The ROI of IoT: Quantifying the Strategic Value of IoT

An Old Woman Weighing Gold Coins (Rembrandt School, 17th Century)

The Digital Transformation: From Conduits to Content

In the earlier days of the Internet of Things, the industry was obsessed with the magnitude of the network and forecasting how many millions and billions connected “things” it will encompass. As it turned out, those predictions were mostly overblown, vague and inconsistent.

But the hypothetical ability to connect billions of devices to the Internet is of little or no consequence to most industrial companies. Of course, telecom companies, wireless carriers, and semiconductor manufacturers see growth opportunities across many industrial sectors, but these numbers are meaningless to an organization that is trying to harness the IoT to optimize and grow its business and its customers’ business.

The fascination with astronomical number of connected devices is finally subsiding and the conversation is moving gradually from data pipes and conduits to utilizing their content to create business value.

In The Outcome Economy – How the Industrial Internet of Things is Transforming Every Business I describe the business value of the industrial IoT that revolve around a number of archetypal business schemas that include new business models and revenue streams, improved assets uptime and productivity, and enhanced customer insight that, in turn, boost customer satisfaction and market share.

Show Me the Money

With such high expectation for significant business outcomes, company leadership is eager to invest in IoT, but not before they see a credible cost analysis of the return on technology investment.

Indeed, many green-field early stage IoT projects require significant investments over an extended period of time: designing new connected products and retrofitting legacy assets, architecting a network infrastructure, and managing network security and data privacy.

Although the availability of cloud-based IoT services and a growing number of IoT platforms, coupled with declining price of sensors and computing hardware make plunging into the IoT’s cold water easier, company management must also take into account the necessary business process transformation: the time and resources to restructure business and customer relationships models, and the arduous shift in organizational structure and culture.

No wonder many in corporate management believe the return on investment in IoT is elusive and the time horizon to tangible benefits makes IoT initiatives prohibitive.

But should the industrial Internet of Things be treated as just yet another IT project, like upgrading a network or implementing a new ERP system? Or does an investment in a promising technology and new business constructs warrants a different, more strategic, approach?

A Different Approach to Evaluating the Internet of Things

Companies must innovate continually and invest in technology to improve efficiencies, be more competitive, and drive profitable growth. They must evaluate and invest in developing and adopting emerging promising technologies and new business opportunities these technologies promise to bring about.

Yet, the decision which technologies to pursue, when to adopt them, and how to manage the implementation process in order to harvest the anticipated business outcome can be daunting.

Two major considerations are associated with any large technology investment: the irrecoverable cost of the project, and the uncertainty about the timing and the magnitude of the value returned.

Irreversibility, often described as sunk cost, of the investment stems from direct spend on hardware, software and the associated training and learning, and the cost of implementation, testing and deployment.

A cloud-based IoT platform reduces direct expenditure on hardware and software, training, and implementation. But at the same time, other irreversible costs such as employing consultants and systems integrators, and absorbing productivity losses during the business transition can easily dwarf direct capital expenditure.

Uncertainty results from the unpredictable nature of a new technology the ability of the organization to exploit it effectively. And there’s uncertainty in how the business transformation undertaken to exploit the new technology will impact the rest of the organization: Will it bring about the excepted change? Will customers and business partners adopt it willingly? Will it disrupt and cannibalize exiting profitable businesses?

Traditional methods to calculate return on investments, such as net present value (NPV) and discounted cash flow (DCF), don’t work well for investments that are associated with the high degree of uncertainty and irreversibility associated with emerging high-potential technologies such as IoT. These methods tend to overstate early-stage costs and devalue the importance of long-term strategic investments and that greater uncertainty at the outset often indicates greater future value.

When considering an early investment in a new promising technology such as the Industrial IOT it is advantageous to employ a different approach and view it through a real options lens.

Real Options

Real options method considers the initial technology inves­t­ments, such as creating a proof of concept, a prototype or a pilot project, as enabling multiple options of future growth. This investment forms a foundation to realize future benefits from subsequent deployments and redeployments of that technology or its derivatives.

This notion is analogous to a fin­ancial call option that confers the right, but not the obligation, to obtain benefits from future owner­ship of traded securities. When using real options to evaluate a technology investment, the cost of the initial investment is the “price” paid to obtain the set of future options. Each follow-on project is evaluated separately as a different option.

The concept should not be entirely foreign to product organizations. Companies make routine investments in innovation and core R&D, in the hope of leveraging innovation by further developing and deploying new products.

Real Options Valuation

If the idea is to defer future value realization, how do you determine the potential value of future options?  How do you compare and prioritize alternative paths? HHpHow do you quantify the future benefits and IoT business solution might bring?

Option value should be evaluated using broad categorizations that incorporate an external perspective of market position and competitiveness, and an inside perspective of innovation and growth.

Creating Market Advantage

Companies make technology investments to drive higher level of competitiveness and business advantage in the marketplace. The option value is determined by the degree to which the new products or services establish a sustainable market advantage and provide effective barriers to entry against existing and future competitors.

Leveraging Platform Foundation

A platform strategy increases the organization’s capacity for effective incremental innovation and flexibility to pursue follow-on investments incrementally in unforeseen areas that are yet to develop. It allows the product organization to exploit knowledge and experience gained during the development and deployment of a new technology across business functions and product lines.

A platforms strategy forms a foundation upon which subsequent implementations create yet a higher-level foundation, which, in turn, enables higher level of innovation, operational optimization, and market advantage.

Options built upon this foundation have greater potential returns and lower level of uncertainty in exercising them.

Innovation Culture

Organizations vary dramatically in their ability to manage the business transformation process all the way from core innovation to effective and profitable deployment. The organization’s innovation culture and process maturity, and its ability to marshal technical, financial, human, and organizational resources, greatly impact the ability to harvest future value of technology.

A mature innovation-oriented culture gives an organization a higher level of flexibility and confidence in selecting and exercising future options, thereby increasing the option value of the initial investment.

Learning Potential

Related to the innovation culture of the organization and its innovation platform foundation, is the extent to which the organization possesses the capacity to maximize learning and apply it continually and effectively.

Companies that excel in continuous learning and knowledge reuse tend to innovate more rapidly and economically, and with a greater likelihood of success, further increasing the option value of the proposed investment.

The ROI of IoT

Investing in Industrial IoT technology is clearly a strategic business decision.

Companies should view the Industrial Internet of Things as a radical technology and business innovation aimed at business disruption. They should consider investing in IoT technology and business infrastructure to capitalize on the sweeping range of operations improvements, new business opportunities, and innovative customer-engagement models enabled by a network of smart, connected devices.

The real options approach is a qualitative evaluation method that can help managers determine the most strategically-valuable path to pursue and prioritize the different options enabled by the IoT platform. It encourages long-term strategic thinking and underscores the future value that will be obtained from early investments in technology.

Even when utilizing a traditional ROI method is mandatory or advised, a systematic and objective qualitative evaluation of future benefits will provide a solid framework to help identify, prioritize, and budget projects to maximize the potential for high option value.

Footnote

Portions of this article are based on the work of Professor Robert Fichman at Boston College on Real Options and IT Platform Adoption: Implications for Theory and Practice.


Image: An Old Woman Weighing Gold Coins (Rembrandt School, 17th Century)
This article was sponsored by Siemens PLM