2020 in Sight

2020 in sight
Innovation pulls the bits together

Special report June 2016

2020 innovation
Ed Maguire Contents
ed.maguire@clsa.com
+1 212 549 8200
Executive summary .......................................................................... 3
Reagan Tangney
+1 212 549 5028
Add the bits together and stir ........................................................... 4
The Unicorn Era winds down ............................................................34
Bits flow into currents .....................................................................53
10 themes from digital to physical ...................................................63

Visit our 2020 mini-site
at clsa.com Artificial intelligence ................... 63 Clean disruption ........................ 94
Virtual reality ............................ 69 Autonomous vehicles ............... 101
Blockchain ................................ 77 Robotics ................................. 108
Open source ............................. 82 3D printing ............................. 116
Security ................................... 88 Internet of Things .................... 123
All prices quoted herein are as at close of business 14 June 2016, unless otherwise stated
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Produced by CLSA Americas LLC. For important disclosures please refer to page 136.
2 ed.maguire@clsa.com 20 June 2016

Executive summary 2020 innovation
2020 in sight
Change is accelerating in Technology-driven creative destruction is impacting many different
information-intensive industries as information technology matures into the backplane of the global
industries economy and society as a whole, and businesses undergo digital
transformation. Following a frothy period, a funding slowdown for startups will
provide established firms with attractive acquisition opportunities. Change is
already accelerating within information-intensive industries like tech, media,
retail, communications and financial services. Next up will be transport,
manufacturing, agriculture, energy, materials and life sciences. We explore 10
innovation themes with disruptive potential and highlight Microsoft, Red Hat,
Salesforce and Splunk as our top software picks.
Add the bits together The information and communication technology (ICT) era is 40 years old.
and stir Cloud computing has industrialized IT, deflating costs and squeezing sector
margins to the benefit of users and businesses pursuing digital strategies.
Value has migrated from infrastructure to platforms, applications and applied
analytics. The stage is set for a coming era of combinatorial innovation.
Artificial intelligence, robotics, mobility and cloud will power new
transformations at the intersection of digital, physical and biological domains.
IT-driven deflation disrupts wages and economic rents from providers, as
benefits accrue to consumers, innovators and transformational organizations.
The Unicorn Era After years of growth in venture-capital (VC) funding and investment,
winds down sentiment is turning more cautious, as the era of Unicorns (privately funded
companies valued over US$1bn) fades with down-rounds and IPO investors
increasingly leery. The pace of new-business formation has rebounded
however. Expect belt-tightening among startups to lead to favorable tech M&A
opportunities for buyers from different industries. Structural headwinds in the
US include slippage in science, technology, engineering and mathematics
(STEM) education, broken immigration policies, costly patent litigation and
over-regulation.
Bits flow into currents We update our technology meta-themes - transparent IT, intelligent
systems and convergence - highlighting the importance of platforms for
innovation. Software remains at the top of the tech value chain as the driving
force in innovation, gaining strategic importance for non-technology
companies as well.
10 themes frame A new generation of high-growth businesses builds on connectivity, massive

innovations in the digital data-processing power, near-ubiquitous reach and powerful analytics. We
sphere and physical world explore 10 themes with disruptive potential that bridge the digital and
physical worlds: artificial intelligence, augmented/virtual reality, Blockchain,
open source, security, clean disruption of energy and transportation,
autonomous vehicles, robotics, 3D printing and the Internet of Things.
Recommended innovation stocks

Our top software picks Ticker Rating Target price Last close Currency
are Microsoft, Red Hat, Akamai AKAM-US BUY 69.00 52.66 US$
Salesforce and Splunk Alphabet GOOGL-US BUY 970.00 732.77 US$
Amazon AMZN-US O-PF 770.00 719.15 US$
Apple AAPL-US BUY 115.00 97.46 US$
Facebook FB-US BUY 161.00 114.90 US$
Microsoft MSFT-US O-PF 60.00 49.81 US$
Red Hat RHT-US BUY 94.00 77.17 US$
Salesforce.com CRM-US BUY 101.00 81.05 US$
Samsung Electronics 005930-KR BUY 1,600,000 1,380,000 won
Splunk SPLK-US BUY 86.00 56.64 US$
Covered by CLSA; all others by CLSA Americas. Source: CLSA
20 June 2016 ed.maguire@clsa.com 3

Section 1: Add the bits together and stir 2020 innovation
Add the bits together and stir

Since we published our 2020 forces converging: Crossing creative disruptions
report in March 2015, US stock indexes have touched all-time highs with
robust capital markets and M&A activity. In 2016, markets have shaken off
early jitters, but there are signs that the sentiment that propelled the boom in
privately funded tech firms is turning more cautious. As the Bubble 2.0
cycle winds down, we see promising consolidation and expansion
opportunities ahead for cash-rich firms. As software continues to eat the
world we expect innovative cross-pollination across domains to accelerate,
with the value-creation criteria inherent to technologies - platforms,
applications and applied analytics - increasingly relevant across industries.
A coming convergence Our subtitle for this report, Innovation pulls the bits together, alludes to a
between the digital coming Cambrian explosion of innovation across disciplines. Information
and physical
technology has become industrialized, and is becoming a substrate of the
broader economy. We see less incremental value creation in technology itself
than the increasing potential to apply technologies to an increasingly digitized
physical world. The next era of innovations will be powered by cognitive
software, robotics and ubiquitous computing applied in combinatorial ways to
transform industries.
The era of Unicorns The era of Unicorns (privately funded companies valued over US$1bn) is
(privately funded fading with down-rounds and IPO investors growing leery. Expect belt-
companies valued over
US$1bn) is fading tightening among startups to lead to favorable tech M&A opportunities for
buyers from different industries. Innovation holds the key to sustainable value
creation, with R&D estimated to drive 1.4% of GDP growth. Businesses continue
to face headwinds including lagging science, technology, engineering and
mathematics (STEM) education, broken immigration policies, costly patent
litigation and over-regulation. With Moores Law and corollaries as a backdrop,
software becomes the defining vector as businesses undertake digital
transformation. Tech mastery will differentiate winners in every sector.
Digitization of business Digitization of business creates deflation, disruption and dislocation. Cloud
allows rapid scale, but it computing industrializes IT and accelerates deflation, impairing infrastructure
creates deflation,
disruption and dislocation hardware and software providers ability to charge economic rents. This
causes the cost to field test a new idea or start a business to plummet.
Startups can scale at unprecedented pace with a fraction of the resources
previously required, increasingly disrupting powerful incumbents in media,
transportation, hospitality and other industries.
Theres growing evidence There are downsides too. Digitally enabled automation depresses wages for
that technology may be less skilled workers, exacerbating unemployment and social costs from
indirectly exacerbating
economic anxiety income inequality. Economic dissatisfaction in the middle class is fueling a
volatile political climate in 2016, though for the most part, proposed policy
prescriptions do not address technologys role in the underlying dynamics.
We highlight Salesforce, We remain optimistic about potential for value creation from combinatorial
Red Hat, Microsoft and innovation. Sustained progress in computing, storage and connectivity powers
Splunk as our top
thematic software picks increasingly sophisticated ideation, design, prototyping, research, product
development and business creation. Value creation migrates up the stack to
platforms, applications and applied analytics. Red Hat, Salesforce, Microsoft and
Splunk are our top thematic software picks, as they exhibit key value creating
characteristics of platforms, applications and applied analytics

Signs of a new industrial revolution emerge

2016 sees continuing In 2016, employment and a range of industries are navigating widespread
disruption from the digital disruption from an industrial revolution driven by ICT. Its not exactly
industrial revolution
bloodless. Leaders have been dethroned, the status quo is fluid, massive
wealth is being created with unprecedented velocity and there is bubbling
discontent in the broader US economy as machines displace jobs and a
disproportionate share of income accrues to an elite few.
Software becomes the For investors, there are attractive opportunities and potential minefields as
defining vector that pace of innovations accelerates. Innovation (inextricably conjoined with
creates winners
technology) is key to sustainable value creation. With Moores Law and its
and losers
corollaries as backdrop, software becomes the defining vector separating
winners and losers. In this report, we characterize 2016 in a big-picture
context, pulse-check the current state of funding and entrepreneurship,
examine drivers and developments within frameworks and explore 10 critical
innovative themes.
Why is innovation so important?

