25 Aug 2011 | Technology

The Internet of Things 

HAMISH DINGWALL RESEARCHES THE INTERNET OF THINGS AND DISCUSSES THE PROSPECT OF IT BECOMING THE NEXT TECHNOLOGICAL REVOLUTION.

In her fascinating book, Technological Revolutions and Financial Capital, Carlota Perez presents the theory that there have been five big technology revolutions in the past 250 years, each accompanied by predictable financial cycles. In order, these were the First Industrial Revolution (from 1771), the Age of Steam and Railways (1829), the Age of Steel, Electricity and Heavy Engineering (1875), the Age of Oil, Automobiles and Mass Production (1908), and the Age of Information and Telecommunications (1971). As we are now 40 years into the last of these, we need to start considering what might be next.

I believe that the Internet of Things, a concept in which objects, as opposed to computers, become connected, is one candidate. There are several reasons. Timing apart, the important hallmarks of previous revolutions are in place: new low-cost enabling technologies, a fresh set of young entrepreneurs, and the potential to have an impact on many industries. This development is important for the equity investor. The Internet of Things will disrupt the status quo as the digital world pushes into new fields, and new businesses emerge. In the past decade, digital companies crossed the deep competitive moats around stable industries. Advertising and marketing have already changed, while electronic readers are now transforming publishing. In addition, the Internet of Things might prove influential in big industries such as banking, healthcare and factory equipment. As a result, holding equities in these areas because they are ‘not technology’ may lead to investors losing money.

First, Definitions
Technological revolutions tend to attract titles as trends become conventional wisdom: before a new concept can be adopted it must be understood. Why one particular name is favoured, while others fade, is not clear, even in retrospect. It is happenstance that we do not refer to the Tramroad Mania of the mid-19th century, whereas Silicon Valley is self-evidently snappier than Transistor or Semiconductor Valley, and the currently voguish term Cloud Computing has the dual benefit of alliteration and of introducing an appropriate metaphor for an intangible aspect of progress. Although not easily defined, the so called ‘Internet of Things’ does convey a degree of intuition in the literal phrase.

Early Connectivity and the Media
In seeking to explain the Internet of Things, one place to start is the Screen Fridge. This received particular attention when it was developed by Electrolux and computing conglomerate ICL at the turn of the century. This was a common refrigerator equipped with a screen and an internet connection that would order such items as fresh milk or cucumbers from one of the first generation of soon-to-be-deceased online retailers like Webvan or Kozmo.com. However, over a decade later, I have never seen an internet fridge available for sale in any store, nor does a single person in my immediate social circle own one and, more importantly, I’m not aware that it has transformed the fortunes of either Electrolux or ICL.

Nonetheless, just as the ‘iron horse’ was a popular description which failed to fully convey the true potential of the steam locomotive, the connected fridge remains one of the commonly-cited examples of the future portrayed by the Internet of Things. The BBC recently reported on the current developments and, once again, drew on the internet fridge for inspiration. Bizarrely, it also illustrated the story with reference to a ‘smart’ wine rack, where the bottles could inform the owner when they were removed. I cannot imagine under what circumstances anyone would possibly want to know this.

First horse: ‘A coach without Horses!!!–nonsense–come, come, Master Dobbin you are “Trotting” but you must not think to hum [Ed: deceive] me because I’m blind!’ Second horse: ‘Well, dash my Wig, if that isn’t the rummest [Ed: strangest] go I ever saw–’.
First dog: ‘I say Wagtail! What do you think of this new invention?’ Second dog: ‘Why I think we shall have meat cheap enough’.

The above cartoon by the British caricaturist George Cruikshank, who lived through the railroad revolution, was entitled ‘The Horses, going to the Dogs’ and shows that there is nothing new about strange media depictions of new technologies. The illustration here is of a traditional stagecoach powered by steam (as in the case of the fridge, the new concept can only be imagined if attached to a familiar item), and the dogs enjoy a macabre conversation as they relish the prospect of making a cheap meal from those imminently redundant horses.

Personally, I suspect that the internet fridge will remain a slightly odd pipe dream, as will the connected wine bottle. However, I am convinced that the Internet of Things will be a serious business.

