Valuebuddies here have no doubt been exposed to a lot of hype as to the prospect of the Internet of Things (IoT) and how many people claim it's the next huge thing. As someone with some experience in the field and value investing, I think I can provide a more rational and factual perspective on this industry than "it's the next Facebook". I choose to write this here because I think Apple is both an excellent example and the best company to make money in this field. Mind you, this isn't a recommendation to buy the stock - IoT makes up a fraction of Apple's revenue. But this will shed light on one of Apple's business segments.
What is IoT? The technology itself is nothing new. Wireless transmission of commands to devices have been around since remote TVs. But from a technical definition, the first widespread commercial IoT devices just came around the a decade ago, with the most well known probably being printers you can print from your computer. Lots of us probably have them, printers we connect to our WiFi and appear as a device on our network. And that's all IoT really is, a device connecting to the Internet. This part might mislead investors - the Internet here does not mean the world wide web, but rather being able to communicate on a wireless computer network, using the same protocols and frequencies computer networks use. But as we know, IoT printers did not make HP Inc fabulously successful and a multibagger.
The technology itself is practically primitive by industry standards. Hell, you can buy a Raspberry Pii, a USB light bulb and a WiFi USB adapter for $15 and boom, you have what is technically an IoT device. Every Tom, Dick and Harry company can cobble together an IoT device. And the practical benefit of it is pretty small - no one is going to pay much money for a light bulb they can turn on with their phone. No, the real benefit of IoT is something that IoT people rarely mention. Instead of talking about smartphone controlled coffee machines and door locks, they should be talking about what happens when you seamlessly integrate many IoT devices. The best example of this right now is Apple. An AppleTV for example, can connect to your iPhone and play high-def YouTube or personal videos. Then you can connect the TV to your AirPods and play sound straight to it. Then if you feel like doing some work, you can load your Mac to the AppleTV and turn on iTunes. That's where, I think, the value of IoT lies. If Apple could only do one of those things, it would just be a mild convenience. But together, there's a multiplicative effect of the benefit. More than that, there's a network effect where owning any single product then makes other Apple products more attractive. It's what is going to differentiate Apple from HP.
From a technical standpoint, this is not easy to achieve. What you need to do to achieve this kind of versatile ability of multiple wholly different devices integrating is a ground up software framework that lets them all communicate with each other where every system has to be, from the start, built to comply with this framework. Few companies have shown this kind of excellent software development skills and hardware integration, the most well known of which is Apple. Microsoft, Huawei and Google are also on this list. This is a field which Apple absolutely dominates because it has complete control over developing all iOS devices. Its only competitor, Android, is an open source OS developed by Google which every vendor that sells it (Oppo, Huawei, Samsung) implement their own way. Because each company tries to differentiate itself, each implementation of Android has a slightly different OS built for the specific hardware that it's company has. This causes a security problem called fragmentation, where the distributed nature of Android makes it a lengthy process to patch newfound vulnerabilities because it goes through each vendor to test and implement, if they bother implement it at all. It's pretty easy to have the Android device control one IoT device - lots of apps on the app store for that - but the kind of seamless integration Apple has, in both software and UI/UX, is on a whole other level. The failure of the Wear OS backs this up.
The UI/UX is also another key factor. This is a qualitative, not technical, opinion, but I think users need to be "nudged" towards using IoT. Partially because a lot of what IoT does could be done somewhat messily, like say plugging your headphones into an adapter then to a TV. And partially because consumer trends are not based purely on practicality but on perception which is influenced by marketing. Like the iPod, which while functionally equivalent to a Creative ZEN, sold infinitely better. This kind of brand marketing Apple also excels at.
So right now I think Apple has vast moats in the IoT business. But what could threaten these moats? That's any other company - or group of companies - that can produce such a seamless, integrated IoT experience. Does any such competitor exist, or will exist? I find it highly unlikely. The first reason being IoT needs a device to control everything. That means you already have to be already selling to your future IoT customers something they already use. Presently, that's either iOS or Android. Windows might be a competitor, and it doesn't suffer from fragmentation like Android. But Windows has the twin fatal weaknesses that it is almost purely a software company whose entire business model is based on software and that has little experience developing hardware (other than the Xbox), and that computers are far less versatile than a smartphone. I can't imagine someone lugging a laptop around to listen to music on the train, or even connecting to a TV when a large computer screen does the same thing.