R&D accounts for around Innovation is critical to value creation in an economy increasingly shaped by
1.38% of annual advanced technology. The most innovative industries typically contribute
economic growth
outsized gains to GDP, create businesses that generate attractive returns for
investors, and in the case of information technologies, enable productivity gains
across a continuum of industries. R&D contributes directly to gains in
productivity. Macroeconomist Charles Jones estimates that R&D accounts for
around 1.38% of annual economic growth. If the US economy had invested
only the same amount on R&D as a share of GDP today as in 1950, productivity
would be 17 to 32% lower. The Brookings Institutes 2015 study, Americas
Advanced Industries, found that advanced industries (those with the top 20%
of R&D spending per worker and a higher proportion of STEM workers)
employed just 9% of the active workforce, but generate 17% of total US GDP.
These advanced industries employ 80% of the countrys engineers, generate
roughly 85% of US patents and account for 60% of US exports.
Bits come together for a Cambrian innovation explosion

Digital technologies will We are on the brink of a veritable Cambrian explosion of combinatorial
manifest in full force innovation, catalyzed by the confluence of cloud computing, mobile
through automation
connectivity, automation and artificial intelligence. What has happened to the
technology industry over the past decade is harbinger for disruption in other
industries - with rapid, highly concentrated value creation on one hand, and
deflationary forces that erode growth and employment on the other. Andrew
McAfee and Erik Brynjolffsens 2014 book The Second Machine Age posits that
the world is at an inflection point where digital technologies will manifest in
full force through automation, resulting in the creation of an unprecedented
range of things.
Starting a company Technology provides leverage for value creation, accelerating the ability for
is cheaper by a factor platforms to dominate and exacerbating the division between winners and
of 1,000x versus a
losers in the economy. Starting a company is cheaper by a factor of 1,000x
decade ago
versus a decade ago. Just US$5,000 in funding can be enough for a new
business to disrupt large incumbents.
Its the combination of Its not one single factor driving acceleration of innovative activity; its the
enabling technologies combination of enabling technologies that creates powerful leverage to the
that creates powerful
economy. The convergence of Moores Law-enabled cloud and mobile computing,
leverage
advanced analytics (artificial intelligence/machine learning/cognitive computing),

robotics and automation is extraordinarily powerful. Gartner refers to a Nexus of

Forces, IDC defines a 3rd Platform comprised of cloud, mobile, big data
analytics and social technologies. Boston Consulting Group describes a software-
driven digital metasystem - a mobile-first environment of near-infinite compute
power and connectivity with the capacity to scale massively sophisticated
analytics in real time. However you define it, barriers to ideation,
experimentation and true innovation are falling away, promising to empower
billions of new minds coming online in the near future.
Technology has become Technology has become an embedded, foundational strata across the
an embedded, economy and society, representing a core infrastructure analogous to energy
foundational strata across
in the Industrial Age. Market boundaries are also shifting because of sharing
the economy and society
and platform economy dynamics. Businesses that were previously based on
the sale of products or assets are now being turned into renting, sharing or
subscription businesses.
The challenge always We share an optimistic though tempered view. Cloud computing, mobile
remains a combination internet, non-traditional user interfaces, advances in programming science
of timing and careful
and artificial intelligence, and falling costs of compute and bandwidth place
selection
unprecedented power in the hands of everyone, from a child with a cellphone,
to entrepreneurs, to researchers seeking to solve the challenges of medicine.
For investors, its critical to time investments in disruptive technologies
appropriately, as there are risks being too early or too late.
Grownups dont believe in unicorns

Signs of trouble or a wall Market sentiment in mid-2016 has apparently shaken off jitters over
of worry ahead? weakness in China and Brazil, but there are growing concerns of macro
headwinds with US GDP in 1Q16 trudging along at a 0.5% rate.
Figure 1
Markets and employment Official employment trends upward while stocks struggle for further gains
recovered from the
20,000 (%) 12
financial crisis DJIA (LHS) US unemployment rate
18,000 11
10
16,000
9
14,000
8
12,000
7
10,000
6
8,000 5
6,000 4
06
07
08
09
10
11
12
13
14
15
06
07
08
09
10
11
12
13
14
15
07
08
09
10
11
12
13
14
15
16
May
Sep
May
May
Jan
Sep
Jan
Sep
May
May
May
Jan
Sep
May
Jan
Sep
Jan
Sep
Jan
Sep
May
Jan
Sep
May
May
Jan
Sep
Jan
Sep
Jan
Source: Research.stlouisfed.org, FactSet
Sentiment is growing more cautious, judging by the dropoff in VC funding

and decline of late-stage investments. GDP in the USA is plodding along at
barely 1% growth despite the official unemployment rate in the 5% range.
There are concerns that the post-recession recovery may be losing steam.
Theres an ongoing debate regarding the future of US growth between the
techno-optimists and those that view technology as ultimately contributing
to slowing GDP growth.

Internet Bubble 2.0 The volatility in the markets in early 2016 marked a shift in investors
appears on its way to tolerance for high-growth software and internet companies with high
deflating not with a bang
but with a whimper perceived risks. Internet Bubble 2.0 appears on its way to deflating not with
a bang but with a whimper. Increasingly disciplined investors are focused on
profitability and consistent execution. Top-line growth accompanied by losses
is not commanding the valuation premiums previously. Skeptical sentiment
among public company investors is impacting VC funding and M&A sentiment.
Startups need to conserve cash and build sustainable, profitable businesses.
Investors are increasingly Investors are increasingly cautious over venture-backed IPOs. On the IPO
cautious over venture- demand front, most recent tech IPOs are trading below issue price. When
backed IPOs
newly public companies have hiccups, investors are punishing the stocks.
After a mis-step, there needs to be a sustained period of rebuilding a
business before investors will award a premium valuation.
Average return of 90 US According to an analysis by CB Insights, the average return of 90 US VC-

VC-backed tech IPOs from backed tech IPOs since Facebooks May 2012 IPO through October 2015 was
May 2012 to October
2015 was just 7.05% just 7.05%. For the same period, the S&P 500 return was 60.5% (over 8x
higher than if an investor had purchased every VC-backed tech IPO during
this period). For comparison, the Dow Jones Industrial Average gained 42.8%
(6x higher) and equally weighted S&P 500 return (a better proxy for
theoretical tech IPO investments) would have gained 67% (9x higher than
IPOs). SecureWorks (SCWX) has been the only tech IPO in 2016, pricing
lower than initially expected.
M&A sentiment has According to the industry analyst firm 451 Groups 1Q16 survey of tech
turned negative and bankers and corporate development execs, 58% expect the number of new
valuations are highly
polarized offerings to decline, versus 43% expecting this in 3Q15 and 27% in 1Q15.
Sentiment has also turned more bearish regarding M&A potential over the
next year, although the flurry of software acquisition activity in late May and
early June may help. Volatility in the capital markets is a contributing factor:
in the first six weeks, stocks including Tableau (DATA), Hortonworks (HDP)
and LinkedIn (LNKD) saw valuations cut in half. Public market sentiment
impacts willingness to do deals. With economic uncertainty from Europe, the
impact of lower energy prices and equity price volatility, participants are
finding it more difficult to get deals done.
Valuations in the M&A Valuations in the M&A markets are polarized as well, with high multiple and
markets are polarized low multiple deals and little in between - not a healthy indicator for M&A
prospects. In 2015, investors were also rewarding acquirers, but this is not
happening this year. Private equity is the only hope for many aspiring tech
Unicorns, but the debt markets are also impacted by stock volatility,
macroeconomic and some political uncertainty. Theres not an obvious
investment cycle playing out in tech like the PC or internet wave either, so
M&A focus is moving to life sciences and biotech.
Late-stage VC financing By 1Q16, the late-stage VC financing environment has become more
has become more challenging and more discerning. There has been an increase in failures
challenging and more
discerning among high-profile startups including Quirky, Secret, Fab.com and others.
Mutual funds have also begun to mark down valuations from private
investment rounds, and the pace of private investments by large mutual fund
firms is slowing as firms find it more difficult to agree on acceptable
valuations.

