You hear and read it everywhere: The Internet of Things will revolutionize the world as we know it. Smart devices from toasters to family homes which are equipped with microprocessors, data storage, operating systems, software, sensors, and IP addresses, and connected via the Internet will dramatically change the way we produce, market, sale, and use products and services. Great new opportunities for innovation and growth, but also competitive risks will arise in virtually all industries and markets. Anyone who hasn’t quite understood the strategic importance and scope of this game changing technology trend just yet is well advised to prick up his ears, as even strategy guru Michael E. Porter has recently turned his attention to the subject matter putting it way up on the collective strategy agenda.
"A new area of competition and prosperity"
Porter and his co-author James E. Heppelmann, CEO of PTC, argue in a recent Harvard Business Review title story, that the Internet of Things has “unleased a new era of competition.” Smart, connected products offer incredible opportunities for new product functionality, enhance product performance, longevity, and reliability, and go far beyond traditional product boundaries. These new and better products disrupt value chains, change competition within industries, reshape industry boundaries, and create entirely new industries. Porter even goes so far as to say that each company needs to ask itself the fundamental strategic question: “Which business am I in?”
Over the past 50 years, Porter explains, there have been three waves of IT-driven competition and growth. During the first wave in the 1960s and 1970s, IT systems enabled the automation of individual activities in the value chain (e.g., electronic ordering and invoicing), computer-aided design, and manufacturing resource planning. The second wave was the rise of the Internet in the 1980s and 1990s and the business opportunities that came along with it. The Internet of Things now constitutes the third wave. But unlike the previous two, it impacts not only the value chain, but also changes the products. "IT is becoming an integral part of the products itself."
Porter believes that these new and better products will unleash “another leap in productivity." In addition, their production will not only change already existing value activities, such as product design, manufacturing, marketing, sales, and customer care, but also create new activities like product data analysis and security. This will lead to a significant "value-chain based productivity improvement." Therefore, the Internet of Things will change the competitive landscape more dramatically than did the Internet. Porter predicts that the enormous productivity potential will soon lead to a "new era of prosperity." The exact timing and extent of this economic boom, however, is open to question. The authors tend to draw an overly optimistic picture here.
Reshaping Industry Structure
Based on his Five-Forces-Model, Porter analyses how the Internet of Things will reshape industry structure:
- Smart, connected products will weaken the bargaining power of buyers as competition will be based less on price but more on product differentiation.
- Smart, connected products will reduce rivalry among competitors as many new opportunities for product differentiation and value-added services arise. However, the increased upfront costs for software development and product design and particularly the very high fixed costs for providing and supporting the necessary IT infrastructure will likely lead to price pressure as companies will seek to spread their fixed costs across a larger number of units sold.
- Complex product design and high costs will create significant new barriers for new entrants. Other barriers include increased customer loyalty and switching costs.
- Due to their superior performance, customization, and customer value, smart, connected products will face little competition from traditional products, reducing substitution threads and improving industry growth and profitability.
- Smart, connected products will considerably weaken the bargaining power of traditional suppliers of physical product components, which will offer less value compared to the smart and connectivity components and can be commoditized or even replaced by software over time. However, IT-suppliers will become more powerful as their know-how and skills are central to product differentiation and cost minimization.
Redefining Industry Boundaries
The Internet of Things “will not only reshape competition within an industry, but also expand the very definition of the industry itself,” Porter argues. Instead of selling individual products, companies will offer entire "systems of related products" to meet a broader underlying need and improve overall performance. As an example, Porter mentions the integration of smart, connected farm equipment, such as tractors, tillers, and planters, which can enable better overall equipment performance. However, the trend doesn’t stop here, Porter says. New "systems of systems" will emerge that will link an array of product systems and external sources of information together. Smart homes, for example, integrate diverse systems, such as lighting, air conditioning, security, and entertainment systems.
Implications for Strategy
To take full advantage of the opportunities provided by the Internet of Things, Porter argues, companies need to answer ten key strategic questions:
1. Which set of smart, connected product capabilities and features should the company pursue?
2. How much functionality should be embedded in the product and how much in the cloud?
3. Should the company pursue an open or closed system?
4. Should the company develop the full set of smart, connected product capabilities and infrastructure internally or outsource to vendors and partners?
5. What data must the company capture, secure, and analyze to maximize the value of its offering?
6. How does the company manage ownership and access rights to its product data?
7. Should the company fully or partially disintermediate distribution channels or service networks?
8. Should the company change its business model?
9. Should the company enter new businesses by monetizing its product data through selling it to outside parties?
10. Should the company expand its scope?
Porter stresses that these questions build upon and reinforce each other, and that businesses need to make clear choices. The goal is to define a “coherent and distinctive overall strategic positioning for the company.”
The full article by Michael E. Porter on the strategic importance of the Internet of Things can be found here.
Porter, M.E., & Heppelmann, J.E. (Nov. 2014). How smart, connected products are transforming competition. Harvard Business Review (online ed.). https://hbr.org/2014/11/how-smart-connected-products-are-transforming-competition