Betting on the Internet of Things

Investing in connected devices could gather considerable steam in 2015 as markets for wearables, smart TVs, the connected car and even the smart home begin to mature.

But a significant shift appears to be taking shape. Investors are thinking less about hardware and more about software, infrastructure and security, the enablers of the Internet-of-Things universe.

This was the key take away from the sprawling Consumer Electronics Show in Las Vegas in January, where VCs took the temperature of consumer electronics business and caught a glimpse of products expected in 2015. VCJ spent several days at the show and talked to dozens of GPs, entrepreneurs and executives.

What stood out was this: Connected devices were everywhere, and the investment excitement for apps and enabling technologies appears on the rise. Fueling the interest is an Internet-of-Things market, Gartner expects it to nearly double in two years and almost triple in three.

“The connected car and home are as big an opportunity as the connected phone,” said Venky Ganesan, a managing director at Menlo Ventures. “When the iPhone came out in 2007 we had a difficult time seeing all the things that would emerge out of that platform. Similarly, it will be tough to envision and predict all the innovations that are going to emerge out of this platform, but I am sure they will and it will be equally transformative.”

The challenge is where and when to place bets. For some VCs, it is still too early. Standards are evolving and device interoperability is minimal. But if the show was a guide, smart homes, TVs, devices and cars are coming at a rapid pace and key pieces of the infrastructure will be needed sooner rather than later.

“The points of connectivity are proliferating,” said Jason Krikorian, a general partner at DCM. “It’s imperative that all these devices and systems work together in a way that is comprehensive.”

Smart home excitement grows

Perhaps, the most investor excitment is reserved for the smart home. Products hoping to remake everyday items, such as door locks, light bulbs and washing machines, were everywhere at the show.

Schlage showed off an Internet connected door lock that opens with a voice command. (It will interface with Apple’s HomeKit.) Chamberlain’s connected garage door opener let’s homeowners check remotely whether they’ve left the garage door open. Sengled displayed LED light bulbs with speakers and cameras.

“The connected car and home are as big an opportunity as the connected phone.”

Venky Ganesan

Managing Director

Menlo Ventures

The biggest hurdle is that platform standards to permit easy installation and interoperability haven’t arrived. Competing formats such as Bluetooth, ZigBee, HomeKit, Iris and SmartThings aren’t likely to converge this year, making investment bets complicated to time.

For DominateFund Managing Partner Ben Parr, it is not too early to get involved. “I think we probably will make our first investment this year,” Parr said. Companies have trouble getting traction and getting prices down, but “there will only be a small set of winners.”

Yet successful products this year are likely to be the most practical ones: Electrical plug adapters that enable smartphone control, connected water leak detectors and motion sensors that function without broad network integration. Over the next year or two, the market will transform from an appliance, or hardware, focus to a services business, said Radek Tadajewski, CEO of hardware maker OORT. Services providers, perhaps manufacturers, utilities or telcos, may give hardware away at low cost in exchange for lucrative services contracts, Tadajewski said.

This could open up opportunities for young companies. One VC already examining the space is Randy Hawks, a managing director at Claremont Creek Ventures: “It’s not about the devices. It’s about the information they are giving me.”

That means integrating data and turning it into value, Hawks said.

Building blocks will be needed to enable this integrated smart home. That means looking at the network infrastructure, but also home security, home automation and data analysis, Ganesan said, whose firm backed hardware maker Dropcam, which Google-owned Nest Labs bought last year for $555 million. Networks need new capabilities to handle expanded loads and the diversity of connected devices. Homes will need the smarts so that locking the door will switch off the lights and lower the thermostat.

“We think we’re just at the beginning,” Ganesan said.

New Enterprise Associates also has its sights on technologies to tie together and improve the ecosystem, said Partner Dayna Grayson. That may mean investments to provide more intelligent location technology, better sensors and better ways to integrate video.