M&A dynamics are While we do expect some pain for underfunded startup companies and overly
favorable for established optimistic venture and private investors, we do think these dynamics set up
companies with plenty of
favorably for established companies with plenty of cash on hand. The
cash on hand
deflation of the Unicorn Era bubble will set up unique opportunities for cash-
rich companies.
Innovations shifts from atoms to bits . . . to atoms

Value creation shifts away One of more prominent questions is whether technology driven innovation has
from providers of run its course as IT has become industrialized. Weve seen prior computing
technology to applications
architecture cycles - mainframe, PC and first-generation web technology
of technology
cycles have run their course. Now the mobile/cloud architecture is maturing
and consolidating. For investors, theres a change in opportunities to invest in
technologies as market value creation shifts away from providers of the
technology to applications of the technology.
Tech system adoption Taking a broader view of technology systems (beyond computing) Robert D.
waves layer upon one Atkinson of the Information Technology & Innovation Foundation lays out how
another in the economy
major tech system adoption waves layer upon one another in the economy. In
Think Like an Enterprise: Why Nations Need Comprehensive Productivity
Strategies, Atkinson posits that one can model the evolution of technology in
the US economy through S-curves. The post-World War II growth wave was
powered by electro-mechanical technology systems (televisions, electric
appliances, etc). This drove growth until the mid-1970s when improvements
in performance and reductions in cost diminished. It was not until the next
wave of digital technologies based on computing and the internet that growth
resumed in the 1990s. The chart below outlines how the cycles of the
adoption S-curves for electro-mechanical tech systems, digital-electronic tech
system and the artificial-intelligence-robotics tech systems.
Figure 2
Technology adoption Evolution of technology systems

cycles occur in nested
S-curves
Source: Robert D. Atkinson, Think Like an Enterprise: Why Nations Need Comprehensive Productivity
Strategies - Information Technology & Innovation Foundation 2016, licensed under Creative Commons
We may be closer to In Atkinsons view, there are good arguments that we may be closer to the
the end of the current end than the middle of the current digital-electronic technology S-curve, as
digital-electronic
the incremental improvements in broadband speed, storage capacity and
technology
S curve computing speed have far less incremental impact than they did in the 1990s,
when the introduction new microprocessors drove steady PC upgrade cycles

among businesses and consumers, along with significant productivity gains

from the adoption of business applications. In his view, advances such as
cloud computing are more stepwise in nature compared to the launch of the
Netscape browser in 1995 and client server computing. Its clear to us that
cloud computing has accelerated the deflationary characteristics of
information technology, making it more difficult for providers of infrastructure
hardware and software to charge economic rents. As such, value creation is
migrating up the stack to platforms and applications. Newer technologies
such as artificial intelligence (AI), autonomous vehicles, drones, robots and
genomics are still in their nascent stages.
A period of slow deceptive Atkinson thinks that it could be a decade or more before there is a new
growth is characteristic of growth wave powered by technologies like robotics and machine learning -
new technologies
but we think this may be conservative. However, we think this analysis
overlooks the nature of accelerating change. A period of slow deceptive
growth is characteristic of new technologies. The early deceptive phase occurs
before growth goes exponential then matures - and the pace of new
technology phases in a Nested S-Curve sequence may be accelerating.
The coming Fourth Industrial Revolution as growth catalyst

Fourth Industrial Dr Klaus Schwabs book, The Fourth Industrial Revolution, posits a new wave
Revolution is about the of innovation that goes beyond smart and connected machines and systems.
fusion of the physical,
This analysis looks back further: the First Industrial Revolution began in the
digital and biological
late 18th century with development of machinery and automation. The
Second Industrial Revolution began around 1870 using electrical power to
create mass production systems with division of labor. The Third Industrial
Revolution began around 1969 using electronics and information technologies
to automate production.
Exponential growth of The coming Fourth Industrial Revolution will be powered by exponential
information technologies growth of information technologies, catalyzing broad disruption across nearly
will power the Fourth
every industry. Building on information technology advances of the Third
Industrial Revolution
Industrial Revolution, the combination of artificial intelligence, robotics, the
Internet of Things, autonomous vehicles, 3D printing, nanotechnology,
materials science, energy storage and other technologies will to be catalysts
for exponential innovation.
This biological component The Fourth Industrial Revolution will be characterized by the fusion of
will be fundamentally technologies across physical, digital and biological spheres. The biological
different from prior
component (reflected in advances in nanotechnology and gene sequencing)
revolutions
makes it fundamentally different from prior revolutions. The Fourth Industrial
Revolution is expected to drive massive supply-side gains of efficiency and
productivity. The decline of costs and frictions involved with delivering,
creating, and consuming products and services will be so significant that
demand will increase, opening up new markets and driving economic growth.
This view downplays concerns about technological unemployment and
inequality resulting from labor market disruption.
Expect more innovations Both the view of an AI-robotics technology system S-curve and the Fourth
from applying digital Industrial Revolution anticipate value coming increasingly from applications of
technologies to the
technology to the physical world - Internet of Things, automation, materials
physical (and biological
world) science, manufacturing, bioengineering, precision agriculture, distributed
energy production. While the exact timing is under debate, we think the signs
are clearly pointing to more innovation coming from applying digital
technologies to the physical (and biological world) - and this is where the
most promising investment opportunities like ahead.

Creating value: Platforms, applications, applied analytics

Many of the operative If one subscribes to the premise that Software is eating the world in Marc
investing principles for Andreessens words, that every company ultimately becomes a software
software companies are
relevant more broadly company, then it follows that many of the operative investing principles for
software companies are relevant more broadly. Weve previously outlined our
views that value in technology migrates upward, from infrastructure to
platforms to applications. The adoption of cloud computing represents the
industrialization of information technology, paralleling the adoption of
electrification of industry beginning in the late 19th century.
Platforms, applications There are three characteristics of software and technology based businesses
and applied analytics are that are capable of generating sustainable value creation in our view:
relevant across industries
platforms, applications and applied analytics. We prefer businesses with
dominant concentration in one or more of these areas because of the ability
to sustain differentiated value and competitive advantage, which leads to
higher margins.
Platform businesses harness innovation from an ecosystem of partners,

which results in far greater creation of value than a single firm could
create. (We cover platforms in greater detail in Section 2 of this report).
Application businesses (more broadly referring the application of various

technologies - software, hardware, and services) create value by
addressing general or specific needs to businesses and users.
Applied analytics businesses make better decisions, reduce risks, are more
effective at sales and marketing and realize more operational efficiencies.
Platform companies Platform companies create value by engaging multiple stakeholders, creating
create value by engaging value across multiple dimensions. They are able to benefit from third-party
multiple stakeholders
innovations and compete more effectively in industries outside their core
domains. Amazons competition is not just e-commerce and retail, but
publishing, grocery, media, IT and other firms. Apples competition is not just
PCs and phones, but watches, music and movie streaming services. Google and
Nest compete against companies like Honeywell, Phillips and Toshiba. Platform
firms innovate faster because they harness the capabilities of partners.
Leveraging technology, they are also are able to generate more value from
fewer resources. Uber is the biggest taxi company, but the company owns no
taxis; AirBnB is the biggest accommodations marketplace but it owns no
inventory; Alibaba is the biggest merchant but it owns no inventory.
Platform companies Platform companies also generate value at a greater proportion than product
generate value at a companies. According to MIT Professor Marshall Van Alstyne, platforms
greater proportion than
product companies represent over two-thirds of privately held companies valued over US$1bn;
three of the top five companies in the US by market cap - Apple, Google and
Microsoft - were platform companies. Platform firms are also becoming more
important in the economy, with the platform companies among the top 20
firms by market cap representing a growing proportion of total market value:
from 10% in 2001 to over 25% in 2014. Platform companies dominate the
technology industry, and leading platform companies in other industries also
tend to be technology intensive. Leading platform companies include Apple,
Facebook, Google, Microsoft, Samsung Electronics, IBM, Intel, Cisco, Oracle,
Amazon, American Express, SAP, eBay and Alibaba.

