The past five years have marked a sea change of industrial companies quickly coming to the realization that their future is digital. Digital data is suddenly seen as more valuable than oil. These companies woke up to find themselves in the Fourth Industrial Revolution (or Industry 4.0) — where sensors and cyber-physical connected systems have changed the very definition of industrial machinery. This has led to an arms race of software acquisitions by industrial manufacturers.
“To build or buy” is a classic strategic question for large corporations, and when it comes to an area that is as far outside an industrial company’s core competency such as cloud and mobile software development, buying rather than building is often their chosen chess move. According to the New York Times, citing data compiled by Bloomberg, in 2016, the number of technology companies acquired by nontechnology companies (682) outnumbered those acquired by technology companies (655) for the first time ever.
In the past few years alone, we have seen giants such as General Electric acquire ServiceMax, Siemens acquire Mendix and Mentor Graphics, and United Technologies acquire Predikto, to name a few among many examples.
Jeff Immelt, the former CEO of GE (a customer of ours), foreshadowed this metamorphosis in 2015 when he said, “Industrial companies are in the information business whether they want to be or not.” The most recent company to make headlines in this regard is Honeywell, whose new CEO is betting the company’s future on software.
The importance of digital technology in almost all industries is undisputed, and not embracing it all but guarantees that large, established corporations will fall behind their competitors. In fact, two-thirds of business leaders agree that they need to be more digitized to ensure they stay competitive. This pressure bears down strongly on industrial companies, with the emergence of Industry 4.0 and most notably the industrial internet of things (IIoT).
“Go digital or go extinct” is not merely a siren song. There are several strategic benefits that can be unlocked by a digitization strategy, through a shrewd approach to acquisitions.
Digital technologies enable industrial companies to better monetize their domain expertise — by enabling them to offer value-added services that leverage insights from sensor data, computer models and artificial intelligence (AI). Such services are typically designed to help their customers obtain better performance from their industrial assets.
Creating new defensible revenue streams from unique value-added services is a strategic necessity in the face of globalization and manufacturing commoditization. As lower-cost manufacturing powerhouses such as China and India are on the rise, they are slowly eating away at the traditional bread-and-butter product lines of high-tech manufacturing stalwarts in the U.S. and Europe. Reinvention is the key to survival for long-established manufacturers.
Take Emerson (a customer of ours on other projects) and its Connected Services. The company paired its Plantweb IIoT platform with expert advisors who remotely monitor sensor trends from devices and then proactively advise customers on critical maintenance and upgrade requirements to ensure operational continuity and high performance in large-scale plants such as oil refineries.
To unlock this benefit, industrial companies should ask themselves, “If deep-rooted expertise is currently a reason our customers stick with us over lower-cost competitors, how can software and digital data amplify that value-add?”
It is no secret that software businesses are particularly attractive to investors due to their inherent high scalability and high margins (due to the extremely low marginal costs of selling incremental units of a software product). The sky-high price/earnings multiples of public software companies is evidence of investors’ love for digital businesses.
By deriving more and more revenue from digital product and service lines, industrial companies can start reaping similar rewards. Notably, Honeywell’s software strategy is currently being widely credited for its stock price rally.
The challenge that large industrial companies face is that it’s difficult to move the needle on profit margins in a multibillion-dollar business. Therefore, it is important to analyze how digital revenue streams can be interwoven into all traditional product lines. If you can release software that complements existing equipment or services that you provide, the software sales can piggyback off your existing sales channel and achieve significant scale quickly.
Software and digital companies are disrupting traditional nontechnology industries at an astounding pace — upending business models that have been stable for decades.
Well-timed strategic acquisitions are a key strategy to avoid disruption. As Anthony Armstrong, co-head of technology mergers and acquisitions at Morgan Stanley, put it, “It’s better to acquire disruptive technology than to be disrupted by that technology.”
It’s not only startup companies that pose a risk of disruption: Industrial companies fear ceding ground in areas like IIoT to the “digital giants” such as Google, Microsoft and Amazon. Acquiring nascent software and digital companies can often stave off the threat of disruption by a digital giant.
Take General Motors’ acquisition of self-driving vehicle startup Cruise Automation — a move certainly timed to offset the threat of disruption of the auto manufacturing industry.
The famous motto of Andy Grove, former CEO of Intel, was “Only the paranoid survive.” As industrial companies want to secure a prosperous future, they certainly need to be paranoid and ask, “Who’s about to eat our lunch?” This can lead to an acquisition strategy that staves off the threat of digital disruption.
A thoughtful acquisition strategy can help industrial companies to come out on top in the new cyber-physical industrial world. Careful execution is also essential after setting the strategy in motion. As Barron’s remarked about Honeywell’s software strategy, “The potential is large, but there is no guarantee that software as a strategy will work. One need look only at GE to see the perils of betting on the IIoT to transform a company.”