Internet of Things: Opportunities and challenges for semiconductor companies

The nascent Internet of Things could open vast opportunities to semiconductor companies—provided that they prepare now.

October 2015 | byHarald Bauer, Mark Patel, and Jan Veira

The Internet of Things (IoT) has generated excitement for a few years now, with start-ups and established businesses placing bets on the industry’s growth.¹ Some of the earliest investments have begun to pay off, with smart thermostats, wearable fitness devices, and other innovations becoming mainstream. With new IoT products under development or recently launched—ranging from medical-monitoring systems to sensors for cars—some analysts believe that the Internet of Things is poised for even greater gains.
Semiconductor companies, perhaps even more than other industry players, might benefit from the IoT’s expansion. With growth rates for the smartphone market leveling off, the Internet of Things could serve as an important new source of revenue. Given the size of the potential opportunity, McKinsey recently collaborated with the Global Semiconductor Alliance (GSA) to investigate the Internet of Things more closely, with a focus on risks that could derail progress. In addition to assembling a fact base, we surveyed and interviewed senior executives from the semiconductor sector and adjacent industries, as described in the sidebar, “Our methodology.”

Sidebar

Our methodology

Our research suggests that the Internet of Things does indeed represent a major opportunity for semiconductor companies—one that they should begin pursuing now, while the sector is still developing. We also found, however, that the timing and magnitude of the IoT’s growth may depend on how quickly industry players can address several obstacles, including inadequate security protections, limited customer demand, marketplace fragmentation, a lack of standards, and technology barriers. Semiconductor companies, which have encountered similar problems in other nascent technology sectors, are well positioned to serve as leaders in resolving these issues.
Another important insight relates to the nature of semiconductor companies themselves. Their traditional focus on silicon, which allowed them to profit in many industries, may not be optimal for the Internet of Things because chips represent only a small portion of the value chain. Instead, semiconductor companies will be required to provide comprehensive solutions—for instance, those that involve security, software, or systems-integration services in addition to hardware. As with any major change, this move entails some risk. But it could help semiconductor companies transform from component suppliers to solution providers, allowing them to capture maximum benefits from the Internet of Things.

A new source of growth

The McKinsey Global Institute recently estimated that the Internet of Things could generate $4 trillion to $11 trillion in value globally in 2025. These large numbers reflect the IoT’s transformational potential in both consumer and business-to-business applications. Value creation will stem from the hardware, software, services, and integration activities provided by the technology companies that enable the Internet of Things.
Analysts also estimate that the current Internet of Things installed base—the number of connected devices—is in the range of 7 billion to 10 billion. This is expected to increase by about 15 to 20 percent annually over the next few years, reaching 26 billion to 30 billion by 2020.
In keeping with these projections, many executives we interviewed stated that the Internet of Things would significantly boost semiconductor revenues by stimulating demand for microcontrollers, sensors, connectivity, and memory. They also noted that the Internet of Things represented a growth opportunity for networks and servers, since all the new devices and services will require additional cloud infrastructure. Overall, the Internet of Things could help the semiconductor industry maintain or surpass the average annual revenue increase of 3 to 4 percent reported over the past decade. These results are particularly significant in light of slower growth in the smartphone market, which has served as the major driver for the past few years.
Our interviews did reveal some ambiguity about whether the Internet of Things would be the semiconductor industry’s top growth driver or just one of several important forces. In particular, interviewees questioned whether the Internet of Things will trigger demand for new products and services, or if there will just be an increased need for existing integrated circuits. Similarly, our survey showed that executives from GSA member companies had mixed feelings about the IoT’s potential, with 48 percent stating that it would be one of the top three growth drivers for the semiconductor industry and only 17 percent ranking it first.
Despite the size of the IoT opportunity, some semiconductor companies have hesitated to make significant investments in this sector. The greatest issue is that products within the Internet of Things tend to appeal to a niche market and generate relatively low sales volumes. With individual products delivering a relatively low return on investment, some semiconductor companies have limited their R&D expenditures for IoT-specific chips, preferring instead to adapt existing products. For instance, wireless system-on-chip players may offer repurposed wireless processors and chip sets for the Internet of Things, while microcontroller players often bundle lower-end processors and connectivity-chip sets to compete for the same opportunity.
As the IoT market matures and increases in scale, semiconductor companies may decide to pursue new approaches more aggressively. Before moving ahead, however, they should first determine which verticals and applications are growing strongly and assess when their markets will be large enough to justify significant investment. While semiconductor companies could potentially capture growth in many IoT verticals, six of the most promising markets—those where we chose to focus our research—include the following:

• wearable devices such as fitness accessories
• smart-home applications like automated lighting and heating
• medical electronics
• industrial automation, including tasks like remote servicing and predictive maintenance
• connected cars
• smart cities, with applications to assist with traffic control and other tasks within the public sector

