared
bikes will be a substitute not only for purchased
bikes
but potentially for cars and
other forms of urban transportation. Smart,
connected
capabilities make such
substitutions for full ownership possible.
Bargaining power of suppliers.
Smart, connected products are shaking
up traditional supplier relationships and
redistributing bargaining power. As the
smart and connectivity components of products
deliver more value relative to physical
components, the physical components can be
commoditized or even replaced by
software over time. Software also reduces the need
for physical tailoring and hence the
number of physical component varieties. The
importance of traditional suppliers to
total product cost will often decline, and their
bargaining power will fall.
However, smart, connected products
often introduce powerful new suppliers that
manufacturers have never needed before:
providers of sensors, software, connectivity,
embedded operating systems, and data
storage, analytics, and other parts of the
technology stack. Some of these, like
Google, Apple, and AT&T, are giants in their own
industries. They have talent and
capabilities that most manufacturing companies
have not
historically needed but that
are becoming essential to product differentiation
and cost.
The bargaining power of those
new suppliers can be high, allowing them to
capture a
bigger share of overall
product value and reduce manufacturers’
profitability.
A good
example of these new types of suppliers is the
Open Automotive Alliance, in
which
General Motors, Honda, Audi, and Hyundai recently
joined forces to utilize
Google’s
Android operating system for their vehicles. The
auto OEMs lacked the
specialized
capabilities needed to develop a robust embedded
operating system that
delivers an
excellent user experience while enabling an
ecosystem of developers to build
applications. Auto OEMs’ traditional
clout relative to suppliers is greatly diminished
with
suppliers like Google, which have
not only substantial resources and expertise but
also
strong consumer brands and
numerous related applications (for example,
consumers may
prefer a car that can
sync with their smartphone, music, and apps).
New suppliers of the technology stack
for smart, connected products may also gain
greater leverage given their
relationships with end users and access to product
usage data.
As suppliers capture
product usage data from end users, they can also
provide new
services to them, as GE has
done with Alitalia.
New Industry
Boundaries and Systems of Systems
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.
Redefining Industry Boundaries
The increasing capabilities of smart,
connected products not only reshape
competition within industries but
expand industry boundaries. This occurs as the
basis of competition shifts from
discrete products, to product systems consisting
of closely related products, to systems
of systems that link an array of product
systems together. A tractor company,
for example, may find itself competing in a
broader farm automation industry.
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
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.
Smart, Connected Products and
Competitive Advantage
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 up-to-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
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”).
He
re 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.
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 of 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 28,000 companies worldwide,
many of which are mentioned in this
article.)
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 ha
rdware, 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
post-purchase 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 10 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.
In some cases, firms can decrease
service costs by replacing physical
parts with “software parts.” For
example,
glass
cockpit
LCD
displays
in
modern
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.
Joy Global
Smart, connected mining
machines such as this Joy Global longwall
shearer
autonomously
coordinate with other equipment to improve mining
efficiency.
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.
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 en
tire
set of choices must reinforce one
another and define a coherent and
distinctive overall strategic positioning for the
company.
1.
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.
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.
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. Fo
r 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.
2.
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.