Figure 3
Leading platform Platform companies have outperformed the S&P 500 since 2006
companies gained 173%
vs the S&P 500s 59% 350 (2006=100)
Platforms S&P 500
gain since 2006
300
250
200
150
100
50
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: CLSA, Factset - Index components: Apple, Google, IBM, Microsoft, Samsung Electronics, Intel,
Cisco, Oracle, Amazon, American Express, SAP, eBay
We favor Salesforce, Red In our software coverage, we favor Salesforce (CRM), Red Hat (RHT), Splunk
Hat, Splunk and Microsoft (SPLK) and Microsoft (MSFT) as top platform picks. All four companies foster
as top platform picks
vibrant ecosystems of application developers and partners that create
powerful network effects through engagement and innovation.
Applications are software Narrowly defined, applications are software programs that address a business
programs that address a or consumer need. We prefer an expanded definition: the application of
business or consumer
technology, or technologies and services that provide distinct utility of value
need
to users. Applications simply consume technology infrastructure in order to
deliver value to the users. They are the raison detre for technology itself.
Successive generations of IT architecture have decoupled compute, storage
and networking infrastructure from the application logic itself, which is where
business value resides.
Applications are less Enterprise applications have predominantly moved to a software as a service
exposed to deflationary (SaaS) model over the past decade. We increasingly see applications that run
characteristic of
on infrastructure as a service (IaaS) from Amazon Web Services, Microsoft
technology
Azure or Force.com. Because application value is measured by the perceived
utility to the user, application vendors benefit from infrastructure technology
cost deflation which is absorbed by hardware, infrastructure software or IaaS.
As a result, application vendors can better sustain higher gross margins.
Applications are not immune to deflation from feature expansion, bundling,
competition, and the transition to cheaper subscription-based models, but the
inherent value is not impacted directly by the dynamics of infrastructure
commoditization.
Applications can be Applications can be horizontal in nature (customer relationship

horizontal, vertical management/CRM, human capital management/HCM, supply chain
and monetized in
management/SCM, financial, procurement, marketing etc) or specific to a
different ways
particular industry (retail, financial services, health care, ecommerce etc).
Applications can also be monetized in ways beyond licenses and
subscriptions. Large internet and e-commerce companies are application

businesses: eBay is an application that makes money from transaction fees;

Facebook and Google make money from user engagement by selling
advertising. Although not typically regarded as such, IT security products are
applications as well.
There are dozens of pure-play publicly traded application companies. Leading

companies include SAP, Oracle, Microsoft, Salesforce, Workday, NetSuite,
ServiceNow, Guidewire Software, Autodesk, ANSYS, Cadence, PTC, Adobe,
Intuit, Blackbaud, Ultimate Software Group, Cornerstone On Demand,
Fleetmatics, Marketo, Real Page, and many others. Wed include security
leaders like Palo Alto Networks, FireEye, CheckPoint, Imperva, Fortinet,
Qualys, Trend Micro and others as well.
Figure 4
Leading platform Application companies have outperformed the S&P since 2006
vs the S&P 500s gains 300 (2006=100)
Applications S&P500
of 59% since 2006
250
200
150
100
50
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: CLSA, Factset - Index components: SAP, Salesforce, Workday, NetSuite, ServiceNow, Guidewire
Software, Autodesk, ANSYS, Adobe, Intuit, Blackbaud, Ultimate Software Group
We favor Salesforce, From our software coverage, we favor Salesforce (CRM), Akamai (AKAM) and
Akamai and Microsoft as Microsoft (MSFT) as top application picks. Salesforce has leveraged its
top application picks
leadership in Sales Force Automation to expand into service, marketing and
commerce. Akamais performance and security businesses leverage its
extensive content delivery network infrastructure to solve technically complex
business problems. Microsoft Office dominates personal productivity software,
and its Dynamics applications are strong in the mid-market.
Applied analytics Applied analytics businesses use data and sophisticated mathematical,
techniques reduce risk, statistical and cognitive techniques to reduce risk, increase sales and optimize
increase sales and
efficiencies. We distinguish applied analytics from traditional data
optimize efficiencies
warehousing and business intelligence tools, which are general purpose
technologies used to build applications. Companies that use analytics
strategically can realize significant financial and competitive advantages. The
retail industry provides a great example: in the 1990s and 2000s Wal-Mart
was able to capture enormous share gains by applying advanced analytics to
its pricing and supply chain. In the 2010s weve seen Amazon gain share of e-
commerce by applying analytics to recommendation engines, dynamic pricing
and its own supply chain, arguably to Wal-Marts disadvantage.

The field of data analytics itself is evolving beyond the data warehousing,
statistical analysis, multi-dimensional analysis and simple reporting that
originated in the 1980s to embrace artificial intelligence (also known as
machine learning or cognitive computing). We cover AI/machine learning in
greater detail in Section 4 of this report. The use of AI techniques by large
internet companies like Google and Facebook is a significant contributing
factor to their financial success.
Applied analytics help Applied analytics also provide the means for companies in maturing or
companies in mature declining industries to protect their competitive advantages and margins.
industries protect
Information-intensive industries have long used predictive analytics: in
competitive advantages
financial services to reduce risk through credit scores, in retail to improve
yield form marketing campaigns, in mobile telecommunications to reduce
churn, in logistics to optimize efficiencies. Its not always obvious which
companies are best at using applied analytics for competitive advantage, but
the success of the Oakland As baseball team chronicled in Michael Lewis
book Moneyball has charted course for companies in many industries.
Figure 5
Leading applied analytics Applied analytics vs S&P 500

400 (2006=100)
vs the S&P 500 gains S&P 500 Applied Analytics
of 59% since 2006
350
300
250
200
150
100
50
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: CLSA, Factset - Index components: Amazon, Google, Facebook, FICO, Netflix, Microsoft, Verisk,
IBM, Visa, American Express
Companies that are leaders in applied analytics include Amazon, Google,

Facebook, Fair Isaac/FICO, Netflix, Microsoft, Verisk, IBM, Visa and American
Express. Firms that are leading investment into AI/machine learning include
Google, Facebook, LinkedIn, Microsoft, Baidu, IBM and others. There are also
companies outside of technology that use analytics to drive new business
opportunities, for instance GE for connected products and IoT, and Tesla for
tracking user experience to drive product improvement.
We favor Akamai and The market for pure-play AI is nascent so there are few if any ways for
Microsoft as top picks investors to gain direct exposure to the components - rather those firms
for Applied Analytics
with the foresight and expertise to apply analytics most effectively are those
that will continues to generate sustainable value over time. In our coverage
universe, we favor Akamai (AKAM), which employs sophisticated algorithms

to solve complex optimization problems, and Microsoft (MSFT), which has

been aggressively investing in AI to embed predictive capabilities into its
platforms and applications. These two are our top software picks for applied
analytics.
Playing secular trends can pay off, but watch the hype
The challenge always Cloud computing, the mobile internet, non-traditional user interfaces,
remains a combination advances in programming science and artificial intelligence, and falling costs
of timing and careful
of compute and bandwidth place unprecedented power in the hands of
selection
everyone, from a child with a cellphone to entrepreneurs to researchers
seeking to solve the challenges of medicine. For investors, its critical to time
investments in disruptive technologies appropriately, as there are risks being
too early or too late.
Traditional big tech Cloud computing has proven a sustainable growth trend for the leading
and SaaS/high-growth providers, particularly for applications. Newer generation SaaS and high-
software performance
growth software stocks have rewarded investors over the past five years.
have bifurcated
There has been pronounced and sustained contrast between the high-growth
SaaS and cloud names and on-premise Big Tech stocks. SaaS consistently
outperformed the S&P500 over the past five years while big (on-premise) tech
has underperformed since 2013.
Figure 6
High-growth software is High-growth software versus big tech stock performance

more volatile, but has
outperformed big tach 300 (May 2011=100)
and the S&P 500 High growth tech S&P 500 Top big tech companies
250
200 107%
150 54%
36%
100
50
May 11 May 12 May 13 May 14 May 15 May 16
High growth index components include Salesforce.com, Workday, ServiceNow, NetSuite, FireEye, Palo
Alto, Red Hat, Splunk, Tableau, Veeva. Big tech index components include Microsoft, IBM, Oracle, SAP,
Cisco, Hewlett-Packard. Source: FactSet, CLSA
IT security benefits from Some secular themes provide a bit more consistency but which need constant
constant innovation vigilance. The IT security industry benefits from the need for constant
cycles, but investors need
innovation to protect data, systems and reputations from myriad evolving
to monitor constantly
threats. IT security is highly dynamic with accelerated adoption (growth) and
maturity cycles, making for periodic disconnections between investor
sentiment and fundamentals. Over the past five years, the sector has both
outperformed and underperformed the market at different times. In 2016, the
group has struggled as companies from different generations like Symantec,
FireEye and Imperva have disappointed investors.

