One industry after another is hit by the digital wave. While the connected customer is already the norm, connected products and digital services are part of the next wave changing traditional paradigms for manufacturers and creating a new normal. Connected products and digital services have the potential to surpass the network effect we know from connected customers by a factor of 100 + x.

Michael Roemer, Guido Hertel and Sebastian Schoemann share their experience with and views on connected products and digital services and the implications for manufacturers.

What are connected products and digital services, and why are they a big deal?

Michael Roemer: First customers got connected, now products are getting connected. Today, there are 2-bn smartphone users worldwide. Connectivity has changed our lives and created digital giants like Facebook, Uber and Airbnb. These companies leverage the network effect of connected customers to create value. It is estimated that by 2020 some 33-bn objects will be connected. The value created by the network effect of connected objects will be 100 + x times of what we have seen with the coming of the connected customer. The changes - and the opportunities - will be huge.

A connected product is a physical product that is connected to the internet, like a connected car or a connected washing machine. These connected products enable companies to offer digital services, for example, an automated replenishment service for the detergent for a connected washing machine. Companies could also offer purely digital softwarebased products that enhance the functionality of a connected product – like Tesla’s autopilot.

Sebastian Schoemann: Manufacturers traditionally have a limited customer relationship, in terms of frequency and intimacy. They are in contact with customers at the time of purchase and in case of complaints. But customers use these products for many years – years in which manufacturers have no clue what customers are actually doing with these products. Connected products and digital services throw light into this black box. They allow manufacturers to have a continuous relationship with customers, and to get to know them and their habits more closely. Manufacturers are moving closer to their customers. Today, successful manufacturers offer the best value proposition for the one-time sale when selling a product. Tomorrow, successful manufacturers will sell a product because they offer the best value proposition throughout the entire product lifecycle.

Guido Hertel: As promising as this sounds, companies have to proceed with great care. Besides the product itself, four core elements are required to make connected products and digital services work: Connectivity, a server infrastructure, an external user interface, and an ecosystem. Connectivity is needed so the product can go online. The server infrastructure orchestrates the connected products and digital services. The external user interface is needed to give the user control of the products, and to monitor his interaction with the product and services. Today products are designed for the customer. Tomorrow’s products will need to be designed for a whole ecosystem, and the product lifecycle. The ecosystem of customers, partners and a developer community, will enrich the connected product’s value proposition through offering digital services – something Apple managed with great success.

Why is it so difficult for manufacturers to identify and activate these four core elements?

Michael Roemer: Let’s take connectivity. There is no standard in place yet to ensure interoperability with third parties. Companies today don’t know what the customer will demand tomorrow. But the choice of digital hardware on the connected product to enable connectivity determines what digital services and digital products will be possible in the future. Digital services or digital products that require a higher memory, or processing power will not be able technology-wise or in a form that endangers the user experience. Connected products and digital services are highly cross-functional and go beyond today’s understanding of the term. Cross-functionality will no longer be limited to corporate borders: It will need to connect the ecosystem to co-create value.

What about the other elements you mentioned?

Sebastian Schoemann: Server infrastructure is one of the most crucial battle-fields: Do I need my own infrastructure, or am I willing to integrate my product into third-party infrastructures? What sounds like a simple question requires a clear business model to provide an answer. If I simply want to enrich my products with connectivity, I probably don’t require my own infrastructure. But if I have plans to use the data, I need my own for data control. Manufacturers also need to decide how much “intelligence” is housed in the connected product, how much on the servers. This influences unit costs and also costs for servicing software. Once connected products are online, their software needs continuous updating – like a smart phone. The ecosystem implies a decision about the operating system upon which the connected product runs. For example, if I go for Apple, Google or Samsung, I enter a rich community of developers. However, I need to be very cautious about the consequences of such a step. Who owns my data and who controls my ecosystem partners? Manufacturers might not want their products to be interoperable with competitors that are using the same partner. Or they might not want to allow certain services that do not fit their brand. Lastly, manufacturers need to manage the external user interface, which could be an app running on a smartphone, a smart TV or a connected car. Do I allow my connected product to be controlled via a third party app to increase user convenience? Or do I create a stand-alone solution to “own” the user interface? Owning the interface - or having a clear business model when giving it up - is essential. Google and Facebook dominate the online ad market as they own the “online” user interface and the resulting traffic. Voice controlled user interfaces (chat bots) like amazon echo, Apple’s Siri or Facebook M have the potential to change all that. Chat bots could disrupt existing platforms because they will “own” the user and be able to route traffic – to Google search or elsewhere. Manufacturers need to consider these developments and include them in decisions about their business model.

Guido Hertel: Product development often takes several years during which market development around connectivity and software outperforms traditional hardware. Future product development will change significantly through connected products. Already today several manufactures design and test virtually new products via simulations – even within larger systems. This created digital image of a product will be used to compare it with the real-life use of the connected product and both being optimized continuously. So called digital twins will emerge i.e. the digital image of the product and the connected product itself. Both will grow over time and influence each other’s development. Real-life use can be fed back to the digital image, new features can be simulated with the digital image before deployment to the connected products. Finally, this continuous digital feedback loop can be used to leverage artificial intelligence options. The world of digital twins will not only impact how we design products, but also how we enhance, upgrade and service them.

How do connected products alter revenue, cost and business models?

Michael Roemer: Changes depend on the business model pursued, and on decisions taken about the four core dimensions outlined earlier. The business model should exploit of the closer customer proximity. We are moving away from one-time value creation for the customer at time of purchase. It’s increasingly about continuous and real-time value creation with and for the customer. For example, collecting customer data offers great opportunity for cross-/ and upselling. Also, the sale of digital products and services is becoming easier: White goods manufacturers like Whirlpool are integrating Amazon Dash into their connected washing machines. The connected product counts the washing cycles and automatically submits an order for a new detergent to Amazon Dash. Amazon pays manufacturer a commission for sending the order its way. It’s a simple form of recurring revenue. Other revenues could be generated by digital products such as downloadable “seasonable” washing program - for a one-time “cashmere wash” in the winter.

Sebastian Schoemann: We foresee a shift from one-off to recurring revenue along the product lifecycle, and a shift from monetizing hardware to software - from products to services. Manufacturers need to pay attention to this shift and adjust their pricing models to value-based. For example, remote maintenance is tempting because it cuts costs, but it might also pulverize traditional revenue from customer services. Also, software and IT infrastructure costs will become more important. Global infrastructure requires large investment and is only effective when a company has a large number of connected products in the field. Marginal costs for connecting products are zero, while marginal costs for product hardware remain real. Manufacturers need to learn to deal with these two types of marginal cost. However, harvesting data from connected products and services allows cost optimization, for example, in product development. One of the most radical forms could be a “platform business model” which manufacturers use to monetize the many-to-many connections created by their connected products - a form of market place between customers and suppliers. Such business models take advantage of the zero marginal cost for digital products.

How does A.T. Kearney support clients in connected products and digital services?

Michael Roemer: Clients are in different positions and maturity levels. But they share challenges. Some are just starting to think about the topic and what it might mean. Others have already developed first pilots in small “incubator” teams and are now looking to get the organization behind it – for rollout and ongoing operation, for example. It’s essential as connected products and digital services go beyond existing operating models. They often require the build-up of new capabilities – even a whole ecosystem. We also help clients thinking about next generation architecture for their products to cope with uncertainty. We guide clients through the complexity of connected products and digital services. We help them make the right decisions about their futures today.

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