Google could conceivably rival Apple. While the Android OS is fragmented, the Google Pixel is under full control of Google. But the Pixel has a tiny market share - less than 1% of the market - and has a very bad track record of developing hardware. I mentioned Google above as a company with the excellent software and hardware integration, I should clarify I mean this is a basic prerequisite to becoming a successful IoT company, not that these companies will be successful.
Open source IoT frameworks might threaten these moats. Both Apple and Android have released software frameworks, respectively HomeKit and Android Things. But this is essentially a standardised way for devices to communicate with smartphones. They are equivalent to a HP printer app rather than the seamless IoT experience Apple provides.
But above all this is what I strongly believe will be the snowballing nature of the future IoT business. Because these devices all use proprietary protocols, it's the opposite of an open source system. So consumers will be forced to pick between mutually exclusive IoT systems. And the network effect mentioned above means that if you buy one IoT capable device, you're more likely to buy another, and another. Given that the cost of replacing an IoT system is going to be huge - much more than each device - it means there will be very high brand loyalty. And the more people that use Apple's IoT system, the more their friends and family will have incentive to join, although I think this is a much smaller effect. I personally have never bought an iPhone because my friend had one.
This may be less of a windfall to Apple than it sounds because Apple still needs to manufacture the products. Say, if it wants to make ApplePrinter, it needs to go against HP, Canon, Brother Industries et cetera. So while it has this indisputable IoT edge, it is effectively entering into various parts of the consumer electronics industry which it has no experience in. Apple has had unusual success in the past in developing high quality hardware with large margins and vertical integration, but it is not guaranteed this will translate to other, possibly very different products. Tim Cook has also said Apple will be focusing on software and services to drive growth. The growth of its IoT segment is virtually unpredictable as it relies on the prices, margins and popularity of it's entirely new IoT products. Potentially but not realistically this includes most consumer electronics.
Again, this is not a recommendation to buy Apple. IoT devices are a fraction of Apple's business. It's quite certain Apple has huge moats in the future IoT industry, but whether this will translate into growth is a whole other question. In short, it has huge moats, but in a very tiny segment.
What is IoT? The technology itself is nothing new. Wireless transmission of commands to devices have been around since remote TVs. But from a technical definition, the first widespread commercial IoT devices just came around the a decade ago, with the most well known probably being printers you can print from your computer. Lots of us probably have them, printers we connect to our WiFi and appear as a device on our network. And that's all IoT really is, a device connecting to the Internet. This part might mislead investors - the Internet here does not mean the world wide web, but rather being able to communicate on a wireless computer network, using the same protocols and frequencies computer networks use. But as we know, IoT printers did not make HP Inc fabulously successful and a multibagger.
The technology itself is practically primitive by industry standards. Hell, you can buy a Raspberry Pii, a USB light bulb and a WiFi USB adapter for $15 and boom, you have what is technically an IoT device. Every Tom, Dick and Harry company can cobble together an IoT device. And the practical benefit of it is pretty small - no one is going to pay much money for a light bulb they can turn on with their phone. No, the real benefit of IoT is something that IoT people rarely mention. Instead of talking about smartphone controlled coffee machines and door locks, they should be talking about what happens when you seamlessly integrate many IoT devices. The best example of this right now is Apple. An AppleTV for example, can connect to your iPhone and play high-def YouTube or personal videos. Then you can connect the TV to your AirPods and play sound straight to it. Then if you feel like doing some work, you can load your Mac to the AppleTV and turn on iTunes. That's where, I think, the value of IoT lies. If Apple could only do one of those things, it would just be a mild convenience. But together, there's a multiplicative effect of the benefit. More than that, there's a network effect where owning any single product then makes other Apple products more attractive. It's what is going to differentiate Apple from HP.