Figure 7
IT security exhibits IT security - strong fundamentals but a crowded market

greater volatility than
180 (May 2013=100)
the market overall Nasdaq Composite IT Security
170
160
150
140 39%
130
21%
120
110
100
90
May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 16
IT Security index components: AVG, Check Point Software, Barracuda Networks, Cyber-Ark, FireEye,
Fortinet, Imperva, Guidance Software, NICE Systems, Palo Alto Networks, Proofpoint, Symantec, Qualys,
Varonis, Qihoo360, Finjan Software. Source: FactSet, CLSA
Weve been highlighting Weve highlighted the 3D printing sector as a key innovation trend since
the 3D printing sector 2011, and since that time the sector has captured popular imagination and
as a key innovation
trend since 2011 investor attention. Interest in and awareness of the potential for 3D printing,
a technology that incorporates a range of techniques including additive
manufacturing, peaked in 2014, and investors aggressively sought out the
limited vehicles to gain exposure to the trend. This pushed valuations to a
peak, followed by a crash, corporate restructurings and protracted period of
underperformance. Despite being a transformative technology for
manufacturing, investor expectations around the consumer opportunity may
have been misplaced, and the expiration of key patents in 2013-2014 has led
to a flood of new market entrants. Declining costs benefit end users, but put
pressure on vendors of the technology.
Figure 8
The 3D printing sector 3D printing stock performance

has ridden a cycle of hype
500 (May 2011=100)
and disillusionment
3D printing stocks Nasdaq Compsoite
450
400
350
300
250
200
67.3%
150
100 -5%
50
0
Index components include 3D Systems, Stratasys, ExOne, Proto Labs, VoxelJet, Materialise.
Source: FactSet, CLSA

Wearable technology Wearable technology was at the peak of hype in July 2015 when FitBit went
was at the peak of hype public, but the shares have disappointed investors since the initial
in July 2015 when
enthusiasm. In our view, wearable tech has been a classic hype cycle story,
FitBit came public
but its yet uncertain whether the sector overall will be profitable enough to
support further IPOs.
Figure 9
FitBit was the first Overly optimistic views on wearable growth caught up with Fitbit stock
wearable tech
180 (Jun 2015=100)
pure-play IPO
Nasdaq Composite Fitbit
160
140
120
100
-7%
80
60
40 -57%
20
Jun 15 Aug 15 Oct 15 Dec 15 Feb 16 Apr 16
The declining cost of solar energy promises to disrupt the traditional energy
industry for the next two decades as the cost curve undercuts utilities own
generation costs. This chart from author and futurist Ramez Naam shows
solar cost undercutting natural gas-generated electricity in the early 2020s.
Figure 10
Solar cost projected to undercut natural gas by the early 2020s
Source: Ramez Naam

Innovation does not Of course, innovation does not insulate investors from the risks of
insulate investors from globalization and competition. Declining cost curves do stimulate adoption
the risks of globalization
and disrupt incumbents, but they also can prove challenging for direct
and competition
participants as well. Despite being one of the most disruptive technologies
longer term, solar stocks are still a difficult investment and have been an
ongoing disappointment to investors over the past five years.
Figure 11
Solar technology Solar technology is real, but solar stocks have been a losing proposition
stocks have been
200 (May 2011=100)
a risky investment Nasdaq Composite Guggenheim Solar ETF
180
67%
160
140
120
100
80
60
40
-73%
20
0
If one assesses stocks according to the Gartner Hype Cycle, the 3D sector
may be nearing the Trough of Disillusionment before reaching the Plateau
of Productivity, while solar remains mired in the trough for some time.
A brief survey of the rich landscape of innovation

A key thread across We explore 10 key innovation themes worthy of investors attention in Section 4.
each category is the A key thread across each category is the essential role that software and data
essential role of
analytics plays enabling accelerating innovation. In our view, these are longer-
software and analytics
term themes that could profoundly reshape markets, the economy and society at
large. As is typical of long-term technology evolution, early stage activities are
small, but with exponential progress, inflection points are likely to surprise.
Innovations in the digital sphere

Artificial intelligence Artificial intelligence (AI), machine learning and cognitive computing are
is seeing another different terms that all refer a similar range of technologies. AI powers
resurgence - this time as
everything from speech recognition to search software, airplane navigation
foundational technology
and auto-pilot systems, video image recognition systems and intelligent
assistants for smartphones. A new generation of self-learning computing
algorithms will be integrated into applications of all kinds. Integration with
advanced robotics will power a new generation of autonomous and semi-
autonomous machines.
Augmented reality and Augmented-reality and virtual-reality technologies are coming to mass
virtual reality devices markets in 2016. The technologies have captured public imagination and the
are coming to mass
first generation of applications and viewing devices have made their debut.
markets in 2016
Virtual-reality is making its entrance first with Facebooks Oculus VR, the
Sony PlayStation VR and HTC Vive. Next up is augmented reality, with
Microsoft HoloLens and offerings from Magic Leap and Meta paving the way
for a new generation of applications and entertainment.

Blockchain technologies Blockchain, the distributed ledger that powers Bitcoin and other
have the potential to cryptocurrencies, is emerging as a transformative technology for the financial
upend the financial
services sector in particular. The combination of advanced mathematics,
services sector
access to massive computing power through peer-sharing, the open-source
ethos and powerful new software enables a new universe of applications for
managing transfer of value. There is an explosion of new blockchain startups
targeting healthcare, media, finance, insurance and other industries.
Open-source everything Open-source principles inherently enable innovation, not just in software,
hardware and services, but through derivative benefits to technology users in
any endeavor. The open-source model has transformed software development
and is increasingly being applied in hardware, networking, crowdsourcing,
media and new business models.
Security is an ongoing Trust is the basis for essential functions of commerce and society. With the
arms race between bad explosive growth of connections, applications, communications, information
actors and security
and systems, threats become more pervasive, driven by technological
professionals
advances and growing involvement of organized crime and governments. As
such, theres growing need for security to facilitate e-commerce, electronic
money transfers and modern conveniences such as ATMs. The IT security
market is a dynamic market, conducive to startups offering fertile ground for
innovators and investors.
Figure 12
Innovations in the digital sphere

