Get Connected to Profit: Embracing Software Propels Growth in IoT Era

Get Connected to Profit: Embracing Software Propels Growth in IoT Era Device Vendors Must Transform into Software Companies – or Become Obsolete A Frost & Sullivan thought leadership white paper, sponsored by Gemalto Author: Avni Rambhia, Industry Principal, Digital Transformation, Frost & Sullivan

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Introduction...................................................................................................................................................................... 3 Transformation into a Software Company is Challenging, but Crucial................................................................ 4 Unlocking Profitability, Growth and Agility through Connected Software......................................................... 4 1. Increased Profitability: Lower Bottom-line Cost Meets Higher Top-line Revenue................................................ 5 2. Agile Innovation: Business at the Speed of Cloud........................................................................................................ 5 3. IoT and Continuous Optimization:The Philosophy of Actionable Metrics............................................................. 6 4. Flexibility in Pricing: Customers Demand Value-based, Usage-based Pricing ....................................................... 6 5. Flexibility in Feature Bundles and SKUs: From Waterfall to Agile............................................................................ 7 The Last Word.................................................................................................................................................................. 8

Conte nt s

Get Connected to Profit: Embracing Software Propels Growth in IoT Era

Introduction Software is not a new concept in embedded and hardware products. For years, devices have become increasingly intelligent, more programmable and more connected. What has changed today is that the trickle of product evolution has become a deluge of business revolution. Market-leading hardware manufacturers who have transformed into software businesses are finding the most success for themselves, while also driving success for their customers. As examples, General Electric has pivoted its business to the Industrial Internet, while Rockwell Automation has firmly positioned itself as the Connected Enterprise company. Cisco Systems’ Cisco ONE software program marks a decisive shift in how its portfolio is packaged and monetized.

The paradigm of usage-based billing, initiated by the rise of the cloud and Software as a Service, is extending to all software and software-powered businesses. Stalwart vendors such as Adobe and Microsoft are at the visible forefront of the transition from perpetual licenses to subscription-based billing. The ripples reach deep within the industry; our research finds that three in four software publishers are already offering usage-based pricing options or are committed to adding this option. Figure 1 below shows the story in numbers for how the Internet of Things (IoT) paradigm and software revolution translate into increased investment and revenues for industries.

Figure 1: The Impact of IoT in Numbers (Sources: Cisco Systems, GE and Frost & Sullivan)

3 Billion

$50 Million

connected devices by 2020 (Cisco)

$10-15 Trillion

MBs of M2M data consumed in transportation in 2018 (F&S)

$10 B

Investment in healthcare IoT; $90B M2M revenue by 2018 (F&S)

Global GDP gains from IoT (GE)

25% CAGR

2015-2020 M2M in utilities & industrial automation (F&S)

The trend is particularly pronounced in the industrial automation market. For example, Frost & Sullivan research finds that driven by the Industry 4.0 smart manufacturing initiative, the Internet of Things (IoT) and machine-tomachine (M2M) communications will play a major role in improved plant performance.1 Reducing total cost of ownership (TCO) of automation systems remains a key challenge, and bringing Internet of Everything (IoE) to bear on the problem is a key focus for 2016. Healthcare is also being transformed by the software and connectivity paradigm. For example, Frost & Sullivan research finds that investment into medical imaging equipment will continue to shift in favor of upgradeable, multi-purpose, and mobile imaging equipment with an emphasis on value-oriented product segments.2 That study further finds that replace-in-place offerings are gaining popularity as an alternative approach to purchasing refurbished equipment.

1 2015 Outlook of the Global Automation Industry, study code NEDA-10, 2015, Frost & Sullivan 2 Outlook for the Global Healthcare Industry, study code NFF8, January 2016, Frost & Sullivan

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Get Connected to Profit: Embracing Software Propels Growth in IoT Era

Transformation into a Software Company is Challenging, but Crucial The implication of the forecasts and trends discussed above, for all vendors in embedded and hardware markets, is that a change in mindset is crucial. If traditional manufacturers such as industrial automation vendors and healthcare devices vendors do not transform into software companies with expedience, they run significant risks of falling profits, eroding market share and increasing irrelevance.

