Earlier this year, Google GOOG acquired Nest Labs for $3.2B. That amount of money for a thermostat company seems expensive. But, so does $250 for a Nest thermostat when you can pick up a $30 programmable model at your local Home Depot HD.
So, why might a consumer buy such a thing? (And why might Google buy such a thing?) Well, the Nest thermostat is not your average thermostat; nor is Nest Labs your average thermostat company.
Programmable thermostats have been around for more than 100 years and for the past 30 years they haven’t changed much. While consumers may buy them, they simply don’t use them. Only one out of every six households even bothers to program its thermostat.
What makes Nest different? Distilled to its essence, Nest offers a thermostat that uses its sensor-suite, an internet connection, and an internal processor to learn and adapt to individual temperature preferences and commuting schedules. It programs itself, and does all of the work.
Nest changes the economics of the thermostat purchase. Consistent with the company’s statements we calculate that consumers can save more than $120 annually by using a Nest thermostat (as shown below). It pays for itself in only two years, explaining why the company is on track to sell 1M units in 2014.
So where do Google’s interests lie? Well, what if the thermostat becomes more than a thermostat?
We envision a future in which every electronic device in the home is embedded with connectivity, adaptive processing capability and a sensor-suite. With the Nest Thermostat as an early example, these devices will provide better owner experiences. To the extent that they share a common platform, additional devices will increase the capabilities of those already installed, providing the system with more intelligent sensor- and user-behavior information. As a benefit of installing a smart fire alarm (Nest Labs has one on offer), homeowners will increase the “smartness” of the smart thermostat and smart lightbulbs that they already own. Consumers will have strong incentives to purchase a suite of smart objects that, at the very least, share a common software platform or, perhaps, come from the same manufacturer.
Moreover, smart object producers’ ability to create adaptive algorithms will depend upon collections of user behavior to analyze. Companies that already have the largest number of smart objects installed will produce the “smartest” new products.
A hardware market that submits to network-effects at the user-level and has natural monopoly characteristics at the producer level should support rapid growth at high margins. Nest offers Google a reasonable toehold in this still-nascent market.
Of course, Google is not alone. Apple APPL has announced a smart-home development platform and has sold 20 million Apple TVs. Television manufacturers such as Samsung SSNFL offer connectivity in most of their models, as well as cameras and voice recognition in their higher-end offerings. Microsoft MSFT has its Kinect sensor interface in 18 million homes, Amazon AMZN has more than 20 million Prime homes, and Sony’s SNE newest Playstation has sold more than seven million units. AT&T T offers home automation alongside home security as does The ADT Corporation ADT. All of these companies are aiming for the same opportunity.
We expect to see fierce competition in the coming years and believe that the ultimate winner will deliver substantial utility to the consumer, commanding an enviable return on investment. In the meantime, we will kick back and enjoy the air conditioning and cost savings.
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