Dirk Slama: PTC has long been known as a leader in CAD and PLM (Computer Aided Design and Product Lifecycle Management). However, most recently you seem to focus a lot on IoT. Your acquisition of ThingWorx and Axeda alone must have cost you nearly a quarter of a billion dollars.

Jim Heppelmann: We see IoT as a disruptive force that will transform existing industries, especially in our core markets like manufacturing and engineering. PTC responded earlier to the growth of software intensive products and service oriented business models with hundreds of millions of dollars of investments in those key areas over the last 10 years. Adding connectivity to the product and service lifecycle solutions we already provide enables our customer to close the loop and transform the way they create, operate, and service their products. These investments will enable us to provide the best possible support for our customers in this critical transformation process, and certainly charts a course for PTC that is quite different from other CAD and PLM providers.

Dirk Slama: We have seen many M2M applications in the last couple of years that were focused on retrofitting RCM-like applications (Remote Condition Monitoring) onto existing assets. Your vision for IoT-enabled products seems to go much further.

Jim Heppelmann: Such retrofitting approaches are important and will continue to play an important role for many established long-lived assets and products, however, we also see a new breed of products emerging that have been specifically designed to leverage the IoT. For these products, connectivity is not an optional add-on; rather it is designed into the product. Many of the core features of these new products will rely on this built-in connectivity. Physical products and related cloud services are forming new ecosystems, like Apple devices and iTunes cloud services. We call this new breed of products “smart, connected products”.

Dirk Slama: So I assume that we need to re-think PLM for these smart, connected products?

Jim Heppelmann: Yes. Traditional PLM tools, in truth, really focus on the early stages of the product’s lifecycle—product design and development. We need to look at the entire product and service lifecycle, including product design, manufacturing, sales/marketing, customer operations, and after-sales services.

Dirk Slama: Let’s start with product design. What are the key issues here?

Jim Heppelmann: On the functional level, the product designers need to take a holistic systems engineering approach to design across the hardware and software layers of the physical product, and across the physical product and the related cloud services. Which new services can be enabled, and from where should they be enabled? And which existing functions can be optimized by leveraging connectivity, for example by replacing clumsy on-board displays and buttons with a Web interface which allows the operator or manufacturer to monitor, control, or configure the product from a new user interface, such as a smartphone? While enabling new capabilities, this approach dramatically increases the complexity of design and requires new design principles.

For example, to design for customization or personalization, designers need to capture the opportunity of hardware standardization through software-based customization. More and more of the variability of products today comes from the software layer, which drives down costs and enables customization later in the process. There is also a virtuous cycle here as innovations in the software layer drive increased value in the hardware, but hardware and software development have fundamentally different “clock speeds”. We might see 10 software releases in the time it takes to create one new version of the physical product on which the software runs.

This leads to another new design principle, designing for continuous upgrades and enhancements so that smart, connected products leverage connectivity for software upgrades throughout the life of the product. Design principles now need to anticipate opportunities to add or enhance product capabilities, and allow for these upgrades to occur remotely and in an efficient manner. Basically, the product becomes a platform on which increasing amounts of value can be delivered via software over time.

We also need to understand the new capabilities required in the development organization. Formerly siloed development teams need to interact much more closely, integrating the products hardware, electronics, software, and connectivity components. Agile software development processes need to be established and co-exist with the more traditional hardware development cycles. New processes need to be defined to close the loop with product design. Direct, continuous, and often real-time data about how the product is being used will give engineering rapid feedback on how well their design functioned in the real world rather than simply guessing based on scenario based simulation and testing. Value can be created from this data by using it to understand how to improve designs so that enhanced second and third generations of products are brought to market more quickly.

Dirk Slama: This also requires a new approach to sales and marketing?

Jim Heppelmann: Smart, connected products create new opportunities and reasons to transform your value proposition and even address completely different markets and refined customer segments.

This requires a different marketing approach and potentially new skill sets, too. The whole relationship with the customer is changing because companies are now able to stay in touch with the product after the initial sale. The product, in a sense, becomes a sensor for the relationship with the customer. Companies can gain amazingly detailed insights into the customer relationship by collecting and analyzing product usage data to understand how the product is performing, how much is it being utilized, which features are being used, and which features are not. This allows companies to improve segmentation, deploy more granular and targeted pricing models, deliver new value added services, and anticipate the needs of their customers. Recurring revenue streams can be created by combining physical products with digital content and services, which requires companies to transform the processes and culture across their marketing and sales organizations, and potentially their business models to capture more of the newly created value. The implications of shifting from a discrete product sale to streams of upgrades and services over the product’s life are dramatic.

Dirk Slama: So “after sales” becomes “sales after the initial sale”?

Jim Heppelmann: Correct. Because products are now connected we can stay in touch with the customer throughout the entire lifecycle of the product. This creates tremendous potential for cross-selling and up-selling. Take, for example, car engines. Instead of manufacturing multiple engines with different levels of horsepower, the horsepower rating on the same physical engine can be modified using software alone. By connecting this smart capability with a cloud service a customer could upgrade his car for his weekend trip up the coast highway; hence smart, connected products.

Dirk Slama: But traditional after sales services are still important?

Jim Heppelmann: Yes, of course. Product usage data can reveal current and potential future problems. Preventive and predictive maintenance are enabling product users and service organizations to prevent machine downtimes and improve OEE (overall equipment effectiveness).

