Finding the best Digital Business Model for IoT. A Quick Guide.

This is the first of a three-part series on how consumer products companies can extend from providing connected products to truly smart products, considering the impact on business models and organisational capabilities.

The past five years have seen an explosion in the growth of connected consumer products. This was first noticeable in the smart home space where start-ups in the US like Nest, Ring and Canary brought in a wave of app-controlled devices. These were stylish, design-led products, intended to appeal to a tech-savvy audience, a world apart from the staid, stuffy offerings from established home equipment companies such as ADT and Honeywell. They offered the convenience of configuring and controlling devices such as home thermostats, security systems, lighting from an app. Not only was this typically a lot easier than fiddling with the physical interface on the hardware itself, but the apps provided the convenience and peace of mind of checking on their home while out and about.

Before long, many of these early-gen IoT start-ups were gobbled up by the tech giants, creating a fair few millionaires. This heightened the threat to incumbent players, sensing the vulnerability to their market positioning and business model. Quite a few of these companies were quick to react and created their own portfolios of connected products. The aim here was not so much to generate new business models, but simply to build or buy the capability to be seen as a credible player in what was thought likely to be a fast-growing segment.

These changes were not limited to the Smart Home space – a large number of industries were seeing a technological transformation, driven by the same combination of cloud computing, mobile apps, cheap and efficient microprocessors, a wide range of comms technologies that created the IoT explosion. The risky option here was to do nothing and be left behind.

Stage 1 – Connecting the Products

The products of this generation were aimed principally at providing the convenience of improved usability and remote access. There was not much business model innovation in this stage. Start-ups were simply concerned with short-term market growth in consumer retail and online channels hoping for a big payout, a strategy that worked big time for the founders of Ring and Nest. In the meantime, incumbent device manufacturers started to produce connected variants of their standard products. For example, Honeywell came out with the Lyric range of round thermostats. These brought the convenience of app control in and outside the home, but at the end of the day, Honeywell were still simply shifting boxes.

Basic Connected Product – Honeywell Lyric Thermostat – 2014

Now tech enthusiasts and early adopters were beginning to install smart heating, lighting, security applications in their home. These were mainly DIY products, by-passing traditional installers, and the future seemed bright. There was one not-so-small problem – money. These products required serious amounts of R&D investment in areas that did not fall within the traditional expertise of the companies concerned. As a result, margins for a large number of companies were significantly lower than what they enjoyed with their traditional products. For many traditional electrical manufacturers, their defensive move into connectivity came at the expense of diluting their margins.

The problem – Costs up, margins down

There was another problem. A connected product is for life, not just for Christmas. These companies had now discovered that providing connectivity was not free – cloud costs continue indefinitely, platforms need maintaining, apps need updating and re-certifying. For some companies, particularly those with scale, and with relatively simple online services, this ongoing cost was manageable. However, where the ongoing costs were high, for example, if providing a video service, or if the service is operating in multiple jurisdictions, each with different regulations, then this created a problem.

For as long as the business model relies solely on product sales, companies were relying on one-off product revenues to offset potentially indefinite costs. When users buy a home lighting product, spending hundreds of pounds in the process, they have a reasonable expectation to use it for many years.

Stage 2 – The Search for New Business Models

To create sustainable revenue streams for connected IoT products, it was necessary to find revenue streams that went beyond the original sale of the product. Soon there was a flurry of activity.

1. The lazy option – Charge for Connectivity

Some companies dabbled with lease or rental agreements, others simply attempted to charge for connectivity. However, for as long as there were companies prepared to provide connectivity for free, simply charging for connectivity was not particularly viable. As a result, I have struggled to find good examples of where this works sustainably, and so will not dwell on this much further

2. Product Renewals and Upsell – Wanting More

The first business model is not really new, but simply ensures that once your customers are hooked onto your products, they keep coming back for more. Apple is a master of this approach in the smartphone space, which explains why, unlike Google, it remains primarily a hardware company. This approach only works in those market segments where there is an acceptance of product obsolescence. This is the defacto business model for wearable products such as smartwatches and fitness devices.

Related to renewing the product is the Upsell Model – use the base product as a hook for end-users to buy further products to expand their system. Once users are bought into the Fitbit ecosystem, they may consider buying a Smart Scale which synchronises body information with the Fitbit fitness app. Ring, the video doorbell system bought by Amazon two years ago, recently released a home security alarm system. The basic system is quite affordable at £249, certainly compared to competing offerings, but the app entices users to expand the system to include a wide range of sensors and cameras, ranging from a simple door sensor costing £29 to an outdoor camera costing £189.