Innovation What it means Who could benefit Potentially at risk Related companies
Artificial Artificial intelligence Advertisers, businesses, Jobs across a wide Google (GOOG), Microsoft (MSFT), IBM
intelligence/ governs everything from consumers, government, range of capacities (IBM), Baidu (BIDU), Facebook (FB), Amazon
cognitive speech recognition to society at large from blue-collar (AMZN), LinkedIn (LNKD),Salesforce (CRM),
computing search, airplane drivers, security many startups
navigation and auto-pilot guards and others to
systems, motion- knowledge workers like
detection systems and translators, paralegals,
intelligent assistants for medical professionals,
smartphones investment analysts
Virtual reality/ Gaming, entertainment, Consumers, game na Facebook (FB), Microsoft (MSFT), Samsung,
Augmented reality commerce, travel developers, content HTC, Sony (SNY), Google (GOOG), private
creators firms Meta, Magic Leap
Open-source The open-source model Entrepreneurs, operators Traditional Red Hat (RHT), Hortonworks (HDP), Microsoft
everything is transforming software of cloud datacenters, proprietary hardware (MSFT), Facebook (FB), Google (GOOG), Intel
development, corporations and service and software vendors (INTC), AMD (AMD), many private firms
crowdsourcing, providers, SaaS including HP, Dell, including DataStax, MongoDB, Acquia
prototyping, datacenters independent software Oracle, IBM,
and the replacement of vendors (ISVs), Microsoft, VMware,
proprietary systems consumers, industrial Cisco, EMC, Juniper,
designers, military, etcc
consultants
Blockchain and Blockchain technologies Startup businesses, low- Banks and other Microsoft (MSFT), IBM (IBM), many private
cryptocurrencies are distributed ledgers income workers, citizens financial services companies - Ripple, Ethereum, CoinDesk,
that enable non- in unstable countries, firms, credit card and Coinbase, BitPay, many others
repudiable exchanges of investors money transfer firms
value between unrelated
parties without an
intermediary
Security Trust is paramount in a Consumers, businesses, Everyone and AVG (AVG), Barracuda Networks (CUDA), Check
connected world. Rising government, society at everything connected Point (CHKP), CyberArk (CYBR), FireEye (FEYE),
levels of increasingly large to the internet, Fortinet (FTNT), Imperva (IMPV), Imprivata
complex IT security including consumers, (IMPR), MobileIron (MOBL), NQ Mobile (NQ),
threats compel businesses, utilities, Palo Alto Networks (PANW), Qihoo360 (QIHU),
increasingly innovative governments Rapid7 (RPD), SecureWorks (SCWX), Symantec
defenses (SYMC), Qualys (QLYS), Proofpoint (PFPT), Cisco
(CSCO), IBM (IBM), CA (CA), EMC (EMC) and
many others
Source: CLSA

Innovations in the physical world

The energy and The energy and transportation sectors are poised to undergo massive
transportation sectors are disruption as the combination of increasingly cheap solar, advances in energy
poised for disruption form
solar and energy storage storage and adoption of electric vehicles will disrupt the traditional oil, gas,
utilities and automotive industries - without regulatory intervention. There are
increasing signs that solar energy is on the verge of becoming the cheapest
source of power, without any subsidies. Innovations and economies of scale in
battery and other energy storage technologies pave the way for large-scale
adoption of utility-scale solar and electric vehicles.
Autonomous vehicles The fundamental nature of transportation is changing as autonomous vehicles

and robotics will prove technological viability and sensor-based vehicle communications
remake transportation
and manufacturing systems promise to ease traffic jams and improve safety. The first generation
of self-driving prototypes is being tested on public roads, with all of the major
automakers and several technology companies investing in research. The
technology is also being extended to trucks, other commercial vehicles and
unmanned aerial vehicles (UAVs). The bigger challenges to adoption lie ahead
with laws, lawmakers and insurance companies.
Advances in robotics are Advances in robotics are having a transformative effect on manufacturing and
having a transformative industry as a new wave of personal and collaborative robotics comes to
effect on manufacturing
and industry market. The top three drivers of the market are increased processing,
reduced cost and size of sensors and programming languages and interfaces.
Beyond nanorobotics, drones and autonomous vehicles (covered robots are
transforming industries like manufacturing, warehousing and distribution,
healthcare, retail and other areas.
3D printing - in a Interest and hype around 3D printing peaked in 2014, leading to

hangover from peak of disillusionment among investors as stocks continued to come under pressure
hype, but technology
is real in 2015. The consumer market appears saturated with low-cost completion.
Meanwhile, advances in industrial additive manufacturing continue to
progress with adoption among manufacturers doubling between 2013 and
2015 and moving beyond prototyping toward full production.
A world connected - the Hype around the Internet of Things reached fever pitch in the mainstream
Internet of Everything media in 2015, as technology and industrial raced to articulate their out IoT
strategies. Our 2014 report Deep Field: Discovering the Internet of Things
focused on growing relevance and opportunities across consumers and
businesses in a full spectrum of industries. Interest in wearable computing
and smart home also reached fever pitch in 2015 as a flood of new market
entrants resulted in a highly fragmented market. In 2016, we are seeing
industrial proof of concept projects chart paths to sustainable ROI, but some
businesses are taking a wait-and-see approach. While the major inflection
point is not expected until 2017-20, seeds for immense transformations are
already being sowed.

Figure 13
Innovations in the physical world

Clean disruption The declining cost of Consumers, Carbon-based fuel Tesla (TSLA-US); ADAS: Mobileye (MBLY-
of energy and solar, advances in businesses, businesses (oil, coal, US); Battery: Panasonic (6752-JP); Sony
transportation energy storage lower entrepreneurs, gas), utilities, some (6758-JP)
the cost of energy cities, society at automakers
and make electric large.
vehicles the default
choice by 2030
Smarter moving Self-driving cars, Consumers, Transportation based Google (GOOG), Toyota Motor (TM), Ford
machines trucks, buses, drone businesses, employment (taxi, Motor (F), General Motors (GM),Mobileye
(autonomous aircraft automobile truck drivers, (MOBL), Raytheon (RTN), AeroVironment
vehicles, drones) manufacturers, auto logistics) (AVAV), Boeing (BA), Northrop Grumman
supply chain, (NOC), Textron (TXT), BAE Systems (BAESY),
military Adept Technology (ADEP), Amazon (AMZN),
Lockheed Martin (LMT), AeroVironment
(AVAV), General Dynamics (GD), SAIC (SAIC),
GoPro (GPRO), Ambarella (AMBA), IXYS Corp,
(IXYS), InvenSense (INVS) and others
Robotics Automated Manufacturers, Labor, especially Amazon (AMZN), iRobot (IRBT), Google
manufacturing, healthcare, employees doing (GOOG), Raytheon (RTN), Moog (MOG),
surgical robots, consumers, military repetitive tasks in Intuitive Surgical (ISRG), Cognex (CGNX),
trainable robotic manufacturing, Accuray (ARAY), AeroVironment (AVAV),
assistants, domestic service, etc Northrop Grumman (NOC), Rockwell
robots Automation (ROK), General Dynamics (GD),
Boeing (BA), Teledyne (TDY), Textron (TXT)
3D printing Custom fabrication, Consumers, Spare parts, machine 3D Systems (DDD), Stratasys (SSYS), ExOne
prototyping, spare designers, industrial tooling, mass (EXONE), Proto Labs (PRLB), VoxelJet (VJET),
parts designers, manufacturing Arcam (Sweden), envisionTEC, EOS
manufacturers, (Germany), Renishaw (UK), Organovo
service providers, (ONVO), Autodesk (ADSK), Staples (SPLS),
materials producers Adobe (ADBE), Microsoft (MSFT)
Connected Myriad implications Consumers, Companies with high IBM (IBM), Cisco (CSCO), GE (GE), PTC (PTC),
everything (IoT, for both industrial businesses, reliance on manual National Instruments (NI),Google (GOOG),
eHealth, sharing and consumer manufacturers, processes Intel (INTC), AMD (AMD), Siemens (SI),
economy) logistics, military, Oracle (ORCL), Salesforce (CRM), Amazon
public safety, (AMZN), Teradata (TDC), SAP (SAP), Splunk
wireless sensor (SPLK), Broadcom (BCOM), Qualcomm
network providers, (QCOM); Apple (AAPL), Samsung, Sony (SNY),
analytic software Nike (NKE), Intel (INTC), Qualcomm (QCOM),
vendors Microsoft (MSFT), GoPro (GPRO), FitBit (FIT) ,
Buddy Platform (BUD - ASX) wireless network,
sensor and analytics vendors
Source: CLSA
Biology, healthcare and new worlds

We dont cover advancements in biotech, genetics and healthcare in-depth in
this report, but want to highlight the potential value creation opportunities at
the intersection of information technology, biology and medicine. There has
also been significant progress in the space race, with SpaceX achieving
several key milestones toward viable reusable boosters in 2015 and 2016.
Computational genomics The declining cost of computing, more powerful systems and the capacity to
are decoding the store and process massive quantities of data create conditions are conducive
software of nature
to accelerating innovation in the life sciences. With Illuminas latest machines
lowering the cost of a sequenced human genome below US$1,000, genomics
is actively decoding elusive mysteries of DNA, the source code for the
human body, with promise of proactive avoidance and better treatment for
cancer, Alzheimers, multiple sclerosis and other chronic diseases.

