Innovation in the Internet of things (IoT) space continues to rapidly progress. Promises of connected devices forming the backbone infrastructure of connected cities and factories in the not-too-distant future are becoming common talking points at major tech conferences, especially as the ultra-low latency of 5G becomes more widespread.
One area where we see the biggest potential transformation is the Industrial Internet of things (IIoT). From the way that companies are manufacturing their solutions to how they sell and deliver these products, we are seeing some fundamental business model shifts in companies that both sell and purchase IIoT solutions.
Traditional IIoT Business Models
Traditionally, IIoT solutions combine two components with seemingly irreconcilable business and revenue models: hardware and software. Both of these components have been sold and bought in dramatically different ways.
Companies usually purchase hardware as capital expenditure (Capex) – a one-time transaction that they depreciate or amortize over a longer time period. Vendors were usually OEMs or manufacturers with sophisticated supply chain operations but typically were characterized by low margins.
Conversely, companies usually purchase and receive software as a recurring service – usually via an annual or monthly subscription that they can renew or cancel.
Initially, because industrial customers financed the bulk of their expenditure as Capex purchases, the predominant way that IIoT vendors could sell was to package everything up as a one-time transaction.
Initially, because industrial customers financed the bulk of their expenditure as Capex purchases, the predominant way that IIoT vendors could sell was to package everything up as a one-time transaction. Software costs were mostly embedded into the one-time purchase fee. This allowed the industrial customer to continue operations as normal, but profoundly limited the growth of IIoT startups. This is because most younger startups in the space did not have the professional or financial resources to replenish their entire customer base year after year by delivering the enormous sales efforts often required to sell 6-7 figure deals into a new industrial enterprise client base.
The SaaSification of IIoT
We’re seeing a fundamental shift in the way IIoT products and services are delivered to customers that reflects the increasing maturity of the customer segment and improving sophistication of the industry’s technological architecture.
Here are three behaviors that have developed during the past couple of years that have reversed the traditional trends:
- Hardware is still a necessary component of the overall platform. However, hardware is increasingly commoditized and IIoT vendors are much more creative about leveraging as many off-the-shelf components as possible rather than building everything from scratch. There is also increasing availability of white-labeled hardware products that IIoT vendors can customize without the burdensome costs of being an OEM or manufacturer.
- Industrial executives are increasingly comfortable with considering IIoT as an operating expense (Opex) item rather than as Capex and are more open to the idea of an ongoing subscription rather than a one-time fee. As companies have digitized, managers and executives have become familiar with the benefits of not having to host or pay for ongoing maintenance for their existing IT infrastructure, but rather to pay for these benefits as a service. It also frees up executives to only pay for needed capacity rather than having to project years worth of usage and activity (often inaccurately). Importantly, categorizing IIoT as an Opex eases up the speed of budgeting because the up-front costs decrease and frees up space for more investments across the entire organization.
- In response, IIoT vendors are bucketing hardware costs within their software subscription pricing to enable higher and longer recurring revenue. As a result, IIoT vendors are resembling traditional SaaS companies now more than ever.
3 Considerations for IIoT Companies Targeting Enterprise Clients
Going forward, the SaaSification of IIoT it will infuse much more flexibility and innovation within the industry. Here are three things IIoT companies, especially startups and growth-stage companies should consider as they build their business or make the strategic transition to SaaS:
How Efficiently are you Acquiring New Customers:
When IIoT startups transition from a single transaction model into a SaaS model, there is usually a significant hit to the bottom line as the business is no longer funded by large, one-time upfront payments. Rather, the company’s growth is driven by more customers paying smaller, recurring revenues over time. As a result, the price of acquiring each customer is a fundamental consideration that determines the company’s ability to scale. Tracking Customer Acquisition Cost (CAC) Payback will be key to understanding how quickly and predictably your company can recover its sales and marketing costs and sustainably increase its customer base to fuel top line growth.
How Loyal is your Customer Base:
Just as importantly, IIoT startups must successfully retain and grow the customer base. If you acquire new customers productively only to see them churn after one year, you need to reinvest sales and marketing dollars to acquire another customer to replace this lost revenue. This trend quickly becomes unsustainable. An effective indicator we use to gauge the health of a company’s customer base is its Gross and Net Revenue Retention Rates. The higher the retention rate, the longer the customer will be generating revenues to drive growth in the business. Low retention rates indicate a “leaky bucket” problem and should compel companies to evaluate its customer success function, the strength of its product-market fit, and pipeline qualification processes.
How to Reimagine Your Sales Compensation Plan:
Because larger, one-time transactions will no longer form the bulk of your business, you’ll need to reformulate how you compensate your sales team. Some companies calculate sales team compensation using Annual Contract Value (ACV) while others use Total Contract Value (TCV). The right option for you depends on how you want to manage your cashflow. Also, consider how you can incentivize multi-year deals to build a recurring revenue base. Finally, you’ll need to change the culture of your sales team. Customer management and success become infinitely more important when you need to renew and upgrade contracts on a regular basis. Your sales team will need the resources and expertise to nurture closer relationships with customers over time.
A Software-Driven IIoT Future
As infrastructure evolves, we are heading towards a faster, more connected future. Thankfully, IIoT business models are keeping pace with this evolution. However, as IIoT companies continue to transition to SaaS, there are sure to be growing pains. Finding the right partners along the way, building out a strong team, and establishing a dynamic culture are key to identifying value drivers and that make for a leading SaaS company.