The challenge ahead

Like many other high-tech innovations, the Internet of Things is garnering intense interest in the press, with reports of connected cars and smart watches making headlines. Although we do not want to diminish the IoT’s potential, our research suggests that the following six issues could derail its growth:

• inadequate security and privacy protections for user data
• difficulty building customer demand in the absence of a single “killer application”
• a lack of consistent standards
• the proliferation of niche products, resulting in a fragmented market and an unprofitable environment for creating application-specific chips
• the need to extract more value from each application by providing comprehensive solutions, rather than focusing solely on silicon
• technological limitations that affect the IoT’s functionality

These problems are not insurmountable, particularly if semiconductor companies are willing to take an active role in solving them.

Security and privacy: High stakes, serious consequences

A majority of our interviewees cited security as an important requirement for growth in IoT applications. One called it the “critical enabler,” claiming that many developers and companies initially underestimate its importance when creating IoT devices. He noted, “Security is not a key issue while your application or product has not reached scale, but once you are at scale and maybe have a first incident, it becomes a most important problem.” Our survey results echoed the interview findings, with respondents ranking security as the top challenge to the IoT’s success. Recent hacks to online car systems also highlight the importance of addressing security challenges for connected devices, vehicles, and buildings.
Ensuring security will not be easy, however, given the numerous applications and verticals within the Internet of Things, each with its own quirks and requirements. For instance, fitness wearables might only require relatively basic security measures that ensure consumer privacy, such as software-based solutions. But IoT applications that control more critical functions, including medical electronics and industrial automation, need much higher security, including hardware-based solutions.
Most executives we interviewed believed that the technology needed to secure the Internet of Things was already available. They were concerned, however, with the piecemeal nature of most security products and wanted to ensure that players protected the entire IoT stack—cloud, servers, and devices—rather than focus on only one of these areas. As one executive said, “Overall security is only as good as its weakest point.”
Semiconductor companies can assist with end-to-end solutions by providing on-chip security, partitioning processor functions on chip, or supplying comprehensive hardware and software services, including authentication, data encryption, and access management. Those that specialize in security might be able to use their own products to provide comprehensive solutions, but others will need to undertake M&A or form partnerships with players further up in the stack to gain broader expertise in software or the cloud. For instance, semiconductor companies could lend their knowledge of hardware security to application designers or network-equipment manufacturers, since this information would assist with the design of secure software.

Customer demand: Developing the end market

Many of our interviewees envisioned a future in which IoT applications are more common than cell phones are today. Others were more cautious, however, with one noting, “No one really knows when the volume will show up; this is a clear challenge. . . . If you cannot show a $1 billion opportunity, then it’s hard to get attention.”
In other technology sectors, a single groundbreaking application or use case—a so-called killer app—has often spurred explosive demand. Such was the case in 2007, when the introduction of the iPhone triggered significant growth in the smartphone market. While the Internet of Things could potentially follow this path, most of our interviewees felt that growth would stem from a string of attractive but small opportunities that use a common platform, rather than a single killer app.
Some of the most innovative IoT applications—and those most likely to stimulate customer demand—could come from start-ups. Businesses outside the technology sector, such as retailers, insurers, and oil and gas players, might also develop interesting products that appeal to a wide customer base, although some of our interviewees felt that these companies would face tough odds. Semiconductor players could help indirectly stimulate demand for IoT devices if they adopt new strategies to help these players thrive. For instance, start-ups and nontechnical businesses often have limited experience with semiconductors, so they might appreciate simple solutions and more hands-on support, including guidance from dedicated field engineers who assist with board-level design and solution integration (from silicon through applications in the cloud). IoT customers might also prefer one-stop solutions—complete platforms with all relevant elements that an IoT device needs, including connectivity, sensors, memory, microprocessors, and software. For some small businesses with limited funds, such platforms may be the only economically feasible option.

IoT standards: The need for consistency

Some layers of the IoT technology stack have no standards, and others have numerous competing standards with no obvious winner. In our survey and interviews, most respondents cited this situation as a major concern, with one executive stating, “What is critical is which standards will win and when this will happen.”
To see how a lack of uniform standards can complicate product development and industry growth, consider connectivity issues. There are competing, incompatible connectivity standards for devices with a low range and medium-to-low data rate—for instance, Bluetooth, LTE Category 0, and ZigBee. With so many options, product designers may be reluctant to create new devices, since they do not know if they will comply with future standards. Similarly, end users may be reluctant to buy devices that may not be interoperable with existing or future products of the same type (Exhibit 1).

http://www.mckinsey.com/insights/innovation/internet_of_things_opportunities_and_challenges_for_semiconductor_companies