The Industrial Internet: An Underestimated Game Changer?

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1 Views Matter DECEMBER 1, 2015 The Industrial Internet: An Underestimated Game Changer? It is well known that the Internet of Things (IoT) has revolutionized the consumer sector in major ways. Interestingly, disruptive technologies are also flourishing in the industrial sector and will be transformational over the next decade. This, we believe, will have an impact that is still vastly underestimated by many. The disruption will be felt in Manufacturing but also in Aviation, Oil & Gas, Power, Transportation, Mining and Healthcare. The Industrial Internet provides companies that adopt the right platforms and technologies with major profit opportunities by improving asset performance and operational efficiency, generating new service offerings and creating entirely new ways of adding value to customers. What is the Industrial Internet? Lucrecia Tam Independent Contributor Virginie Maisonneuve Managing Director The Industrial Internet can be defined as the union of a number of old and new technologies: Machine Learning, Big Data, Internet of Things, and Machine-to-Machine communication. In simpler terms, it is the combination of Big Data analytics with smart networked products - where smart products range from a pump to a jet engine to complex industrial machinery. Smart products are already ubiquitous. The term smart product refers to objects, devices and machines that are equipped with sensors, controlled by software and connected to the Internet. They collect all types of data, analyse them and share them with other devices, as depicted on the following page. The Industrial Internet: An Underestimated Game Changer? DECEMBER

2 Source: Michael Porter, Harvard Business Review November 2014 Scoping the impact of the Industrial Internet While the market opportunity of the Industrial Internet is still in the process of being evaluated, one of the most moderate estimates points to potential related spend growing from $20bn in 2012 to $514bn in 2020; ROI from this spend is estimated to increase from 13% to 150% over the same period **. A more optimistic simulation exercise based on productivity gains created by the Industrial Internet adds $15 trillion to global GDP by 2030***. In terms of units, currently in 2015, nearly 15bn smart products are connected to the Internet globally. By 2020, the number of connected products is expected to rise to 30bn. Of the current 15bn smart products, consumer and home technology account for approximately 50%, mobility accounts for 25% and industry 20%. The chart on the following page captures the essence of the Industrial Internet which is at the core of Industry 4.0, or fourth industrial revolution, a term that originated from a German government strategic project that promotes industry digitization. Once the smart products leave the factory floor they remain connected via the Internet and are constantly exchanging large amounts of data during use. It is these large amounts of data (big data) that constitute the most important components of the Industrial Internet. The data are subsequently analyzed and refined and become the tool used to control the smart products themselves. The analysis of big data thus generated may yield knowledge that gives rise to new business models. Moreover, the Industrial Internet provides an environment where products continue to evolve and potentially generate new after-service sales long after they enter into service; it sets a new environment where a firm and its customers have an ongoing relationship that is not limited to one product or service. 2 The Industrial Internet: An Underestimated Game Changer? DECEMBER

3 Source: Accenture. Who will benefit? Sectors that are benefitting from Industrial Internet technologies include: Agriculture: Some of the large companies in the sector are at the forefront of creating integrated data systems aimed at optimizing farm productivity while saving water and energy. OEMs are liaising with chemical companies to build intelligence into their machines to generate data to supply precision farming data to growers. Aviation: Aircraft OEMs gather information from engine sensors which allows their customers (airlines) to optimize engine performance for example analyzing fuel data can help airlines change flight procedures to reduce fuel use. This also helps aviation suppliers deepen relationships with both airlines and aircraft OEMs. Power: Smart grid technology enables utilities to analyze huge amounts of data across generation, transmission and distribution equipment. This analysis can be used to alert utilities of possible overload conditions, allowing adjustments that can prevent black-outs. Building Automation: Companies that offer building products and integrated building management systems can gather data about energy consumption and performance metrics. These companies can use the data to tailor products, solutions and advisory services that allow customers to reduce energy costs. The Industrial Internet: An Underestimated Game Changer DECEMBER

4 A major potential game changer in relative corporate competitiveness There is little doubt that the Industrial Internet has the power to change the competitive landscape forever. Digital technologies are changing the production processes in most sectors and in many cases redefining industry structures. Leading industrial and high-tech companies are already adopting these technologies and integrating them into their value chains. Manufacturing companies realize that innovation in the manufacturing process, even for simple products, offers gains in profitability and new growth opportunities. A survey conducted by the World Economic Forum**** (see figure on the following page), shows that companies are using new technologies mainly to reduce cost or grow revenues: 79% of those surveyed say that optimizing asset utilization is a key driver for adoption, while 74% say the same about creating new revenue streams through new products and services. This clearly has a major impact on relative competitiveness in several ways. First, the Industrial Internet can drive cost reduction by helping companies achieve higher operational efficiency. These efficiency gains can be attained through predictive maintenance and remote management, allowing for less unplanned downtime and higher asset utilization. Second, the Industrial Internet can help companies generate additional revenue streams resulting from the new analysis conducted, as well as from the interpretation and refinement of the data emanating from smart products. This is a software-driven process which will increase understanding of products, processes, customers and partners in the value chain. The ultimate goal is product innovation and new business. Third, the Industrial Internet can help drive worker productivity higher by replacing (in some areas) workers conducting low-level or risky tasks with intelligent machines, potentially improving performance at a lower cost. Increased worker collaboration with machines and other workers could result in much higher levels of productivity and a better, more human work environment. Fourth, the use of data and services can span beyond a specific firm as the Industrial Internet will enable the evolution of new connected ecosystems, allowing the sharing of data and services among companies. This development will blur traditional industry boundaries but companies will benefit from sharing the cost of data and even collaborate with one another. As with any major new global competitive trends, companies that do not adapt to the new technologies are at risk of losing market share, falling behind in the product development cycle, and damaging their reputation with both customers and investors. 4 The Industrial Internet: An Underestimated Game Changer? DECEMBER