For example, most service events today require multiple passes.  The first pass enables a technician to identify the nature of the failure and what will be required to correct the problem; the second pass is to perform the actual repair. With smart, connected products, service technicians can obtain all “first pass” information remotely, and may even be able to perform the repair remotely if the failure can be remedied via software.  The savings associated with reduced service calls can be substantial, and the product usage data can also be used to validate warranty claims and to identify warranty agreement violations, another huge expense for most product companies today.  These approaches allow a manufacturer to transform its service business from reactive to proactive and create substantial gains in both service and operational efficiency.

However, this doesn’t come for free, and also has the potential to disrupt the high revenue, high profit service businesses that many companies have in place today. Service organizations that connect product condition and operations data with existing service processes can transform those processes, and potentially enable new processes and services that take advantage of the insights that come from the smart, connected products. By monitoring a product’s condition and proactively delivering service, sometimes via software, a company can improve the reliability and availability of the product. The potential benefits are significant, including reductions in field-service dispatch costs and capital costs for spare-part inventories.  The threat of disruption comes if the benefit of the reduced need for spare parts and service visits accrues to the end customer, who then pays less for the cost of service. This reduced service demand may create a kind of “service paradox” for companies pursuing a smart, connected product strategy.

Dirk Slama: You recently co-authored the HBR article “How Smart, Connected Products are Transforming Competition” with Prof. Porter from Harvard Business School. In this article, you identified 10 strategic choices derived from the push towards smart, connected products.

Jim Heppelmann: The transformation ahead of many companies requires a clear definition of the goals and strategy in this area. A strategy requires trade-offs that create a unique competitive position, which has to be defined at the executive level and communicated to all relevant stakeholders. There is no right or wrong answer, only choices that must reinforce one another and define a coherent and distinctive overall strategic position for the company. Our framework of 10 strategic choices can help to define that company-specific strategy. The first set of questions is around the product and service strategy, starting with: Which capabilities should the company pursue? A smart, connected product drastically expand the number of potential product and service capabilities, but just because a company can offer many new capabilities doesn’t ensure there is sufficient value for customers above incurred costs to the company. Next is how to best deliver those new product and service capabilities by determining how much functionality should be embedded in the product vs. the cloud. Factors like required response time, expected network availability, complexity of the user interface, and frequency of service events or product upgrades will impact those decisions. The next set of questions is around the technology infrastructure required to enable smart, connected products. Developing the technology stack for smart, connected products requires significant investment in specialized skills, technologies, and infrastructure that have not been typically present in manufacturing companies. Some of the early pioneers like General Electric and Bosch have invested heavily via a largely in-house route to capture first-mover advantages and retain greater control over features, functionality, and product data. However, just as Intel has specialized in microprocessors and Oracle in databases, new firms that specialize in components of the smart, connected products technology stack are already emerging, and some in-house efforts may overestimate the ability to stay ahead, turning an early lead into a long-term disadvantage. A related question is whether the system architecture should be open or closed, where key interfaces are proprietary and only chosen parties gain access. While this has clear benefits for the company to control and optimize the systems, over time we expect closed approaches to become more challenging as technology spreads, ecosystems develop, and customers resist limits on choice.Dirk Slama: The increasing focus on product data also requires a strategic take?

Jim Heppelmann: Yes, we see data and the insights derived from analytics becoming the key differentiator in a smart, connected world. This is really key to capturing the full opportunity. There are three strategic choices specific to data, first of which is: What data do I need? Capturing and analyzing data is fundamental to value creation, but also imposes costs and risks. Variable product costs increase from additional sensors, carrier-based data transmission, and so on, and fixed costs from robust analytics capabilities and skills required to translate big data into insight. And almost any data collected brings with it the risk and burden of data stewardship to ensure that all the data is secure and protected over time.

This relates to the next data choice around how the company manages ownership and access rights to the data. Firms must determine their approach to data ownership, sharing, and transparency. For example, providing data access to upstream component suppliers may improve component quality and innovation but may lead to new competitive threats if the supplier develops value added services for the end customer using the data. The services that GE Aviation provides directly to airlines based on data collected from the aircraft engine is a real world example for Boeing and Airbus.

This brings us to the third data choice about monetizing the data. Companies may find that the data they capture is valuable to entities beyond their traditional customers, creating new services or even businesses. The challenge is in defining mechanisms that provide valuable data to third parties without alienating existing customers or increasing regulatory risks.

Dirk Slama: All of these choices seem to open up some corporate level decisions around the company’s business model and scope.

Jim Heppelmann:  Yes, through the capabilities and data generated by smart, connected products, firms are now able to maintain direct and deep customer relationships through the products, which can reduce the need for distribution channel partners. Tesla Motors, for example, has disrupted the automotive industry by selling cars directly to consumers rather than through a dealer network. In an existing business we would only caution not to underestimate the relationship that customers may have with existing channel and service partners.

Through those same capabilities, data and direct relationships companies may be inclined to change their business model from product sales towards product-as-a-service. As customers pay for the utility of performance of the product instead of the ownership of the asset, the value of the smart, connected product improvements, like improving product quality or service efficiency, will captured by the manufacturer.

Finally, as products continue to integrate in product systems and diverse networks, many companies will have to re-examine their core mission and determine what role they want to play in these larger systems; should they attempt to provide the platform and services for the entire system or play a supporting role in a broader industry landscape?

All difficult choices, but we believe that by providing the right strategic framework and ensuring the right environment for their execution, IoT and smart, connected products will be the foundation for the next era of IT-driven productivity growth for these companies and their customers.