So You Want to Build an Internet of Things Business

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Earlier this month, Google made headlines by acquiring Nest Labs, the connected home startup, for $3.2 billion in cash. Although Nest has received significant fanfare for its smart products, some have argued that the price is a very generous premium for a small company that only a year ago was valued at $800 million. But, perhaps more importantly, why would Google — given its track record of market successes, strong design and engineering talent, and unique brand reputation — choose to buy its way into the Internet of Things (IoT)?

Perhaps because it is really hard to create organic growth through connected devices. It requires linking physical product and software experiences – designing for convergence – in a way that few large companies have done successfully to date. While many companies have explored home automation, connected car, and wearables, the practical realities of building and scaling an ecosystem of connected products and services are more challenging than most senior executives realize. And getting the convergence wrong can have serious implications for a company’s bottom line and market reputation.

More specifically, designing for convergence involves three big challenges. Any of them individually is difficult — but to build a successful IoT business, a company must manage to do them all well.

Connect Vision to Real Customer Needs

It’s exciting to envision futuristic scenarios in which previously analog products come to life. How could they all turn “smart,” and exchange information with each other in interesting ways? But the most compelling value propositions usually start with a focus on a single customer pain point. Mike Slattery, VP of Connected Car for AAA Club Partners, knows this. “When we built SMARTtrek, our connected car platform, we knew there were many potential scenarios to solve,” he says. “But we focused on one meaningful service – combining roadside assistance, repair, and auto insurance – to create a unique connected experience. SMARTtrek provides location assistance to help us quickly dispatch and find our members, as well as insights into vehicle diagnostics to troubleshoot and ultimately provide the best possible repair experience.”

Whether your IoT vision revolves around cars, thermostats, refrigerators, or anything else, make sure you’re focusing on a problem to which customers want a better solution. Then figure out how that problem can be solved in a simple, intuitive way through an integrated hardware and software platform.

Integrate Physical and Digital Development

Designing connected experiences requires the integration of very different development skill sets and processes. First, you need hardware production, which calls for product design and engineering in a linear, often lengthy development cycle. Second, you need digital and software design, which happens in short, modular development loops and requires support from different kinds of designers (for example, specialists in user interaction) and programmers. While both hardware and software depend on good design to succeed, the approaches are like night and day – and being great at designing for pixels does not easily translate to being great at designing for atoms. Take it from Bug Labs CEO Peter Semmelhack (who has a software background). “Hardware is hard,” he admits in his book Social Machines. “Any disruption in the development of your product will have 3X greater impact on your schedule than you anticipate.”

The implication for most companies is that they rarely have both capabilities. The core strengths are in such contrast that they are rarely resident in one company. This is a huge hole that many large companies encounter in their IoT journeys – and in particular, has seemed to be the downfall of a number of crowdfunded IoT companies, despite their appealing ideas for new IoT offerings.

Bridge Different Business Models

The IoT is leading to new avenues of growth but also threatens how companies have historically made money. Hardware companies traditionally derive profits by balancing product revenues with the costs associated with materials, manufacturing, and fulfillment. On the flip side, digital companies usually leverage service business models, often with recurring revenue streams. For connected devices, the two worlds collide in a confusing way: the hardware company has to begin accounting for the costs of tracking data and supporting a service, while the software company has to start managing the costs of making and distributing physical products.

Steve Blank, the entrepreneur and Lean Startup advocate, has said, “A startup is an organization designed to search for a repeatable and sustainable business model.” As they embark on that hard task, connected device companies are further challenged by the fact that they have an old business model they must successfully transition out of.

Make, Buy or Partner

Back to Google, then – and every large company attempting to build an IoT-based business. They face the challenge of creating a robust hardware company with physical products, plus the complexity of running a service company, too. No doubt they have watched some companies make the transition through internal initiatives and organic growth, but have also noted how most others struggle. A client recently said to me, “The outcome of this effort is a business, not a set of products.” As simple as that statement is, it is hard to wrap an organization around the change it suggests. So expect to see more companies, like Google, decide that acquisitions or select partnerships (like Google’s collaboration with Asus for tablets) are easier routes to building a connected device business.

So You Want to Build an Internet of Things Business was originally published on Harvard Business Review.

Filed under: Business Design, Gordon Hui