Sources of value and the 3 control points in the Internet of Things

When we visited Christian von Reventlow, the new Senior Executive for Product and Innovation at Deutsche Telekom a few months ago, he left us with two challenges. The first one: What will drive consolidation in the Smart Home space? – It seems somehow like a very forward looking question, as the market is probably in its pre-nascent phase. But, as practitioners learnt in the last two decades the hard way, many things are strange around this market. Hundreds of proprietary attempts, no winner. Even the experts lose oversight with so many players that all lack consumer appeal and still it is very difficult to distill any pattern for success. That also leads to his second challenge: What will customers pay for? – He also had a third one, but I will come back to that later.

So, let’s try to find an answer to the first two challenges from Mr. Reventlow. The second one is probably easier and will lead to the first as we will see. If you look at the global statistics, the Smart Home Market in total generates anything between USD 10-20bn in revenues. This includes entertainment, security, home automation, energy management as well as lifecare/assisted living categories. More than 95% of the revenue is hardware. Projections into the future show that most experts do expect that hardware will dominate this market for quite some time. Now we know that the key thing about the future is that it is uncertain. And the outcome is depending on how we are shaping the future. In the current paradigm – “aaah, here is a piece of hardware, add a radio, connect somewhere and create an App to control it” – this pattern will definitely remain the same. Consumer appeal, too. Horrifying, isn’t it?

Much more interesting than referencing predictions about the future market development is to deconstruct the inner workings. Let’s go down this route. There are three ways, people will spend money on the Consumer Internet of Things – Hardware Sales, App Spending and Access Revenues. I will turn to each one of them and then return to the consolidation question.

1. Hardware Sales

As of today, most of the revenues come from hardware. This is disappointing, since it is not generating a lot of value for the industry as a whole. I would even have the hypothesis and argued before that most of these revenues are cannibalizing existing hardware spending and is overall not margin enhancing. The key driver is to “keep a foot in the door” – very bad motivation, never created a lot of value for anybody…

It is simply adding connectivity to existing products, and most of the time, thereby diminishing its usability once the smart features are used…that is the hard reality of smart home today. But it also contains an opportunity. In most hardware categories, there is a lot of discontinuities coming from internet enabled production, supply chain and business model changes. On top, most hardware companies fear disintermediation of their customer relationships and therefore feel that they should also be some emerging interaction opportunities with end customers.  

The opportunity is to embrace this challenge and turn the hardware component model into exactly that: a digitized, ongoing consumer interaction. Consider light: LEDs do not break as traditional bulbs did. They have a long life. And they have low margins. Bleak outlook: Depressing margins while at the same time the frequency of customer interaction decreases rapidly. Instinct tells you: Hmm, run boy, run as fast as you can. Or…turn it around. Sell a light experience instead of a bulb. Integrate with a couple of sensors and other smart devices in your environment so that you can adapt the lighting experience to the environment – time of day, type of activity, temperature…and enter into a recurring deal with your customer, where consumers do pay a monthly premium for their connected devices, and whenever one of them breaks, you can even offer a free replacement as part of your offer.

Carefully set up, you turn a calamity into a growth opportunity to increase customer interaction, enlarge the category breadth and at the same time – if you are smart and make your appliances and components available to developers in a way they understand – open up your dump hardware for new uses in other application areas. Similar cases hold true for heating control, security solutions, energy management or other types of Consumer or Household equipment

2. APP Revenues

The Consumer Internet of Things will still be Internet. That is, people will use it like they use the internet – through web services and apps. Total app revenues may be at USD 50 bn – across all categories, and it is hard to become one... It is a good assumption that nobody is really paying for an app itself. That was a short dream a couple of years ago. The revenues mainly are coming from In-App purchases and from Advertisement – roughly 50:50. Same will apply to Consumer IoT, perhaps a little more In-App purchases than Advertisement, as people will prefer some more privacy around their IoT or Smart Home offering.

Consumers will only start paying for these services, if they become really, really helpful, and if there is a natural way that they get in contact with those apps. People do only use a good 2 dozens of apps per month, with more than 80% of their time spent is concentrating on 5 apps. So, here is the challenge:

To become relevant, Smart Home – or the wider field of Consumer IoT needs either form an integral part of the lucky set of “Top Fives” for many people or become one itself.

