Part I: Is The Smart Home Stuck?

This is Part I in a five-part series titled, “What The Next Billion Dollar Smart Home Startup Will Look Like”. Be sure to read Part IIPart IIIPart IV, and download the free eBook to catch Part V.

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This week Amazon announced that it was acquiring smart home startup Ring for one billion dollars. That means that the five-year-old Ring is the first unicorn—venture capitalist speak for a startup valued at $1B or more—in the smart home space since Nest Labs in 2014.

At a time when the number of billion dollar startups is soaring—latest estimates say 279—not a single smart home company will remain on the list once Ring’s acquisition is complete. Even while GoogleAmazon, and Apple aim their massive war chests squarely at the smart home, the valuations for smart home startups don’t seem to be matching up.

As other sectors see massive bottom-up disruption from startups, it’s worth wondering—is the smart home stuck?

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The Last Smart Home Unicorn

Coming off the $2B private equity buyout of Vivint in 2012, analysts and VCs were already buzzing about the smart home automation industry. By the time Google acquired Nest in early 2014 for $3.2B, it seemed like smart home startups were on a tear.

And for a while there, they were. Soon after being brought into the fold at Google, Nest itself announced a major $555M acquisition of Dropcam. Samsung, not to be left out, announced it was acquiring SmartThings for $200M later that year. Nest quickly responded by acquiring SmartThings competitor Revolv to position itself for total smart home domination.

But then things started to cool off. By 2016 word began to spread that Nest, now a separate entity under Google’s Alphabet Inc., was struggling to produce results. It was later revealed that Alphabet had been actively shopping Nest to buyers, even as Google itself was making a renewed push into the smart home.

Finally, in February 2018 it was announced that Nest would be merging back into Google’s hardware division, effectively ending Nest as a standalone venture. It was clearly the right move, but the symbolism was lost on no one.

It was an unceremonious end for the highest valued smart home startup to date.

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What Makes a Unicorn?

Among tech and finance circles, people like to use the term “unicorn” to describe startups valued at over $1B. The connotation is clear, it’s the type of rare opportunity that VCs and founders alike spend their careers dreaming about. They’re companies that send ripples through whatever industry they’re in, and usually signal a long-term change in business as usual.

Uber, at $69B, is the largest unicorn. Airbnb, at $31B, is up there too for its revolution of the hospitality industry. SpaceX rings up at $21.5B for its potential to privatize space travel. Stripe is valued at $9.2B for simplifying credit card transactions online. Spotify comes in at $8.5B for swallowing the entire record industry. And Instacart—the last-mile grocery delivery company—is now worth $4.2B.

These companies, and dozens like them, are watched like hawks because they have the ability to move markets despite their relatively recent emergence. So what is it that makes a tech startup able to become so valuable so quickly? Or what makes any venture so valuable for that matter?

There is endless speculation among experts about what traits are necessary for a unicorn, but we’re going to focus on two that seem most important in the smart home industry—the ability to scale quickly and the ability to take advantage of network effects.

These two traits, as much as any others, are what can take an idea from zero to one billion very quickly. They are also, less than coincidentally, two areas where smart home startups struggle.

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The Smart Home Conundrum: Scale Globally—Without Drowning In Data Costs

Clearly, the ability to scale quickly is one of the most important traits of revolutionary technology. That’s the only way to describe Airbnb’s rise from a few air mattresses in a San Francisco flat to the largest lodging company in the world in less than a decade.

Ten years ago, crashing in some unknown person’s house or hopping into the back of a stranger’s car was considered reckless behavior. Today, it’s the preferred way to travel around the globe.

These examples of radical scale offer a maxim: if you want to build technology that changes how everyone around the world interacts with their surroundings, it needs to be able to reach everyone around the world quickly.

The smart home industry has had no problem with the first part of that maxim. You can go all the way back to Walter Cronkite newsreels in the 1960’s, or Apple Computer ads in the 1980s, to find people dreaming of the days to come when their home just worked. The market is primed for disruption.

It’s the second half of that scalability maxim—being able to expand to users around the world quickly—that has kept smart home startups stuck.

