August 2019 Investment Banking Convergence Amid a Shifting Industrial Landscape In This Report What is industrial technology? Convergence trends and a roadmap for Industrial Technology value creation Identifying value drivers in the industrial technology sector Industrial technology public market update CONTENTS William Blair Insight 1 William Blair Industrial Technology Banking Franchise 7 Industrial Technology Market Update 11 WILLIAM BLAIR INSIGHT Convergence Amid a Shifting Landscape Advancements in theses as they identify opportunities created an opening for suppliers to technology are powering to transform their industries. look at acquiring businesses they wouldn’t have considered in the past the advent of fully What Is Industrial Technology? because of the potential for major connected manufacturing To understand what defines industrial channel conflict. environments and technology, it is important to begin by understanding what it is not. The The Industrial Technology Stack transforming business sector isn’t simply industrial One of the most valuable aspects of an models throughout the businesses with engineered products, industrial technology business is its industrial sector. significant aftermarket sales, growth ability to provide solutions throughout that far exceeds the rate of GDP the “technology stack” through More recently, automation has defined expansion, and/or high-profit integration of software and data productivity advancements in the margins. While industrial technology analytics into processes that enable manufacturing sector. Developments companies generally display these real-time decision-making across the in fundamental technologies have also characteristics, we believe that enterprise both inter- and intra- brought lower production cost, high- industrial technology companies are factory. The industrial technology performance sensing, connectivity, defined by the benefits that their stack is the collection of software and and data processing to the supply solutions enable in terms of providing hardware required to collect data, chain and manufacturing sector—all actionable insights, connecting extract useful information, and helping transform the way businesses hardware, automating process, or provide actionable insights into the operate and essentially “closing the leveraging data to generate revenue- manufacturing environment. The top loop” across the entire enterprise— producing insights. This includes all of of the stack is typically segmented into from manufacturing to delivery to the the sensors, electronics, software, and “information technology” (IT) end user. services that enable businesses to functions controlled at the transform stand-alone hardware into corporate/enterprise level and Lines that once delineated segments of fully automated solutions. “operational technologies” (OT) the manufacturing environment have designed to control production disappeared as devices on the plant Traditional industrial business models processes at the plant level. In most floor provide real-time visibility to the have focused on selling hardware organizations, those individuals executive suite. This convergence is based on traditional value drivers responsible for purchasing and vendor allowing traditional manufacturing such as quality, price, and lead times. selection processes varied by the IT businesses to embrace new business For most, the business model was and OT environment. This separation models—opening the door to new focused on driving high aftermarket created a natural choke point where revenue streams from software, content in hardware rather than a data and information either remained analytics, and services—that focus on solution-based approach that fixed a at the factory or was distributed to delivering value procured through specific pain point for a customer. senior management as a report recurring operating expenditures as New technologies have enabled produced on a periodic basis. opposed to traditional price-times- cheaper computing, greater volume purchase-order economics. connectivity, and more sophisticated sensing into this environment— These trends and others are shaping enabling new business models and strategic roadmaps and acquisition opportunities to capture additional strategies throughout the industrial value. Moreover, the erosion of the technology sector. In this report, we value (maybe more aptly described as will examine what these changes protected/proprietary go-to-market mean and how investors should frame channels) created by the traditional their decision-making and acquisition exclusive distributor/rep network has 1 Industrial Technology Stack The development of the Industrial process optimization, and, ultimately, creates opportunities for Internet of Things (IIoT) has occurred new business models for suppliers performance-based contract in parallel to the traditional designed to transform one-time structuring and other creative pricing automation stack and is also hardware sales into recurring revenue models. For example, companies can transforming the way manufacturing streams by selling a longer-term now sell machine uptime or monetize businesses operate by bypassing value proposition. the insights gleaned from a broad barriers between IT, OT, and the installed base. This enables hybrid factory floor. Devices on the plant Business Models Are Evolving business models that combine one- floor (e.g., equipment, machinery, Convergence within the industrial time capex purchases with ongoing controls, etc.) can now connect technology stack has also created service contracts that drive high- directly to enterprise-wide digital powerful new opportunities for margin, recurring periodic sales, as platforms that have access to large industrial companies to transform well as opportunities to foster direct- amounts of data from a multitude of business models. In the past, the basic to-consumer interaction, building devices and processes across an model for a hardware company was to deeper brand loyalty and engagement. enterprise. These systems enable sell the equipment and then sell the businesses to optimize production and aftermarket parts once the original We believe that an industrial supply chain processes in near real system needed repairs or upkeep. businesses’ ability to transform their time, leveraging emerging artificial Now that sensing and connectivity revenue mix from one-time product intelligence and analytics software. By systems are embedded in many sales is limited by their ability to providing an enterprise-level view of products, companies can offer capture data and analyze the operations, these digital platforms predictive maintenance, performance performance of their systems in the enable better decision-making, optimization, and other services. This field. Acting as a steward of the William Blair 2 WILLIAM BLAIR INSIGHT Transformation of Industrial Business Models 1 2 3 4 5 Traditional Hardware Aftermarket Sales Remote/Monitored “Product as a Service” “Value as a Service” Sales Services (PaaS) (VaaS) Revenue Hardware focused Hardware sale with Leverage sensors and Periodic payment for Potential to capture value Generation aftermarket parts / connectivity to provide products and uptime of all ROI and maintain Limited ability to services remote monitoring ownership of data understand ROI Per use contracts Razorblade model Beginning of predictive Cost-plus pricing model Seller may own product machines (similar to a rental car) Hybrid model – Capex purchase and ongoing service contract Capex Opex Examples The first The next frontier frontier production data generated by the control the manufacturing process, more cost-effective solutions while company’s systems may enable a but because the hardware provider providing enhanced capabilities. For business to generate new service- lacked visibility of the data necessary example, a simple valve used in an oil based revenue streams. These to create a record of its and gas application will require additional services could include hardware’s performance. external input to control flow rates, anything from basic services— automatic shutdown, and other such as remote monitoring and Convergence Trends and a functions. However, integrating predictive maintenance—to Roadmap for Value Creation metering and connectivity into the more advanced software to help There are three key convergence valve allows a valve manufacturer to customers optimize their overall trends taking place that will create offer monitoring, predictive process performance— opportunities for manufacturers to maintenance, and a host of other artificial intelligence. differentiate themselves, expand use- solutions. As manufacturers work to cases for their product offerings, and create closed loops at the facility level, Ultimately, we believe there is a implement new business models to this transition is creating massive longer-term path for some businesses capture value. We believe that the market opportunities for companies to develop and implement even more industrial technology stack provides a whose solutions build on this trend by intriguing business models, such as framework for thinking about how capturing data from machinery and “Value as a Service” (VaaS). Under this these convergence trends will define turning it into actionable intelligence. model, the hardware provider retains investment opportunities. ownership of the equipment and data From an M&A perspective, we believe it generates and charges a fee based 1. Higher