The Industrial Internet of Things is a mega trend that is expected to transform existing businesses and create new ones – see chart below summarizing the research findings from the McKinsey Global Institute report (published in June 2015).
However, we are still in the early days of this transformation and actual deployments have barely scratched the surface. 451 research states that optimizing operations is the most common reason for deploying IIOT solutions, especially amongst manufacturing and utilities enterprises. While enhancing customer targeting is critical for retail, reducing risk is more important for financial and government segments. Security concerns, along with a lack of end-to-end solutions combined with a scarcity of skilled technical resources are currently inhibitors of enterprise IOT adoption. Another data point is that most VC backed company commercial traction in this sector has been at the infrastructure layer – hardware, networking, security and data. Hardware layer (chip) investments include Tessel, Pinoccio, Spark and Arduino. Networking/Cloud infrastructure investments include Ayla Networks, Jasper Networks, Iotera, PubNub and SigFox. Security investments include Mocana, Bastille Networks, Bayshore Networks and Weaved. Data infrastructure investments include Decision IQ, Maana, PingThings and Mnubo. CB Insights has categorized the IIOT into 9 emerging categories – 6 horizontal and 3 vertical ones – see the following chart:
Challenging Traditional VC Models
IIOT is challenging the traditional VC model across several dimensions:
Increasingly important role of Corporate VC’s
- A key theme of IIOT is transforming existing businesses through operational efficiencies, not just creating new ones. This requires start-ups in this arena to establish collaborative models with incumbents instead of do-it-alone models in order to create and capture value. This will likely result in a bias towards M&A exits rather than billion $ IPO’s.
- Most traditional VC’s lack domain knowledge around not-so-glamorous IIOT use cases and are therefore unable to provide this value add to start ups. This is another reason for startups to work with VC’s with deep operational experience in this industry as well as collaborate with larger players earlier in the process for product definition and validation.
- New business models are emerging as VC funded ideas do not need to be just broad and finely tuned (as in other sectors). In fact many IIOT startups are narrowly focused on specific problems and vertical markets. Such a “vertical solution” approach is often outside the comfort zones of most traditional VC’s. Furthermore issues around data privacy and data ownership are creating their own challenges around data monetization for startups.
Large technology vendors are being strongly influenced by two IIOT vectors: a) How it will impact their existing products, customers and markets; b) What new adjacent market growth opportunities it will create for them. Consequently corporate VC’s are pursuing aggressive IIOT eco-system investments as part of their overall strategies to identify new businesses or identify technologies to transform existing ones. According to a recent CBInsights three out of the top 4 investors in IIOT are corporate VC’s – Intel, Cisco and Qualcomm with True Ventures being the only pure VC firm.
A few examples to elaborate on emerging corporate IIOT strategic themes:
- GE is making investments around building smarter industrial machines and delivering business process improvements to its traditional customer segments such as aviation, rail, healthcare, power and oil and gas through advanced analytics. Key investments include being a founding member of IIC, Predix Industrial data lake development and eco-system investments to seed and identify best of breed IIOT analytics applications.
- Cisco is focusing its efforts on the theme of intelligent and secure-IIOT infrastructure and is partnering aggressively with industry incumbents like ABB, Honeywell and GE to deliver complete solutions. Key investments include ruggedized industrial networking infrastructure, acquisition of Jasper Networks and investments in PaaS cloud connectivity startups.
- Intel is touting IIOT as a key driver of its virtuous cycle of growth (data center and memory being the other drivers). Key investments include IOT SoC chips and investments in IIOT applications and infrastructure to create demand for its chips.
Finally the fragmentation of IIOT tools provides an additional opportunity for larger players like Cisco and GE to play a solution provider or systems integrator role with enterprise customers – e.g. knitting together their own solutions with startup company best of breed technologies. In fact, in many scenarios many startups are being forced to work with large integrators after going through a success proof of concept, where they were able to demonstrate superior capabilities against the same system integrators.
Implications for Early Stage Investments
To be successful in early stage investing in this sector will require:
- Startups delivering core solutions instead of technology building blocks alone. BGV portfolio company Intellivision (intellivision.com) a leader in video analytics and smart connected IOT cameras is a good example. The company delivers full video analytics solutions for surveillance and smart connected homes. In an era of robotics, drones and automated vehicles, where a multitude of sensors help in control and maneuverability, computer vision has become a critical technology need. While open source solutions like OpenCV provide a good starting point, accuracy and real time are features one cannot compromise on. IntelliVision has some of the highest accuracy rates and is integrated directly into chipset. In order to win with this strategy, you have to have best-in-class solutions with proven performance metrics.