What is the Internet of Things really about?
The best way to describe the concept of an Internet of Things is to consider what can be achieved by fitting objects with a sensor and an actuator, some local computing intelligence, and a network connection. The point about the sensor is important. We are accustomed to an internet where many of the shared data are entered manually by people on personal devices, then subsequently retrieved and used by other people. An internet of mostly inanimate objects which collects, shares and uses data without human intervention has the potential to radically change so many economic activities. Thought of in this way, the applications are limitless. I will discuss three in particular.

Thinner Wallets
Near-field communication is a set of specifications for secure, short-range, wireless connection. The underlying technology has been around for almost 10 years, but was boosted in May 2011 when Google revealed plans for the Google Wallet payment system. The vision is that the way we pay has already shifted in history, from gold coins to paper money to plastic cards, and is about to make a further shift to an intelligent wallet based around the mobile phone. The mobile wallet has established itself reasonably well in Japan, and there are many trials currently taking place around the world. Although few phones are currently equipped with the technology, many observers predict that hundreds of millions of devices will carry it within a few years.

The change will cut across large industries: internet platforms, online and offline retailers, banks and payment networks, advertisers, phone operators and handset manufacturers. Apple’s iPhone has shaken up the industry over the past four years, causing significant problems for traditional mobile companies like Nokia and Research in Motion. Consider the extent to which this has happened, and it is easy to imagine how the added functions of near-field communications technology may place the smartphone even closer to the heart of the Internet of Things.

Healthier People
A smarter smartphone is only a superficial illustration. A more important area is healthcare, particularly where health and computing converge. Issues of cost and treatment outcomes are challenges for the traditional model of Western medicine. In the context of the Internet of Things, the questions are simple: how much data about people’s health do we collect and how do we use it? At present, nurses and doctors tend to collect data manually, so their time as a cost is a significant barrier to how much data we accumulate.

Moreover, we currently fail to share or process data as much as we could. Earlier this year, one of my colleagues spent time at the managed care group Kaiser Permanente’s innovation centre, experiencing, at first hand, the potential of an intelligent hospital based around an integrated web of cheap sensors located in beds and bathrooms. The data are shared, assessed and used in new ways that prevent and cure illnesses. In time, these innovations will lead to realising long-awaited benefits of more personalised medicine.

Lighter Industry
My third example is more obscure, but may become the most important of the three. From the cotton gin to computer-aided design software, factories and industrial plants have been in the vanguard of the five big technological revolutions identified by Perez. They are also likely to be at the forefront of the next. We are already seeing radio frequency identification (RFID)-type implementations in industry. Chip identification, as well as GPS and wireless technology, will allow industrial firms to keep tabs on heavy equipment and personnel, and to save money and time. Some companies have already grown considerably on the back of these developments.

However, the next step, after simple identification activities, is to sense and collect more useful readings. Gathering data such as temperature, strain, moisture, corrosion, count or foreign particles is expensive, dangerous or impossible to do manually in a production environment. People are simply less efficient than device networks at conducting routine checking activities. Once the data are collected, networks can send it across large plants, or groups of plants, to improve the operation of these facilities in real time. The result saves money, increases efficiency and raises safety levels. Could we avoid the next Deepwater Horizon or Fukushima Daiichi, thanks to the Internet of Things?

The Inevitability of Change
The examples above are only a subset. Broadly defined, the Internet of Things shows characteristics which may produce a true technological revolution. It has the potential to unleash Joseph Schumpeter’s ‘perennial gale of creative destruction’ across any area of life which might  benefit from data collection, sharing, processing and application with less human intervention. The smart grid, the smart home and office, remotely-operated military robots, and intelligent automobiles with telematic control driving systems are all likely applications in major industries. As is the case with most large technological shifts, it is the underlying cost factors which control the pace of adoption and produce new ways of doing things. The most important of these costs relate to manufacturing a sensor, providing local intelligence as processing power advances, supplying a network connection, and providing local power to the node in the network.

