In the midst of increased M&A activity in the smart building space, it is natural to consider the implications to building owners, operators and other competing solution providers. Do these acquisitions mean that smart building technology is maturing and has “arrived”. Or, were these acquisitions made opportunistically?
It’s hard to know, and the answers may not be black or white, or even consistent across each transaction. However, our view is that this is not a sign of vast industry consolidation, at least not yet. Instead, this is a sign that some large OEMs are making opportunistic acquisitions of differentiated technology. Why do we think this? First, the firms that have been acquired are successful, but have not grown to a level where they really have disrupted the market. Recent acquisitions by established vendors appear to be focused on selling the innovative, acquired technology through established sales channels. Additionally, there are still many dozens, if not hundreds, of startups providing energy and building management technology. And new ventures are launching.
One interesting aspect of these transactions is the sales approach employed by startups, and how it contrasts to channels utilized by established building equipment and services vendors. Many of the companies being acquired have direct sales models - they have a sales force that calls on building owners and operators.
This may add to the confusion and market fragmentation, as many owners and operators receive sales calls from numerous vendors. The acquiring companies, such as Siemens, Acuity Brands, JCI, Ingersoll-Rand (Trane), and Engie (to name a few), have more established sales teams and a wider variety of channels to market (both direct and indirect).
The overarching goal of these acquisitions seems clear: acquire innovative startup technology and sell it through a proven distribution network, which will provide a significant bump in sales. This likely is why the acquiring firms are in some cases paying high premiums.
But, if selling through these existing channels, rather than depending on the startups’ sales and marketing engines, is the premise of many recent acquisitions, why don’t more startups try this before they are acquired? In such a scenario, the advantages of being acquired by a large, established player are realized through a partnership: exclusively or primarily selling to vendors (not to building owners/operators).
A recent A16Z podcast about selling though an indirect channel provides some valid points about why a startup in the technology space should sell direct. While it isn’t focused on the smart building space, the points are applicable. The podcast guests note that selling indirectly (through a partner) is particularly perilous, especially when there are only a few incumbents. This is because the large incumbents can squeeze startups on price, thereby reducing margins.
It’s true that for many buildings systems and services submarkets, there a few incumbents that own large shares. But, this market is unique. Smart building technology may not be an established budget line item. Startups not only have to build sales forces from scratch, they also need to help their prospects find and secure budget. If an established player already has a budget line, it may be easier to use some of that capital on smart building technology. Moreover, while some parts of the building landscape are consolidated (e.g., chillers), other parts are not (e.g., HVAC service, see here and here).
Other market observers see the advantage of partnerships in building services. McKinsey, in a recent post about building controls, wrote: “the traditional value chain for commercial-building construction is poorly aligned with the new era of connectivity.“ McKinsey added that “building-infrastructure players will need to transcend the traditional value chain and take a broader vantage point in their pursuit of connectivity-enabled solution sales. Direct relationships with end users likely hold the key to success.“ So, from McKinsey’s point of view, the existing sales relationships, plus the more connectivity-enabled products from startups and innovators, will be a key to succeeding in this market in the future.
Navigant Research echoed these points, noting that “as customers expect even more robust and comprehensive solutions, strategic partnerships are emerging as a powerful pathway to market entry or expansion.“
Smart building vendors are missing opportunities for growth by not selling through channel partnerships. The overarching market trends seem to favor these innovative offerings, but it may take years for them to reach the late majority in the market. That may be too long for a startup to fight for each individual sale.
Second, any startup that is able to secure a quality channel partner will reduce its cost of sale. While some startups may not be willing to give up their direct relationship with end building owners, history shows that the cost of doing so can be dangerous. Many startups selling to utilities have made the same choice - it’s better to have 10-20 solid utility clients, even if it takes years to secure each one. The direct sales option may yield faster sales, but many will be small and insignificant.
Based on the current transactions in the market, it appears that OEMs are looking to bring innovative technology in-house. At the same time, they will likely invest in their own internally-developed technology, too. Another point raised on the A16Z podcast relates to the startup’s ability to reach distribution before the larger incumbent can catch up on innovation.
In short, the startup must get the word out to the majority of customers before the incumbent can bring a competitive solution to market. Because most building and HVAC OEMs have their own branches and can control distribution through them, it is very difficult for a startup to achieve a comparable level of distribution. Continuing to innovate and develop an increasingly advanced solution may not matter if it isn’t widely distributed. OEMs realize this, and that’s why there have not been more mergers and acquisitions of the hundreds of smaller smart building vendors.
Selling through a channel partnership may also help with some of the most common objections from building owners and operators that are considering smart building technology. Building owners and operators are risk-averse, for good reason, and may be skeptical that a new firm will actually be around in 5 years. Additionally, the money saved on direct sales and marketing efforts can be directed to customer success.
Providing adequate training to the building operators that will use new technology is the key to adoption, but it is often overlooked. Finally, an established vendor may be able to use the startup’s technology to deliver its own services – the startup will still get the sales it needs, and there is less adoption risk when building service providers are using the technology. Many facility managers and engineers have been in their jobs for decades, which may make it difficult to encourage them to use new products. The rise of as-a-service models in buildings, which combine a service offering with a technology backbone, are an example of this hybrid delivery model.
Some startups see the value in channel partnerships, but have not been able to secure them. This may be because the potential acquirers do not believe the technology is unique, or because they too are having trouble sorting through the fragmented smart building market. What should innovators in this position do?
First, it may be advantageous to find middle-tier OEMs and service providers that don’t have a full “line card” of offerings. This is especially true for parts of the value chain that are fragmented with innovators and established players. This could include focusing on independent ESCOs, HVAC service providers, or commissioning firms. By letting the fragmentation work to that startup’s advantage, it can position itself as a differentiator for channel partners that use it.
Second, being less focused on owning the customer experience may pay dividends. While owning the end user is a common refrain of technology entrepreneurs that seek to disrupt existing markets, many building owners and operators trust their current vendors and are unlikely to risk a years- or decades-long relationship to work with a firm with only a few years of history. But, the combination of a long-term vendor relationship and advanced, leading-edge technology can be very powerful.
Third, there may be smaller building types that have very insulated value chains, and operate outside of the purview of the primary OEMs and service providers. Finding these markets may be the key to scaling from a series A to a series B round, and beyond.
While the indirect channel does have its own share of risks, it may be a more successful model in the long run. For smart building vendors looking for growth, it is worth considering. Time spent developing an indirect strategy and initial deployment model likely will have applicability to the direct approach, too. Customer demands for advanced buildings may also push incumbent OEMs to bring new, innovative products to market through collaboration with startups. It’s prudent to be ready for this pull.