- Focus on Analytics and Cybersecurity – the sectors where startups will be best poised to create and capture value. Analytics innovation will be driven two factors: a) Tsunami of MegaData – According to IDC 40% of all data generated by 2020 will be machine generated, yet most companies remain ill prepared to leverage this for competitive advantage; b) Latent Economic Value – McKinsey and ABI estimate that $11.4 trillion will be created from IIOT driven productivity improvements. A big driver of this will be analytics ($25B from Maintenance analytics alone). Innovations in Machine Learning (Neural Networks/Deep Learning) – are beginning to deliver the data science needed to deliver insights from the above. This spans issues such as ability to scale, improved signal to noise ratios, lack of labeled data for training, and the use of deep learning models that adapt as the contextual environment changes. Companies like Predikto (predikto.com) – Predictive Maintenance for Transportation Verticals along with Sentient (www.sentient.com) – AI platform employs deep learning to a number of verticals and Maana (www.Maana.com) – Data mining and machine leaning solutions for IOT) are promising early stage companies in this area. Cybersecurity will be the another area of significant value creation opportunity for startups because of two reasons: a) The surface area of attack for IIOT is immense due to factors such as – Cloning of things, malicious substitution of things, eavesdropping attacks, Man-in-the middle attacks during key exchanges, firmware replacement attacks, routing attacks, Privacy threats and extraction of security parameters; b) Security is fast becoming the #1 bottleneck for broader IIOT deployments (451 research findings that the #1 concern inhibiting IIOT deployments amongst enterprises is security). Companies like Bayshore Networks (www.bayshorenetworks.com), Device Authority (www.deviceauthority.com) and Bastille Networks (www.bastillenetworks.com) are good examples of startups in this space.
- Developing Solutions for Vertical markets – We believe that there will be an emergence of IIOT full stack vertical solutions startups that can deliver solutions required by enterprises instead of having to pursue a DIY strategy with consultants and SI’s. Deep product experience, filling in a gap that is not available within the SI world, is a necessity to win in this market. A common challenge such investments face is questions around the size of the total and serviceable addressable markets (TAM and SAM.) Contrary to a broad approach, startups have to choose a “niche market” that they can dominate. A successful strategy for such full stack vertical solutions startups is to have a viable “bowling alley” strategy (http://chasminstitute.com/) where they seek a beachhead that will allow them to leverage their success in the initial niche market to attack an adjacent related niche market.
- Partnering with Larger Eco-system Vendors – Finally startups will need to leverage the domain knowledge possessed by strategic partners around IIOT use cases to shape their product and technology development earlier at earlier stages of their life cycle.
- Cross-border start ups – According to the McKinsey Global Institute report on the Internet of things, “over the next ten years the potential number of IoT uses is likely
to be higher in developing economies. The applications that drive the most value in developing economies differ from those in advanced economies and, in some cases, because there are no legacy technologies to displace, developing economies can “leapfrog” in IoT implementations”. The high volume of estimated installations in developing economies reflects the shift of global economic growth to those areas, which has important implications for companies that compete in IoT equipment and service markets. China will be one of the largest users of IoT systems in factories as well as in other settings. Countries with oil and
gas operations—among the most important early adopters of IoT—will also be major geographic markets.” Cross-border startups that can address these international market opportunities will be well positioned for success.
The IIOT value chain and eco-system is a complex one, this combined with the important role of existing industry incumbents makes for a complex start up value creation and capture journey. Value creation from early stage investing in IIOT will require a different model, one that is more aligned:
- Around balancing vertical investment bets instead of purely broad horizontal ones
- With the DNA of corporate partnering required to collaborate with incumbents in the early days to deliver complete enterprise solutions rather than pursuing purely go it alone value building strategies
- Towards return models with a bias more towards M&A exits than Unicorn IPO exits
Anik Bose (BGV General Partner) shares his perspective on the industrial internet of things (IIOT).
Over the past 18 months we have seen a sizeable chunk of our deal flow coming from the IIOT sector. During this time we have also engaged in active dialogue with larger technology firms that are playing an important role in the IIOT eco-system. This blog attempts to synthesize our perspective based on our interactions.