Undoubtedly, this transformation creates disruption, risk and uncertainty. Product architectures, as well as tools to price, deliver and support products must be overhauled. Fundamental business processes such as reporting revenue, managing reserves and incentivizing sales forces must change. Back-office infrastructure must evolve rapidly to support seamless integration for new business models and improved visibility. Rather than grapple with so much change and uncertainty all at once, businesses often seek to take evolutionary or incremental steps to stem their loss of revenue and tackle slowing growth. The truth is, however, that we are squarely in the midst of a revolution.

As such, transformation is inevitable and the time for an incrementally evolutionary approach has passed. Moreover, there are clear and compelling business benefits to be gained from aggressive investment into and effort toward that transition. In the next section, we discuss five key areas of benefit and growth that result from a software-driven product and services mindset.

Unlocking Profitability, Growth and Agility through Connected Software The world today is moving at an increasingly accelerated pace. The age of custom-built products, with weeks spent on refining requirements and months required for fulfillment, is approaching its end. Technology, processes and innovation need to match this speed. Powered by flexible and open software-based designs, every industry is recalibrating toward rapid deployment, accurate measurement and real-time optimization. Transition to flexible product stock-keeping units (SKUs), dynamic monetization capabilities and connected ecosystems delivers clear benefits to vendors and customers alike.

Figure 2: Transformation to Software Paradigms Yields Clear Business Benefits

Increased Profitability

Flexibility in Deployment

Flexibility in Pricing

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Software v/s Hardware

Agile Innovation

Continuous Optimization

Get Connected to Profit: Embracing Software Propels Growth in IoT Era

Discussed below are the key reasons why hardware companies need to embrace the revolution of transforming themselves into software businesses.

1. Increased Profitability: Lower Bottom-line Cost Meets Higher Top-line Revenue A transition to software business models is directly correlated to increased profits, primarily due to lower bill of material costs and further due to lowered costs for operations and fulfillment. Software is inherently more profitable than hardware, with margins for pure software businesses typically exceeding 50%, while hardware margins are often lower than 10%. Further solidifying this concept, Frost & Sullivan research found, for example, that IoT application development for the healthcare sector is the key area of focus among small and medium software developers in recent years due to the faster return of investment and high profit compared to Typical software technology development.3 profit margin Vendors often balk at software form factors because the gross compared to sales price can be much lower — particularly when standardized hardware hardware is purchased off the shelf and software is simply licensed. This gives rise to the misconception that transitioning product lines toward software negatively impacts revenue. The important thing to look at, however, is net profit and profit margin. When implemented well, profit margins for software-based business units can range from 2X5X higher than hardware-centric business units.

2X-5X

The paradigm of managing software SKUs through hardware rather than software also yields operational efficiency due to benefits such as inventory streamlining, consolidation of SKUs and shortened sales cycles. By decreasing bill of materials costs through use of commercial off-the-shelf (COTS) hardware and lowering the costs of order fulfillment (for example through electronic activation), companies can further improve profitability. Achieving this in a manner that is transparent for end users without causing leakage of revenue through piracy is certainly a challenge, but one that can be effectively overcome with state-of-the-art monetization solutions.

Enterprise customers across a range of markets, including automotive, retail, transportation, broadcasting, healthcare and automation, are increasingly seeking open, virtualization-friendly systems with standardized interfaces. Correspondingly, proprietary hardware platforms are quickly falling out of favor as they create lockin and are rigid in form and function. Future-proof products with a connected software approach are more competitive in the marketplace and are more resistant to price wars with other commoditized competitors.

Last but not least, companies switching to software fulfillment paradigms often unlock new revenue streams by virtue of instantly unlocked upgrades on deployed products. This delivers a boost in topline revenue with minimal fulfillment overhead, which increases profitability even further.

2. Agile Innovation: Business at the Speed of Cloud Software paradigms allow agile responsiveness to changing customer capacity and feature requirements. In response to customer requirements, vendors can quickly turn features on and off, or unlock additional capacity on demand.