CRISPR is a technology One of the most significant advances is a new technology, CRISPR, which
that allows unprecedented enables scientists to edit genomes with unprecedented precision, efficiency,
ability to edit genomes
and flexibility. CRISPR (Clustered regularly interspaced short palindromic
repeats) are segments of prokaryotic DNA containing short repetitions of base
sequences followed by short segments of spacer DNA from previous
exposures to a bacterial virus or plasmid. CRISPR interference technique has
enormous potential applications, including altering the germline of humans,
animals, and other organisms and modifying genes of food crops. While there
is a lot of potential, there are also ethical considerations: Chinese scientists
have applied the technique to nonviable human embryos, which hints at
CRISPRs potential to cure genetic diseases but also raises the prospect of
genetically designed babies.
Connected health poised Mobile healthcare technology is seeing robust innovations among consumers
for steady adoption and professionals, though adoption is concentrated at the ends of the
spectrum among the very healthy and very sick. There has been an explosion
of FDA-approved apps for diagnostics and treatment as well as monitoring.
Despite robust VC investment and high-profile media coverage, the market
remains nascent and highly fragmented. We expect Apple, Google, IBM,
Microsoft and Qualcomm to foster a robust ecosystem of startups and
partnerships with care providers and pharmaceutical companies.
The new space race A new generation of privately funded companies is pursuing a range of
ventures including commercial space-cargo flights, low-Earth-orbit space
tourism, asteroid exploration for resource extraction and longer-term plans
for manned space ventures to the Moon and Mars. SpaceX has successfully
landed its reusable booster rocket, potentially saving tens of millions of
dollars per launch and opening up an opportunity for greater activity. Major
aerospace firms Boeing, Lockheed Martin and Northrop Grumman are actively
engaged, alongside leading private companies SpaceX, Virgin Galactic and
Planetary Resources.
Techno-optimists versus secular growth skeptics

Techno-optimists see Theres an optimistic school of thought that convergence of information
current disruptions to technologies, clean energy and connectivity bringing billions of new minds
industry and employment
as temporary online will catalyze enormous gains in wealth, health and quality of life.
The most passionate advocates like Ray Kurzweil and Peter Diamandis of
Singularity University see the current technological disruptions to industry
and employment as temporary, paralleling the dislocations seen in prior
industrial revolutions. People have dealt with change in the past, ergo this
time its just another cycle set to play out along historical lines.
Tapping into Technologists and investors tend to project the future in stepwise terms.
accelerating change Human beings naturally have linear intuitions about the future because
linear thinking progresses logically from experience. However, innovations
and paradigm shifts occur at an accelerating, often exponential pace. This
creates a disconnect. The way the exponential progress in technology
accelerates change can be illustrated by comparing mass adoption of
inventions over the past 150 years. One only has to look at the rapid
growth of Facebook and the explosive growth in tablet computing that the
iPad catalyzed to appreciate accelerating paradigms.

Figure 14
The rate at which new Adoption paradigms are accelerating

inventions reach
0.1 (Years)
widespread adoption
is accelerating ?
The
Facebook
Mobile Web
10 Phone
PC
Radio Televison
Telephone
100
1860 1880 1900 1920 1940 1960 1980 2000 2020
Source: Ray Kurzweil, KurzweilAI.net
Working our way out of the trough of a super cycle

Carlota Perez frames Klaus Schwabs view of a Fourth Industrial Revolution differs from
current problems as a economist Carlota Perez who views us in the middle of a multi-decade ICT
consistent pattern seen in supercycle. Perez draws from economists Nikolay Kondratieff and Joseph
prior technology shifts
Schumpeter in framing multi-decade waves of technological change that occur
in surges about once every 50 years. The current ICT revolution is the fifth
upheaval experienced by the capitalist system since the first industrial
revolution in the late 18th Century. Since we first encountered this thesis in
2011, we grow more convinced of its applicability to current conditions.
The turning-point period Carlota Perez defines the turning point as the current phase of the grand
may last a few more years ICT supercycle that commenced with the crash of the internet bubble in the
early 2000s and persists today. Perez view is that this turning-point period
may last a few more years, with structural changes to the economy working
themselves out until we emerge into a new economic golden age in the
decades ahead.
Figure 15
The historical record: Bubble prosperities, recessions and golden ages

INSTALLATION PERIOD Bubble collapse DEPLOYMENT PERIOD
No., date, TURNING
revolution, core
country
Bubble prosperity POINT Golden Age prosperity Maturity
1771
The Industrial
1st Revolution
Canal mania 1793-97 Great British leap
Britain
1829
Age of Steam
2nd and Railways
Railway mania 1848-50 The Victorian Boom
Britain
1875 London funded global Belle Epoque

Age of Steel and market infrastructure build-
3rd heavy Engineering up (Argentina, Australia,
1890-95 (Europe) "Progressive
Britain/USA/Germany USA) Era" (USA)
1908 Europe
The Roaring Twenties
Age of Oil, Autos 1929-33 Post-war
4th Autos, housing radio,
USA
and Mass Production
aviation electricity Golden Age
USA 1929-43
1971
Internet mania, Telecoms,
The ICT 2007/08 Sustainable global
5th emerging markets,
-????
Revolution
Financial casino & housing "golden age"?
USA
Source: Carlota Perez

The installation phase An installation period typically begins within a mature economy, with a great
is a period where new deal of experimentation in the free markets. What typically follows is a frenzy
firms are formed and
of investing, inflated asset prices and speculation followed by a crash (or
older firms fail
crashes). This happened in the 1920s followed by the Great Depression, and
again in the 2000s with the crashes of the first internet bubble and global
financial crisis and Great Recession. This decade we are experiencing a
protracted transition as the economy readjusts and the ICT revolution
propagates through society and the economy.
Every major technology The coming deployment period (which Perez has estimated may commence
development surge before the end of the decade) will see expansion of both new and rejuvenated
has seen the same
sectors, as the potential of new technologies comes to fruition. This is a
pattern play out
period of creative construction, where benefits of wealth are spread more
broadly and capital and finance decisions are directed towards production
rather than speculation.
Technology exacerbates economic imbalances

Despite the promises of Despite the promises of innovation, economist Robert Gordon and others are
innovation, there are quantifying painful economic imbalances that are becoming more
increasingly painful
pronounced. The modern digital revolution has yet to deliver on the promise
imbalances
of better jobs and higher productivity. Instead, the new economy is creating
immense wealth with far fewer workers, with income growth stagnating for
the vast majority of employed. The stratification of income growth over the
past decade has concentrated the majority of income gains in the top
percentile while the median income in 2011 is 8% lower than in 2007, having
peaked in 1998. These figures show earnings from labor are declining as a
share of total economic output, but the share gains from highly skilled sectors
have been growing.
Figure 16
The Great Decoupling of Median income and employment have diverged from GDP growth
income and employment
500 (1967=100)
from GDP growth
accelerated in the 1980s Private employment Labor productivity
450
Real GDP Median household income
400
350
300
250
200
150
100
50
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: Research.stlouisfed.org, FactSet
Some economists believe Since the 1990s there has been a transition from an industrial-based to an
growth is over in the US information-based economy where big investments are being made in
technology and technology industries and although innovations in technology
are awe-inspiring some (like economist Tyler Cowen) believe they are having
less transformative effects as inventions once did. Robert Gordon, professor
of economics at Northwestern University, believes that after an initial boost in

productivity and growth from 1994-2004, the potential impact from further
technology innovations will be minimal. He predicts that for the next 25-40
years, real per-capita disposable income of the bottom 99% of the US income
distribution will grow at an average annual rate of 0.2%, a tenth of the pace
of the 2% per year for the century before 2007.
Digital innovation is not as Author Nicholas Carr writes in The Arc of Innovation There has been no
significant to society as decline in innovation; there has just been a shift in focus. Were as creative as
late 19th century inventions
ever, but weve funneled out creativity into areas that produce smaller-scale,
less far-reaching, less visible breakthroughs. From 1876-1886, we saw the
development of the internal combustion engine, light bulb, steam turbine,
railroad, car, phone, movie camera, and toilet among others. From this time
until the 1950s life in America changed drastically. These were large-scale
inventions that had a big impact on the way we live. Carr (as well as others
like Tyler Cowen) believes that innovation is fundamentally less impactful
today. There are other possible causes for declining growth such as a decline
in education, lack of R&D investment, or short-sighted investors that pressure
companies away from long-term investments.
Cutting a broad swath through unskilled jobs