The platform will mature in the next year or two, said Grayson, who has an investment in APX Labs. “It’s not there, but it’s close,”

For Spencer Tall, a managing director at Allegis Capital, a less recognized point of entry may be the enterprise, where investing could be more exciting than in the consumer space. It is not hard to imagine corporations giving employees smart apps to unlock doors, access computers, turn on lights and open applications, he said.

Connected car apps

Also attracting considerable interest from entrepreneurs and venture capitalists is the connected car. In the past year, the technology ecosystem has noticeably advanced.

“There are lots of app ideas out there big and small,” said Ljuba Miljkovic, chief product officer at Automatic Labs. Miljkovic foresees a time when apps stores exist for cars and developers make money.

One example of the growing ecosystem is a partnership with Nest Labs that Automatic highlighted at the show. The result is an app that alerts the Nest thermostat when a homeowner returns.

Another company banking on the expanding ecosystem is Pioneer Electronics, which at the show unveiled radio consoles designed to work with Android and iOS platforms.

”It’s not about the devices. It’s about the information they are giving me.”

Randy Hawks

Managing Director

Claremont Creek Ventures

The app community “will go from being a community of a couple hundred to a huge community,” said Ted Cardenas, a Pioneer vice president of marketing. “The potential is exponential.”

VCs are paying attention. “The connected car is pushing us to think of the car as a platform and enabling a set of applications, some of which we have not yet imagined,” said Ganesan, whose initial focus is infrastructure investments that might include wireless data pipes to the car or even an operating system.

Apps are likely to follow.

“You can see that is going to happen in the next couple years,” Hawks said. “I think that is going to be pretty interesting.”

Hawks foresees ride sharing and traffic apps as the industry moves to a more open platform. A business with traditionally long product development cycles controlled by big carmakers can begin to see shorter ones.

“Now we are seeing some cracks in the walled garden,” he said.

Wearables face commoditization

Last year, wearables were big at CES. This year, they were bigger, with a second generation of devices bringing new functions, such as heart rate and blood-oxygen monitoring, and better smart watch integration.

The battle for the wrist will be in full swing in 2015.

In the process, consumer behavior will change and an app ecosystem is likely to emerge. Investment opportunities could emerge over the next 12 months, said Jeff Richards, a managing partner at GGV Capital. “I just don’t think we know what they are yet.”

Richards said the Apple Watch could be the product with the biggest impact in 2015. “I think it’s going to be an enormous success.”

But commoditization could make investing a challenge. “The mistake is to go after the millennials in the wearables market,” said Tall of Pioneer Electronics. “They are too fickle.”

The real market is the older market and people who have trouble sleeping, he said. In the enterprise, corporations may someday ask employees to wear devices for wellness and maybe for daily job management.

Already, efforts at differentiation are beginning. FitLinixx, for instance, is targeting serious athletes with its AmpStrip, a stick-on Band Aid-like device expected in June that monitors heart rate, distance traveled and steps taken.

Another way to differentiate might be self-design, suggested Paul Weinstein, a general partner at Azure Capital Partners. Weinstein said he is intrigued by the notion that people might design and personalize their devices, particularly jewelry or garments.

The connected TV matures

The platform with perhaps the greatest maturity is the connected, or Internet-enabled, TV. But so far the potential is largely unfulfilled. That could change.

“I think it is going to be a very big year” for smart TV, said Krikorian, who co-founded Sling Media, which satellite company EchoStar Corp acquired for $380 million in 2007.

CES offered evidence. In perhaps the show’s most important announcement, satellite provider Dish Network unveiled a 20-channel Internet service at about one-fifth the price of cable TV, or $20 a month. The announcement illustrated how quickly distribution is moving to the Web and how traditional cable business models are under stress.

Krikorian said that as an investor, he is focused on “enablers” of the new environment. That might include technology making advertising more relevant, or handling identity and payment information. Apps should be interesting as well.

Already DCM has investments in content recognition company Cognitive Networks and in 1 Mainstream, an app creation platform.

There appears to be an acceleration of unbundled content, Krikorian said.

That should be good for investors.