When supported with an appropriate provisioning and monetization layer, these operations can be executed quickly without the overhead of manual order processing or physical reconfiguration. Of course to fully capitalize on this 3 Connected Health: Mobilizing the power of IoT, study code D6B2-TV, December 2015, Frost & Sullivan

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Get Connected to Profit: Embracing Software Propels Growth in IoT Era

benefit, businesses must learn to transition from a number of bespoke configurations to a single architecture based on COTS hardware, with features and capabilities electronically enabled and parametrized through licensing.

A key challenge with custom-built products today is the tremendous pressure on customer teams to accurately define all requirements, over the expected useful lifetime of the purchase, when ordering new equipment. The ability to reconfigure products after deployment limits the risk for customers in case they fail to correctly identify all their product requirements up front, and provides future-proof protection of their investment. This can rein in long sales cycles and encourage investment, even when customer appetite for spending or risk is low. The software approach also future-proofs customer investments against technical disruptions.

Importantly, the ability to refresh firmware or software remotely and after the product is deployed allows vendors to continuously deliver new feature updates as well as timely security patches. This stream of updates represents tangible value to customers, who are consequently more likely to establish long-term subscriptions or maintenance agreements. The combined result includes faster sales, stronger cash flow, higher customer trust, and increased customer loyalty.

3. IoT and Continuous Optimization: The Philosophy of Actionable Metrics The “Internet of Things” refers to the philosophy of actionable metrics and builds on a perfect storm of connectivity, continual updates of software, and bringing to bear the power of cloud computing to optimize the performance of individual process components. Gathering data and deriving analytics is critical to optimizing products and business relationships. That Organizations who increased efficiency in process starts with a software mindset. Exploiting it fully requires their product going beyond the software mindset to the Internet mindset. development process

82%

by using smart manufacturing

There is no dearth of real-world examples showing how data capture and analysis can result in powerful insights for optimizing and growing businesses. Frost & Sullivan research found that 82% of the organizations that implemented a smart manufacturing process experienced increased efficiency in their product development process. As one specific example, a production gain of 30% was reported by a manufacturing company by the implementation of IoT technologies in the production line.4 Rockwell Collins, in its annual report for 2015, states that “the Connected Enterprise is transforming the world of manufacturing and production, [and] will drive more change in industrial automation and information in the next 10 years than in the past 50.”

Data can be parlayed into deeply insightful predictive analytics that deliver further value to vendors and customers alike. As insights into activities and products become more mature, there is benefit to being able to fine-tune or even overhaul data acquisition and analytics components over time. Software-based systems are inherently suited for this type of optimization and evolution.

4. Flexibility in Pricing: Customers Demand Value-based, Usage-based Pricing One of the most significant changes we have observed over the past decade of covering the software monetization market is the shift in power — away from software publishers who could demand onerous perpetual licensing terms and toward customers who are voting with their wallets for transparent, flexible pricing. As enterprises aggressively 4 D60A-T1, Internet of Things (IoT) -- Disruptive Opportunities in Key Sectors, September 2014, Frost & Sullivan

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Get Connected to Profit: Embracing Software Propels Growth in IoT Era

control costs in a challenging economy, optimizing assets is a key initiative. Correspondingly, there is a shift away from fixed upfront sales toward subscription pricing models, pay-by-usage billing and on-demand feature activation.

Software Paradigm

Actionable Metrics

Transitioning beyond CAPEX toward hybrid & OPEX pricing

Once vendors embrace the software paradigm and implement actionable metrics, they are equipped to implement new pricing models such as usage-based billing or surcharges for temporary surplus capacity. In essence, this allows a transition away from purely CAPEX business models in favor of opening up a spectrum from CAPEX to hybrid to fully OPEX business models. The challenge many companies face on this front is in transitioning existing sales and invoicing processes away from focusing on product sales and toward being focused on customer relationships. A key aspect of achieving this transition is incorporating new levels of efficiency, automation and visualization into the back-office system as it is rebuilt to track orders, implement billing and generate dashboards.

There is often a concern voiced about such models cannibalizing traditional business models. However, Frost & Sullivan research finds that companies that have opened up the option of usage-based billing (for example, based on number of times a device is used, peak number of daily users, or level of usage of specialized features) have reported satisfaction with corresponding revenue growth. Furthermore, increased customer satisfaction, stronger competitive positions and higher customer loyalty is reported.