These cost factors make an Internet of Things inevitable. Conventionally, technology is considered unpredictable, especially in financial circles. In some ways, of course, this convention is quite correct. Certainly, there are difficult questions around which applications expand first, which companies take advantage, and what real value is priced into shares, given that many pioneers in these fields are unlisted. However, it is falling cost that creates economically viable applications from science fiction. From this vantage point, the notion that an Internet of Things will happen over the next 20 years is just as predictable, perhaps even more so, than the notion that some economies will be larger in 20 years time than they are now, or that people will still be buying canned coffee and Kit Kats from Nestlé.

Barriers to Revolution
There are obstacles to overcome. First, there will be investment costs to establish the infrastructure, and this will herald typical battles between those who pay in the early stage, and those who enjoy a free ride on the spending of others. There are already signs that the tug-of-war has begun, as unholy alliances form in the emerging mobile-payments industry, or consumers push back on smart meter programmes which raise their bills. Second, there will be resistance to changing the way we do things. For every application, there are people (nurses trained to monitor patients’ vitals, engineers familiar with existing infrastructure) who will, like Cruickshank’s horses, correctly foresee that there is more to lose than to gain at a personal level. Third, technology always proceeds randomly in fits and starts, and the many impractical solutions that the public does not need (the smart fridge) or want to embrace (collection of personal data) will slow real development

Broader Implications
In the abstract, there will be disruption to manual methods of data collection, sharing and processing. The flip side of this is an increase in productivity, as more efficient ways of doing things permeate. However, I should stress that this is an abstract concept and economists still debate the impact of past technological change on productivity and wealth. Links between economic growth and the stock markets are even more tenuous. The causal relationships are difficult to pin down with hindsight, and rarely strong enough to yield predictive power.

It is much easier to forecast that, while some businesses and individuals will lose out in competition with the Internet of Things, there are terrific opportunities for companies adopting new methods. Of course, existing internet companies have their chance.This is especially true where the Internet of Things overlaps with cloud computing, large quantities of data, and networking activities. However, as the recent news of Google and Microsoft shutting their respective smart meter software tools hinted, it would be unwise to assume that only these giants will take the lead. Just as the internet of computers has had a way of consuming its young and spawning new progeny, the Internet of Things is likely to produce fast-growing businesses which do not yet exist.

By definition, it is likely that some of the emergent businesses will benefit from a network effect, where the value of membership rises with the number of participants. This feature explains why growth and attractive economics can scale rapidly, as we have seen in the areas of voucher business and social gaming, which will provide two of this year’s hotly-anticipated IPOs. I expect to see a repeatable pattern of new businesses forming as the Internet of Things develops and the number of applications expands quickly.

No less important is the impact of existing businesses which adopt methods from the Internet of Things to improve their operations and offer new services. Very often we are unable to predict how the specifics of a technology will evolve (and I suspect that few people can with any certainty). What we would much rather do is back good managers who adapt to and use technology. I cannot think of an industry that will remain entirely unaffected by the Internet of Things, and many businesses with foresight are already adapting. For example, in automobile insurance, a sector which thrives on data, forward-looking managers have begun to offer in-car devices to measure drivers’ actions. The notion of monitoring the likelihood of an accident in real time, and rewarding good drivers with lower premiums, is very much in the realm of the Internet of Things.

Conclusion
Winston Churchill was correct when he observed, “the further backward you look the further forward you can see”. Although major shifts to a new technology often appear puzzling, far-fetched, unpredictable and intimidating to those living through them, there are common and familiar features which repeat every time. The approaching Internet of Things is probably one shift which will have an impact on future decades, and it will challenge what we assume are the normal confines of technology.
 

These notes may contain investment information which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are those of Hamish Dingwall and do not necessarily reflect those of Baillie Gifford or other investment managers within the firm. Investment markets and conditions can change rapidly and as such the views expressed are those of the manager and are subject to change without notice.

Hamish Dingwall
Hamish graduated BA in Philosophy, Politics and Economics from Oxford University in 1994. He joined Baillie Gifford in the same year and became a Partner in 2007. Hamish is a Global Sector Specialist having previously spent a number of years as an Investment Manager in our Japanese Equities Investment Team.