This is a tough challenge, isn’t it? – My personal view: There is a segment of people that want to use a smart home app, but it is rather small. Smart Home, Smart Car, Smart…is more likely to be part of your utility/productivity tools, communication, social media and media experience. It is more a capability that is used by apps, than a lucky hit in the “Top Fives”.

Will people spend money on Smart Home or related Applications? – Probably not a lot. If at all, Smart Home will more likely become a relevant In-App revenue source, as it enables premium use cases like streaming to all boxes in the home or enabling scenes, enriching social interaction or creating the family community online…but there is an important learning from it: The consumer Internet of Things is probably not so much a category in its own right, but more of a horizontal capability that is added to enrich our everyday internet experience.

There may be some focused exceptions: Think about elderly care, in house cockpits, B2B applications like facility management support tools…, but they will all be around highly specific use cases. So think twice, before you add a useless smart home App to the existing universe of wasted efforts.

3. Access Revenues

Here comes the most disruptive opportunity from Consumer IoT: Access Revenues. What? – Access? – Wasn’t that the dying business, telecoms are in? – This dinosaur stuff? – Exactly. Here is why: Global telecoms revenues are around USD 1.500 bn, a third of it coming from fixed line, or USD 500 bn. A total of almost USD 600 bn comes from broadband data access – be it mobile or fixed access – which is the growing part of the business, while voice and text revenues are declining rapidly both in fixed and mobile. Even if we talk so much about Apple, Samsung, Google, Facebook, and others, the combined total revenue of telecoms CE and Over the Top (OTT-) Players is only half of what the telecoms still take home. Why should that be the same in the future?

A new business model for the internet?

Good question. The only reason is that the access is the best place to put trusted value added services for the customer. And that is the main driver for the Consumer IoT.

The emergence of the Consumer Internet of Things could mark a turning point in the way we will consume internet in the future – and that is concerns about security and privacy. 15 years ago, before we all learnt how the internet will evolve, we had three conceptual models how the commercial model in the internet may evolve – supply side dominated business models that essentially lead to a “third party pays” paradigm and the illusion of the internet as a “free resource”, demand side dominated models, in which consumers will pay for the internet as a new form of service delivery, and pick and choose from trusted sources, as well as the Infomediary model, in which the internet would organize like a market place and the major business model would be neutral market making. It has turned out that the first model is the by far pre-dominant business model in the internet age, and the last one is more or less irrelevant as a business model. The second model finds its niches e.g. in “intranet” or “private cloud” solutions, mostly B2B, and always when security and privacy is a core concern.    

Indeed, if consumers would find that security and privacy is an important issue in the IoT area, it might create room for a service based internet model…but that would probably not accrue as a pay per use or specifically for every application, but a fee to a service provider that generates the adequate level of privacy and security to the consumer or the household.

At least a telecoms business opportunity…

Here is a little story for an integrated telecoms provider. You are serving fixed and mobile customers. You do not really know who they are – on the one side, you have fixed access information, on the other side, you have mobile numbers. You struggle to create data models that support to understand who is belonging together. But you could add a very valuable service to your fixed access – connectivity to all kinds of connectable devices that come to the home. You allow them to be hooked together and by doing so, new exciting use cases emerge over time (provided that you thought about creating widespread access for developers...). Since you are carefully encrypting all data provided to you on the router, you can offer to your customers that trusted services can use the data and access the smart stuff at home.

At this point, you may be inclined to make that service as local as possible, and create your own API that nobody is using to create apps, since they do not scale beyond your own base. You should try exactly the opposite…align with the other telecoms and the few utilities in the field on a joint standard how you represent things in the cloud. That will generate appetite in developers and shield your infrastructure migration to build up a trusted platform service…You did that? – Great. 1.5m developers are waiting for this to happen (and by the way: you also solved the choice of the hardware guys…they simply integrate with your framework). So, new exciting use cases emerge…

Some of them are related to presence. You can offer to your customers that they can register their mobile phone in the local WiFi, and use that as an indicator of presence. They may add that to the user identity service you are offering as well. A nice picture of the user is visible when he is at home. So, she can also check which of her family members are at home as well. All of a sudden, you create a family context. You are helpful, and for some you will even become essential. Feels good?

