According to Michael Porter's 1979 theory, any industry’s competition is driven by five competitive forces:

• Bargaining power of buyers
• Nature and intensity of the rivalry amongst competitors
• Threat of new entrants
• Threat of substitute products or services
• The bargaining power of suppliers

The composition and strength of these forces collectively determine the nature of industry competition and the average profitability for incumbent competitors.

Industry structure changes when new technology, customer needs, or other factors shift these five forces. Smart, connected products, or the Internet of Things (IoT), will substantially affect structure in many industries, not least smart commercial buildings and home automation, as did the previous waves of IT in the 70s and internet-enabled IT in the 90s.

Smart, connected products dramatically expand opportunities for product differentiation, moving competition away from price alone. Knowing how customers actually use the products enhances a company’s ability to segment customers, customise products, set prices to better capture value, and extend value-added services.

Bargaining Power of Buyers
Smart, connected products allow companies to develop much closer customer relationships. Through capturing rich historical and product-usage data, buyers’ costs of switching to a new supplier increase. In addition, smart, connected products allow firms to reduce their dependency on distribution or service partners, thereby capturing more profit, which serves to mitigate or reduce buyers’ bargaining power.

Simultaneously, smart, connected products can increase buyer power by giving buyers a better understanding of true product performance, allowing them to play one manufacturer off another. Buyers may also find that having access to product usage data can decrease their reliance on the manufacturer for advice and support. Finally, compared with ownership models, “product as a service” business models or product-sharing services can increase buyers’ power by reducing the cost of switching to a new manufacturer.

Nature and Intensity of the Rivalry Amongst Competitors
Smart buildings also has the potential to shift rivalry, opening up numerous new avenues for differentiation and value-added services. They will also enable firms to tailor offerings to more-specific segments of the market, and even customise products for individual customers, further enhancing differentiation and price realisation.

This creates opportunities to broaden the value proposition beyond products, to include valuable data and enhanced service offerings. The huge expansion of capabilities in smart, connected products may also tempt companies to get into a feature and function arms race with rivals and give away too much of the improved product performance, an environment that escalates costs and erodes industry profitability.

Such rivalry among competitors can also increase as smart, connected products become part of broader product systems. Historically, manufacturers of home lighting, security, and climate control systems have not competed with one another. Yet each is now vying for a place in the emerging “connected home” that integrates and adds intelligence to a wide array of products in the home.

Take Alarm.com for example who, as their name suggests were focused on security but have developed in home automation adding devices like lights, locks, smoke detectors and smart thermostats to their portfolio. The company’s record profits in 2015 have moved them into direct competition with Google’s smart home acquisition, Nest and established players like Ecobee.

Threat of New Entrants
New entrants in a smart, connected world face significant new obstacles, starting with the high fixed costs of more-complex product design, embedded technology, and multiple layers of new IT infrastructure. Barriers to entry also rise when agile incumbents capture critical first-mover advantages by collecting and accumulating product data and using it to improve products and services and to redefine after-sale service. Smart, connected products can also increase buyer loyalty and switching costs, further raising barriers to entry.

Barriers to entry go down, however, when smart, connected products leapfrog or invalidate the strengths and assets of incumbents. Moreover, incumbents may hesitate to fully embrace the capabilities of smart, connected products, preferring to protect hardware-based strengths and profitable legacy parts and service businesses. Product companies are also facing challenges from other non-traditional competitors like the entrance of Apple to the smart home automation market.

Threat of Substitute Products or Services
Smart, connected products can offer superior performance, customisation, and customer value relative to traditional substitute products, reducing substitution threats and improving industry growth and profitability. However, in many industries smart, connected products create new types of substitution threats, such as wider product capabilities that subsume conventional products.

Lighting, for example, has moved from a pure illumination device to one, which can sense and respond to occupant preferences, mimic sunlight colour progression, or even work in place of WiFi data transfer. The relatively stagnant lighting industry has blossomed under the IoT movement as explored in our previous smart lighting industry report. For information on Lighting, please subscribe to our mailing list below.

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The Bargaining Power of Suppliers
The development of smart, connected products is also revolutionising traditional supplier relationships and redistributing bargaining power. As the smart and connectivity components of products deliver more value relative to physical components, the physical components can be commoditized or even replaced by software over time. Software also reduces the need for physical tailoring and hence the number of physical component varieties. The importance of traditional suppliers to total product cost will often decline, and their bargaining power will fall.

However, smart, connected products often introduce powerful new suppliers that manufacturers have never needed before: providers of sensors, software, connectivity, embedded operating systems, and data storage, analytics, and other parts of the technology stack. Some of these, like Google, Apple, and AT&T, are giants in their own industries. Earlier this year GE announced collaborations with Apple and chip-maker Qualcomm, pursuing a path of digital technology and recognising the growing appetite for multifunction LEDs to reinvigorate its 130 year old lighting business.

IT firms have talent and capabilities that most manufacturing companies have not historically needed but they are becoming essential to product differentiation and cost. The bargaining power of those new suppliers can be high, allowing them to capture a bigger share of overall product value and reduce manufacturers’ profitability.