The downside of this approach is that over-extending the product range can dilute what the brand stands for or what the core offer is. For example, consider Hive smart heating from British Gas – this has extended from heating to security and lighting. This offers a clear upgrade path for customers who start off wanting a smart thermostat, but it is less obvious that people would go to British Gas as an entry point to smart lighting and security products.

Upsell and Freemium Offering – Amazon Ring Security System – basic package – 2018

3. The Freemium Model

The second option for creating sustainable revenue streams lies with offering paid-for services over and above the basic proposition. This is the Freemium Model, popularised by Spotify which offers an ad-funded Spotify Free services, as well as an all-you-can-eat Spotify Fremium. Again, Amazon Ring provides a good example of this at work. Ring offers app connectivity for free, allowing users to receive alerts or view video remotely. However, on payment of a monthly subscription of £8/month, they can store video footage in the cloud, or provide automatic phone calls in case of a suspected intrusion.

4. Monetising Data – Partnering with other companies

The third option for monetising your smart product is to partner with another company which either complements your offering, providing a combined proposition that is greater than the sum of the two parts, or can enhance their offering through data sharing. In most of these models, data sharing is the glue that enhances the value of the system.

There are plenty of compelling examples across multiple industries, though the insurance and wider fintech space provides a host of great examples. Insurance is all about assigning a monetary value to risk, and the data provided by connected devices can have a large impact on the risk (usually by reducing it), thereby lowering costs for end-users, and increasing profits for insurance providers.

Leakbot by Homeserve, in partnership with Aviva – 2019

The UK start-up Neos bundles a range of smart home IoT products, including cameras and a leak detector from home service specialist Homeserve with a home insurance product offered by Aviva. In this way, not only does the user buy a compelling product and service bundle, but the fact that Aviva knows that these devices are installed and are being used increases the profitability of the insurance product. The car insurance industry has long cottoned on to the value of usage data to insure high-risk groups, namely young drivers. Instead of relying solely on demographic profiling, so-called Usage-Based Insurance, allows insurance companies to charge drivers according to how much they drive and their style of driving. One example of such a partnership is Allianz providing data from its global telematics platform to Marmalade, a specialist car insurer for younger drivers. This data is used to calculate premiums, enforce driving curfews and provide driving style feedback to its users.

5. The Ecosystem Play – Don’t bother – Leave it to Google and Amazon

Possibly the most powerful means of creating business value through a portfolio of connected products is to create a platform into which other companies plug in their products and services. This is the Ecosystem play, and although many large companies have tried to pull it off, so far, very few have done so successfully. Indeed, in the Smart Home space, only Google with Google Home and Nest and Amazon with Alexa have managed to create thriving ecosystems. Both Google Assistant and Alexa are not only voice assistants, but have quickly become the de-facto integration platforms for all sorts of connected products. As platforms benefit from strong network effects, once they establish a critical mass of support, it becomes nigh on impossible for any other platform to emerge.

Enter the Trojan Horses – Nest Hub and Alexa Show – 2019

Consider Google, who recently announced that it is rebranding its Google Home products as Google Nest, requiring Google accounts for any Nest product. This way, by ensuring that anyone who uses a product connected to its ecosystem is using a Google account, Google is intent on building as comprehensive a picture of its users’ physical actions as it currently has of their online activities. The Google ecosystem is a powerful information-harvesting programme making use of facial and speech recognition to add to its insight into individual users’ preferences.

Similarly, Amazon makes use of its growing Alexa ecosystem to build further insight into its users’ preference. By offering more interaction points for its users through its Alexa and Echo enabled devices, like Google it is intent on building insights into its customers’ preferences. This is then monetised through tailoring its promotions and offers to its customers, as well as being able to build more customer data into its advertising platform. Like Google, the ecosystem is an exercise in information harvesting.

Stage 3 – Combine the Approaches

To most companies creating consumer connected products, the secret to sustainable success will require the following combination. First, provide the basic service for free. This allows you to develop a relationship with your users, providing insight into their preferences, and most importantly, giving a springboard for further monetisation strategies. Then seek to create a series of must-have services, priced aggressively enough not to act as a barrier to adoption. If possible, create a family of interconnected devices that builds on this proposition. Not only does it in itself add revenue, but it creates a product mix that is more difficult to imitate by competitors, and also provides more opportunities for creating paid-for services. The final piece of the jigsaw is to combine your service offering with that of players in adjacent or complementary fields, thereby creating opportunities for incremental sales or data monetisation.

In Part 2, we will explore what ‘Smart’ means in Smart Products and how smart algorithms and learning features can be used to strengthen the business models described in this post.