Serving the family or household community

As typically only one family member is really keen on organizing all the technical stuff at home (let’s call him “Daddy”), he will provide that also for all other family members. Another family member (e.g. “Mummy”) is not so much into tech, but likes that the family is organized and shares stuff like important dates, pictures, favorite playlists, kitchen service or shopping lists,… these services can very easily be integrated, and become more valuable if they can relate to specific household information as they provide better and more meaningful service.

Additional value can be generated by the telecoms provider by handling the dispatching of actions in the household, DRM as a service based on the trust anchor in the router as well as guaranteeing offline functionality even if the internet is down as a convenience service to the household members. Cool. You see: Consumer IoT is actually the future of Consumer telecoms…got that?   

Three control points in the Consumer Internet of Things

With these three sources of revenue, it becomes also clear how the consolidation of the industry will take place – it will be around three control points – (1) end customer experience, specifically from a few inspiring hardware/software combinations that create superior customer value, (2) the trusted access point as a service delivery center into the home, as well as (3) an open and widely distributed interoperability standard that allows web developers to reach scale as they integrate things into their applications.

The emerging industry structure is almost clear, with the big uncertainty coming from telecoms action in the field.

• A few Consumer Brands that will excite customers with their unique integration of hardware and software to obtain superior usability and customer value. That will be players like Apple, as well as potentially emerging companies like Netatmo, Nest or Withings. To predict who will emerge is hard. They are unicorns.  
• Trusted service delivery platforms into the home. The incumbents here are telecoms providers, but their position on the one side is contested by device manufacturers like Samsung and Apple that attack the home from all fronts – be it mobile devices, the home or the media side – no wonder that both Samsung and Apple increased their standards on encryption on their devices significantly, and also mandate that for partners (as Apple HomeKit does). On the other side, OTT players like Google and Facebook pro-actively expand into providing access as well, and therefore form a potential threat to become relevant as trusted parties. Hard bet though, as they would need to master the credibility challenge that is inherent in their current business model
• Standard interoperability. The hardest fight for value will be around the interface to the developer. Who will own the semantic model that translates the physical world into the cloud? – Here the game is completely open. If you ask me, I would prefer that we do not adopt the “wait-for-Google-to-do-it” Strategy, as James Surowiecki named the common telco attitude in an article on Google Fiber in the MIT Technology Review last year, but rather proactively take a move to align on an open internet standard for a basic semantic meta model for the Consumer Internet of Things. Why that? – As establishing trusted platform services into the home will take time, the distribution of value as well as the ethical standards on data protection will be decided along the way – dependent on who can move faster. And the fastest is the party that allows to spread more broadly in a shorter amount of time…so it is high time to act.

Epilogue – The third challenge

I promised in the beginning that I will turn to the third challenge that Mr. Reventlow had for us: How can telecoms better succeed to defend their position given all the efforts they put into innovation in the past…hmm, here is a try... Telcos are utilities. They provide basic horizontal services around communication and trusted service delivery based on their access infrastructure. In the past two decades, regulation has driven margins down for those parts of the value chain. So, telecoms feared commoditization as “bit pipes”, and wanted to integrate upwards and compete with global service providers operating on their infrastructure. But, their thinking is bound to their base and footprint. As a consequence, telcos invested billions into defending vertically integrated models rather than opening to standardized horizontal application interfaces and tried to compete against the OTT players that actually made their networks valuable – by creating a never ending stream of vertical innovation. Will they do a better job this time? – It is perhaps the pivotal moment of truth in two decades, where they can redefine at least a part of the internet story to their benefit. If they only act smart…

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This piece is arguing that the key for the Consumer Internet of Things mainly is in the hand of telecoms providers. If they act, it is in their best self-interest as well as in the best interest of consumers. If they don’t, consumer equipment vendors and internet companies will take over. In order to shape the industry, telecoms need to work on two levels: Creating a trusted service delivery around the connectivity equipment (routers, set-top boxes and smartphones) they bring into the home, as well as coordinating on a semantic interoperability framework to create scalability for developers fast. That is what we are excited about…

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