For the smart home industry, perhaps more than any other tech sector, scaling up has the potential to go very badly, very quickly. The cloud costs of scaling a connected device are a real issue. Importantly, if you miscalculate the amount of data the average device will eat up per day it can turn your IoT business model upside down before you even know what happened.

It may not become obvious to you until you ship your 1,000th or 10,000th device that you’ve made a critical error, and that you’re already drowning in data costs. And at that point, don’t expect any pity—or subscription dollars—from your customer base.

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IoT Infrastructure Is Not Where You Innovate

For those smart home startups that manage to avoid being driven out of business by unexpected data costs, they usually do so by growing very slowly and very carefully.

From day one, the engineering team will give everything a personal touch, building their connected device cloud from the ground up. While this certainly gives you more cost control, this is not how billion dollar startups scale.

For instance, Instacart didn’t get to $2B in revenue by building everything from scratch. It relies on Platform as a Service (PaaS) companies like Heroku to provide a stable infrastructure out-of-the-box on which it can develop its world-changing app.

If we are to see more rapid innovation in the smart home, and more billion dollar valuations, the best minds in the industry need to stop spending all of their time building infrastructure. We need secure, cost-effective tools that allow anyone with a great idea to grow from 1,000 to 100,000 users overnight—without going belly up.

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It's All About Network Effects

Equally important to the value of a startup is the concept of network effects. Network effects describe the phenomena that as more people use certain products, those products become increasingly valuable to all users.

The most common examples today are social networks. We’ve all heard about a hot new social networking app, only to download it and discover you can’t find anyone on it to talk to. Pretty worthless.

Log into Facebook, on the other hand, and you’re bound to connect with longtime friends and distant relatives within minutes. Its immense value as a communication tool rests on the fact that everyone is on it.

The ability for a company to benefit from network effects is a crucial component to what makes something a billion dollar idea versus just a profitable one. That exponential value created from each incremental user is what creates dollar signs in investors’ eyes.

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Lacking An Open Smart Home Ecosystem

Network effects are also crucial for success in smart home automation. More specifically, the potential for indirect network effects is what is so important for the success of a smart home startup and what’s largely missing today.

Indirect network effects are described when “the increased usage of one product spawns the production of increasingly valuable complementary goods.” The classic example of this is the App Store. The popularity of the iPhone spurred developers to come up with new applications, which in turn made the iPhone more valuable and more popular for customers.

This symbiotic relationship is nearly impossible for a smart home startup today because there is no single protocol for developers and device manufacturers to build on. Each new device is an island.

Realizing the Benefit of Network Effects in Smart Home Automation

Releasing a connected doorbell can provide homeowners with a useful tool, but it doesn’t really promise true smart home automation if it doesn’t work with anything else in the house.

Sure, you can see if a guest is at the door, but does the door automatically unlock to allow them in? Can the lights in a darkened entryway come on at the right moment as the connected speaker welcomes them in and says hello?

What if you’re a short-term rental owner? What if you could have your guest's favorite temperature settings, lighting, and music queued up the moment they walk through the door?

The smart home needs expansive, open ecosystems so that device manufacturers and app developers can integrate with any device in the home with a single set of APIs, and develop in-home automation experiences once reserved for science fiction.

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It May Be Closer Than We Think

The reason we don’t encounter these magical experiences daily is not because the connected device technology isn’t there. It’s only because the effort to coordinate all of these different devices across dozens of manufacturers is still really hard to do.

It shouldn’t be this way. The connected lock manufacturer shouldn’t have to hire a full-time developer team just to build and maintain integrations. There also shouldn't be a sense of looming dread that you could bury yourself in cloud costs the moment you start to scale.

Device manufacturers and smart home app developers should be able to scale quickly and easily, while being able to instantly integrate with an open ecosystem full of hundreds of other smart home devices.

With more versatile smart home ecosystems and cost effective cloud platform providers, we will see innovations start to come alive that totally change our relationship with our lived environment—and the startups that develop them will become household names.

It's all a lot closer than we think.

 

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This was Part I in a five-part Series called “What The Next Billion Dollar Smart Home Startup Will Look Like”. Click below to download the entire series as a free eBook. 

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