From a technical standpoint, this is not easy to achieve. What you need to do to achieve this kind of versatile ability of multiple wholly different devices integrating is a ground up software framework that lets them all communicate with each other where every system has to be, from the start, built to comply with this framework. Few companies have shown this kind of excellent software development skills and hardware integration, the most well known of which is Apple. Microsoft, Huawei and Google are also on this list. This is a field which Apple absolutely dominates because it has complete control over developing all iOS devices. Its only competitor, Android, is an open source OS developed by Google which every vendor that sells it (Oppo, Huawei, Samsung) implement their own way. Because each company tries to differentiate itself, each implementation of Android has a slightly different OS built for the specific hardware that it's company has. This causes a security problem called fragmentation, where the distributed nature of Android makes it a lengthy process to patch newfound vulnerabilities because it goes through each vendor to test and implement, if they bother implement it at all. It's pretty easy to have the Android device control one IoT device - lots of apps on the app store for that - but the kind of seamless integration Apple has, in both software and UI/UX, is on a whole other level. The failure of the Wear OS backs this up.
The UI/UX is also another key factor. This is a qualitative, not technical, opinion, but I think users need to be "nudged" towards using IoT. Partially because a lot of what IoT does could be done somewhat messily, like say plugging your headphones into an adapter then to a TV. And partially because consumer trends are not based purely on practicality but on perception which is influenced by marketing. Like the iPod, which while functionally equivalent to a Creative ZEN, sold infinitely better. This kind of brand marketing Apple also excels at.
So right now I think Apple has vast moats in the IoT business. But what could threaten these moats? That's any other company - or group of companies - that can produce such a seamless, integrated IoT experience. Does any such competitor exist, or will exist? I find it highly unlikely. The first reason being IoT needs a device to control everything. That means you already have to be already selling to your future IoT customers something they already use. Presently, that's either iOS or Android. Windows might be a competitor, and it doesn't suffer from fragmentation like Android. But Windows has the twin fatal weaknesses that it is almost purely a software company whose entire business model is based on software and that has little experience developing hardware (other than the Xbox), and that computers are far less versatile than a smartphone. I can't imagine someone lugging a laptop around to listen to music on the train, or even connecting to a TV when a large computer screen does the same thing.
Google could conceivably rival Apple. While the Android OS is fragmented, the Google Pixel is under full control of Google. But the Pixel has a tiny market share - less than 1% of the market - and has a very bad track record of developing hardware. I mentioned Google above as a company with the excellent software and hardware integration, I should clarify I mean this is a basic prerequisite to becoming a successful IoT company, not that these companies will be successful.
Open source IoT frameworks might threaten these moats. Both Apple and Android have released software frameworks, respectively HomeKit and Android Things. But this is essentially a standardised way for devices to communicate with smartphones. They are equivalent to a HP printer app rather than the seamless IoT experience Apple provides.
But above all this is what I strongly believe will be the snowballing nature of the future IoT business. Because these devices all use proprietary protocols, it's the opposite of an open source system. So consumers will be forced to pick between mutually exclusive IoT systems. And the network effect mentioned above means that if you buy one IoT capable device, you're more likely to buy another, and another. Given that the cost of replacing an IoT system is going to be huge - much more than each device - it means there will be very high brand loyalty. And the more people that use Apple's IoT system, the more their friends and family will have incentive to join, although I think this is a much smaller effect. I personally have never bought an iPhone because my friend had one.
This may be less of a windfall to Apple than it sounds because Apple still needs to manufacture the products. Say, if it wants to make ApplePrinter, it needs to go against HP, Canon, Brother Industries et cetera. So while it has this indisputable IoT edge, it is effectively entering into various parts of the consumer electronics industry which it has no experience in. Apple has had unusual success in the past in developing high quality hardware with large margins and vertical integration, but it is not guaranteed this will translate to other, possibly very different products. Tim Cook has also said Apple will be focusing on software and services to drive growth. The growth of its IoT segment is virtually unpredictable as it relies on the prices, margins and popularity of it's entirely new IoT products. Potentially but not realistically this includes most consumer electronics.
Again, this is not a recommendation to buy Apple. IoT devices are a fraction of Apple's business. It's quite certain Apple has huge moats in the future IoT industry, but whether this will translate into growth is a whole other question. In short, it has huge moats, but in a very tiny segment.