For vendors, usage-based billing offers intangible advantages such as predictable and steady cash flow, which SaaS providers have enjoyed for years. The confidence that they will only be billed for actual usage has been shown to encourage enterprises to try additional features or upgrade packages that normally they would not have purchased outright. Companies of every size in every vertical are evolving toward a choice of licensing and pricing models, ranging from small businesses with specialty or niche products, all the way up to the examples of Adobe, Cisco Systems and Microsoft noted earlier.

5. Flexibility in Feature Bundles and SKUs: From Waterfall to Agile A recent survey commissioned by Gemalto finds that 88% of ISVs experience some type of challenge with their pricing and bundling. These challenges include the inability to repackage feature bundles without engineering involvement; difficulty in adapting to marketing demands in a timely manner; and inflexibility in defining new bundles of features in response to changing customer demands. Hardware companies are finding that their customers are evolving much in the same way as traditional ISV customers, with increasingly urgent requests to only acquire (and pay for) as much of the product as they will actually be using.

88%

ISVs who experience challenges with their pricing and feature bundling

As hardware companies begin to build, license and monetize products in the manner of software companies, they become much better equipped to automate the process of enabling and parametrizing features to best suit their target customer or customers. The process of upgrades for customers is also simplified. For example, Frost & Sullivan finds that within the

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Get Connected to Profit: Embracing Software Propels Growth in IoT Era

healthcare market, replace-in-place offerings are gaining popularity as an alternative approach to purchasing refurbished equipment. A compelling case study is for MRI machines, where revenue streams have grown when an updated system can be deployed on-site while keeping in the field the most expensive component—the magnet.

A key aspect of this transformation is personalization. Often considered a consumer trend, personalization is emerging as a key differentiator, even in business sale situations. A software-based product, pricing and fulfillment approach goes a long way in enabling businesses to be responsive to changing customer needs. Software architectures also provide internal product agility. It used to be that high reliability, low power consumption and dense computational capability were only available with custom-designed hardware or tightly controlled embedded systems. Improvements in general-purpose computation silicon are allowing commercial off-the-shelf silicon to deliver equivalent benefits, performance characteristics and competitive price points.

Furthermore, custom-designed hardware often involves months of design and commitments for production.

Choosing commercial-off-the-shelf (COTS) cores grants significant flexibility to product designers in developing, upgrading and redesigning products, while reducing risk and development costs. These benefits translate into better products, lower R&D costs, and enhanced competitive differentiation.

The Last Word There is a seismic shift under way in how customers are choosing, using and paying for their devices and software, with a corresponding revolution in device design and monetization. This is driven by the paradigm of the Internet of Things; the power of analytics to leverage Big Data and decimate costs or multiply profits; and the push toward instant-on purchase and provisioning even in enterprise scenarios. This wave of disruption is giving rise to exhilarating growth forecasts for connected devices and products across a range of verticals.

There is a dark lining to this silver cloud: failure by any hardware company to modernize at a competitive pace puts it at risk of becoming obsolete. To capitalize on this revolution, hardware vendors must embrace a software mindset and transform their business and products accordingly.

Objective analysis of industry best practices and growth opportunities across verticals spanning healthcare, industrial automation, transportation, retail and more underscore the critical importance for companies to move aggressively toward software-based feature management, usage-based pricing and virtualization-friendly architectures with piracy-proof deployment. State-of-the-art software monetization systems are able to help vendors tackle challenges of IP theft, counterfeiting and revenue leakage that inevitably arise in software-based products. State-of-the-art monetization back-office platforms are similarly well equipped to deliver key capabilities, such as unified management of varying business models and enforcement methods, automation of order fulfillment, and automated renewals and upsells.

Certainly there are perceived challenges and potential risk as businesses make this transformation. However, the clear and compelling upside of this transformation more than compensates for the initial upheaval. Profitability, agility, competitive strength, customer satisfaction and product quality all surge forward when the possibilities offered by software-based architectures, connected ecosystems and software monetization are harnessed to their full potential. Industry leaders are already investing tens of billions of dollars in the strategic direction of connected, intelligent systems. Are you at the table?

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