5 Awareness and Hurdles Some industries are more advanced in their level of adoption of Industrial Internet technologies than others. In particular, Aviation, Oil & Gas, Power, Transportation, Mining, and Healthcare are currently undergoing major transformation. In a recent survey conducted by General Electric and Accenture, 73% of executives for the companies surveyed indicated that they are already investing more than 20% of their overall technology budget on Big Data analytics and more than 2-in-10 are investing more than 30 percent. Moreover, nearly 75% of executives expect that spending level to increase just in the next year*****. It is important to note, however, that a fully-fledged Industrial Internet still needs to overcome some important hurdles. Security and privacy lead executives list of concerns, especially in light of the increased frequency of cyber attacks. Companies will need new security platforms that protect everything from the smart products on the factory floor, to transaction authentication to system-wide safeguarding. Other important hurdles include cooperation and data sharing between operational systems that currently function in silos as well as some degree of uncertainty about the economic value to be created from deploying untested and costly technology. The Industrial Internet: An Underestimated Game Changer DECEMBER

6 Source: GE and Accenture Broader repercussions We are still in the early innings of the Industrial Internet. But if we use consumer IoT developments as an example, the implication is that we are at the onset of a new industrial revolution. The opportunity for value creation in the economy is changing radically and the benefits will extend beyond industrial companies. More efficient manufacturing and resource optimization, for example, results in improvements in environmental areas through better use of natural resources and energy. Smart, connected products can also help improve human conditions in healthcare, transport, etc. In sum, society at large will benefit. Conclusion In a slow growth world, every single shift in the competitive landscape has magnified consequences on companies. As the industrial sector is undergoing this extremely important revolution, investors must be diligent in understanding the full impact of the Industrial Internet on various sectors and companies and evaluate which can remain competitive and innovative through the economic cycles. Lucrecia Tam Virginie Maisonneuve 6 The Industrial Internet: An Underestimated Game Changer? DECEMBER

7 Sources: *The industrial internet is a term coined by Frost & Sullivan and refers to the integration of complex physical machinery with networked sensors and software. **David Floyer, Defining and Sizing the Industrial Internet, Wikibon, June 27, ***Peter C. Evans and Marco Annunziata, General Electric: Industrial Internet, Pushing the Boundaries of Minds and Machines, November ****World Economic Forum in collaboration with Accenture, Industrial Internet of Things: Unleashing the Potential of Connected Products and Services, January 2015 *****GE and Accenture, Industrial Internet Insights Report for 2015, 2014 The Industrial Internet: An Underestimated Game Changer DECEMBER

8 About the Authors Lucrecia Tam Lucrecia was most recently a vice president and global Sector Specialist/ portfolio manager at PIMCO in London, focusing on industrials for the global growth equity strategies. Prior to joining PIMCO, Ms. Tam worked for Schroders Investment Management in London as a Global Sector Specialist for Industrials Prior to that, she was an analyst at Allianz Global Investors Capital in San Diego and an equity research analyst at Deutsche Bank Securities in New York. Ms. Tam has a Master of Science in Management from Boston University and Bachelor Science in Computer Science from Roosevelt University in Chicago. Virginie Maisonneuve Virginie is founder and Managing Director of Maisonneuve Global Advisors. Virginie s background in asset management spans over 28 years and she served most recently as CIO-Equities, MD at PIMCO (London). Prior to this she worked as Head of global equities at Schroders (London), Co-CIO at Clay Finlay (New York) and held various senior portfolio management positions at State Street Research (San Francisco), Batterymarch (Boston) and Martin Currie (Scotland). She started her career as a consultant for the French Ministry of Foreign Affairs in Beijing (China). Virginie has an MBA from ESLSCA (France) and a BA from Dauphine University (Mandarin Chinese). She also has a first-degree diploma in Political Economy from People's University (Beijing, China) and is a CFA Charterholder. 8 The Industrial Internet: An Underestimated Game Changer? DECEMBER

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