By Markus Larsson, PARC VP of Global Business Operations
As consumer internet businesses have grown up, the market power enabled by the internet has been on full display. It is becoming increasingly clear that there are intrinsic properties of digital online services well-suited to create natural monopolies. There are several different models, which can be broadly categorized in three buckets with varying characteristics. The common denominator is that they all benefit from demand-side economies of scale (or network effects):
- Social Networks (e.g., Facebook, Snapchat): Now that social networking user growth has reduced, displacing or outcompeting the incumbent(s) will be virtually impossible. Everyone you know is already on the same network – why switch? The only realistic scenario – apart from strong anti-trust intervention – is new generations of Internet users adopting alternative social networks, mainly motivated by not being on the incumbent’s network.
- Marketplaces (e.g., Uber, Craigslist, Amazon): Possibly the most powerful model, establishing networks of suppliers and buyers in two-sided marketplaces. This is even harder to displace than social networks at critical mass, since the prime motivation to participate are economic – you want to participate in the marketplace with the largest audience to maximize profits. Craigslist is an obvious and well-chronicled example of this model where despite a long time of no apparent product development the service is still going strong. Of course, there are several newly launched competitors, high and low profile, but even if they succeed, Craigslist has had a remarkable run. Everyone posts there because everyone looks there.
- Machine-learning-based recommender systems (e.g., Google): Services that improve recommendations with access to vast amounts of relevant data will attract more users, get more data, and continue to improve, establishing a virtuous cycle. In this model, there is nothing stopping users from using competing services, except that the leading service will ultimately provide the best result, continually improve, which leads to more and more users, making it difficult for new entrants to compete profitably within any reasonable timescale.
In each case, due to the control of the relationship with end users that these models enable, suppliers are effectively commoditized – and commoditization kills pricing power. This is true for all monopolies, but it’s historically unusual that so many industries with these characteristics have emerged over such a short period of time.
In parallel, the Industrial Internet of Things (IIoT) has been emerging, and large industrial enterprises are placing big bets on the convergence of physical and digital worlds in the industrial ecosystem, by incorporating machine learning, data analytics, sensors, and artificial intelligence. Soon, individual pieces of equipment will understand entire interconnected manufacturing and distribution ecosystems, enabling them to self-organize and prioritize activities given business goals and constraints.
What do the dynamics in the consumer Internet space tell us about the Internet of Things (IoT) and specifically, the IIoT? How should executives in the industrial space create strategic options and modernize in order to leverage these effects and avoid being commoditized?
- Get the differences and similarities right. The consumer internet market and the IIoT market are different – in some aspects very different. Compared to the consumer market, the industrial ecosystems look more like a handful of islands where connectivity and standardization is very important, but what is between them may not be as important in the immediate term. Services experimentation in IIoT will almost certainly be substantial, but outcomes will be driven by cold, hard financial logic, which isn’t always the case on the consumer side (few consumers have a procurement department). However, there are dynamics that could replicate themselves in the IIoT space. If a company gets cyber-physical services and its associated business model right they could experience runaway success as the quality of service improves with scale. In effect, they can create a near-natural monopoly, effectively commoditizing upstream and downstream complements. That said, since suppliers and customers into a (hypothetical) service like this have a different economic incentives and bargaining power than your average Internet consumer – in particular a strategic disincentive to allow monopolies in their value chains – the likelihood for a monopoly to emerge is likely smaller.
- Understand the business you are in, and how IoT services can align with it. “Customers don’t want 1-inch drills, they want 1-inch holes” is the most popularized version of this sentiment. We have seen how ‘equipment’ suppliers can change their business from selling equipment to selling value (e.g. Rolls-Royce). Crucially, a full-blown business model transformation isn’t the only path forward. Our partners at East Japan Railway (JR East) have started leveraging sensing and analytics to increase efficiency of operations and reduce unnecessary time its trains spend out of commissions due to scheduled, but ultimately unnecessary routine maintenance. This reduction enabled by IIoT aligns perfectly with JR East’s business model of owning and operating transportation infrastructure and charging riders to use it.
- Acknowledge the ecosystem and partner to win. As with any Internet-enabled service business, IIoT services will require a set of skills that industrial players haven’t naturally acquired. User experience (UX) design, software development, software product architecture, model-based reasoning, and cyber-physical security are a few of the core skills. Teams with these skills operate differently than the engineering staff who industrial executives are used to managing. Partnering to complement the industrial core business will be imperative.
- Pay attention to market power aggregation. Strategically, industrial corporations must not only understand their own strengths, but maybe more importantly, they must understand how the rise of the dominant online services may dilute their ability to monetize. Executives may consider: what value can the IIOT bring to its current customers; what partnerships can be formed to advance its position; how will standards and data sharing counter undesired power aggregation; and, how learning from consumer Internet dynamics can help, all while acknowledging the important market and buyer differences.
The IIoT market is growing, and we continue to create the building blocks that allow industrial players to get started. With capabilities in cyber-physical security, advanced modeling of physical systems, deep learning, AI, machine learning, UX design, and printed sensors for industrial equipment, combined with a partner-oriented open innovation business model, we’re able to accelerate the development of these new services.
The industrial players that get the business model right can reap significant benefits.
Markus Larsson is responsible for PARC’s client implementation of advanced technology and innovation. PARC’s extensive commercial, government and academic portfolio shows the company’s ability to partner with a variety of organizations to help advance their offerings by implementing breakthrough technologies, including data analytics, sensors, AI, machine learning, security, manufacturing, energy and more.