Software and artificial The phenomenon of technology replacing jobs is not at all new. Whats
intelligence are replacing different now is that its software and artificial intelligence replacing tasks and
tasks and jobs at a
jobs at a dramatic pace. The downside for employment is that fewer people
dramatic pace
are required in many industries (eg, airlines, manufacturing and the supply
chain). As service-sector tasks are increasingly automated, this reduces the
need for cashiers, toll takers and potentially taxi drivers as weve previously
seen technology replace stenographers, typists or bookkeeping people.
Pessimists foresee a jobless future

Some believe tech Theres been a lot of discussion of the impact of technological unemployment.
unemployment will lead Martin Fords Rise of the Robots - Technology and the Threat of a Jobless
to need for universal
Future paints a dire scenario arguing that technological unemployment is
basic income (UBI)
inevitable, it will be pervasive, and societies will need to implement a
universal basic income (UBI) to address citizens needs. A number of
prominent economists including Lawrence Summers, Nouriel Roubini and Paul
Krugman have publicly expressed concerns that successes in technology are
eliminating jobs. Robert Reich has said that robots will take away good jobs
that are already dwindling. They will in short supplant the middle class.
Concerns over Concerns over technological unemployment are not new, stretching back
technological most prominently to the Luddites in the early 19th century. In the US,
unemployment
Congress has commissioned studies at the end of the 1897 recession and in
are not new
the late 1930s to ascertain the impact of labor-saving devices on human
labor, and in the 1961 recession, President John F. Kennedy created an Office
of Automation and Manpower in the Department of Labor on the premise that
the major challenge of the Sixties was to maintain full employment at a time
when automation, of course, is replacing men. Robert Atkinson of the
Information Technology & Innovation Institute argues that if technology-led
productivity growth really has been the culprit behind Americas anemic job
growth since 2009, one would expect that Americas productivity growth rate
would be higher than normal. In fact, US productivity growth has tracked at
about half the previous rate since the end of the Great Recession.
One of most widely quoted studies on technological unemployment (by

Osborne and Frey) estimates that 47% of US jobs could be eliminated by
technology over the next 20 years. However, the McKinsey Global Institute

Technology will mean sees more job redefinition instead of unemployment, foreseeing that very few
more job redefinition occupations will be automated in their entirety in the near or medium term. A
instead of unemployment
recent OECD report sees less risk of unemployment, rather certain activities
will be automated, business processes will transformed, and jobs redefined.
Benefits from ICT There is a productivity paradox, which refers to an observation made in that
investment could play out as more investments are made in information technology, worker productivity
on a larger scale over time
declines instead of increases. Part of the challenge is measuring value from
ICT is the typical delay between the installation of new systems and
realization of productivity benefits. MIT professor Erik Brynjolffson found a
five- to seven-year lag between deployment of an enterprise-resource-
planning (ERP) system and subsequent benefits. In a review of over 50 ICT
and productivity studies between 1987 and 2002, Jason Dedrick, Vijay
Gurbaxani and Kenneth L. Kraemer of the University of California, Irvine
concluded that the productivity paradox had been effectively refuted, with
greater investment in ICT associated with greater productivity growth.
Living in a world of digital deflation

Nearly every business Deflation is an inherent characteristic of information technologies, and nearly
where technology every business where technology dominates must reckon with deflation.
dominates must reckon
Moores Law has continued unabated since 1958, and there are corollaries
with deflation
across storage and connectivity. Digitization and hyperconnectivity have served
to eliminate frictions that allowed value to accrue to intermediaries, particularly
in media businesses. So many businesses are built on a model of scarcity.
The music industry saw Digitization typically brings significant deflationary pressure. This impacted
revenue decline from newspapers and music, TV is coming next. The print newspaper industry
US$16bn in 1998 to
increased from US$20bn in 1950 to US$60bn in 2000, then saw revenues drop
around US$6bn in 2008
in half by 2010 because of web advertising. The music industry saw revenues
decline from US$16bn in 1998 to around US$6bn in 2008 as listeners access
music through YouTube, Spotify, Pandora, iTunes and other sources.
That there is less of an Whats increasingly clear is that there is less opportunity to extract economic
opportunity to extract rents from IT itself with adoption of cloud computing. Amazons founder Jeff
economic rents from
Bezos charted the course for Amazon Web Services by targeting highly
infrastructure IT
profitable business models of HP, Oracle, IBM and others: Your margin is my
opportunity. With over 50 price cuts since 2006, Amazon Web Services has
accelerated the deflationary trajectory characterized by Moores Law with
economies of scale and highly aggressive pricing, leaving traditional
enterprise server and storage hardware vendors hurting. Apple (and for a
time Samsung) were the only vendors of smartphones able to sustain profits,
while early industry leaders like Nokia, Ericsson and Blackberry have failed or
struggled. Open source software has also eroded both revenue growth and
profitability for infrastructure software providers as well.
Highly automated Highly automated companies need fewer people to generate more value.
companies need fewer While tech employees (especially with specialized skills) tend to be well paid,
people to generate
by nature they are deflationary to employment; there are a lot fewer jobs
more value
required at tech firms to generate net profits than in other sector. A vivid
example of the leverage that technology provides is illustrated by the
difference in net income per employee across different industries. Tech
leaders generated an average of US$250,029 of net income per employee,
banking generated US$84,238, autos generated US$38,533, retail generated
US$11,485, and fast food generated US$6,787.

Figure 17
Technology firms Tech leaders net income per employee vastly outpaces other industries
generate far greater
300,000 (US$)
profits per employee
than other industries
250,000
200,000
150,000
100,000
50,000
0
Fast Food Retail Autos Banking Tech
Source: CLSA, company filings, Brett King - Tech components: Apple, Microsoft, Google, Facebook, IBM
and Oracle; Banking components: Bank of America, Wells Fargo, Citibank and JP Morgan Chase; Autos
components: Ford and GM; Retail components: Walmart, The Home Depot, Target and Costco; Fast food
components: McDonalds and Yum!
Adoption of technology creates value by automating tasks and improving

productivity, but also this has deflationary impact on wages. Its our view that
technological advances are also a key factor behind the growing divergence
between rising corporate profits and labors declining fortunes. When
technologies arise that reduce the need for human workers at lower costs, the
cost of technologies also tends to decline over time.
Increasing evidence This allows productivity gains without impacting corporate profits, while
that technology drives reducing labors share of the pie. Andrew McAfee of MIT compared labors
value creation but is
deflationary to wages share of corporate expenses versus corporate profits as a share of GDP. 2015
data show ever-widening divergence since the last recession. Corporate
profits, meanwhile, have never been higher in absolute terms or as a
percentage of GDP.
Figure 18
Technology reduces Labors share of corporate profits declining since 2002

frictions that
280 (1947=100) (1947=100) 104
support wages
Corporate profits (LHS) Labor (RHS)
260 102
240 100
220
98
200
96
180
94
160
92
140
90
120
100 88
80 86
60 84
1947
1949
1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: Research.stlouisfed.org, Andrew McAfee (MIT) Corporate profits calculated by profit per unit of
real gross value added of nonfinancial corporate business.

Authors John Seely Brown and John Hagel of the Deloitte Center for the Edge
identified a fundamental paradox facing business that they dub The Big
Shift. On the one hand, new technologies create vast possibilities for doing
things better, faster, cheaper, more convenient and more personalized. Per-
capita labor productivity has been steadily improving. However, returns on
assets for businesses have declined over the past 50 years and businesses
are not effectively capturing value from these new possibilities. Return on
assets for US companies has fallen to almost a quarter of 1965 levels.
Digitization and dematerialization turn everything into software

A fundamental shift The twin forces of digitization (of information and media) and dematerialization
as human business (reducing goods and services to software) have profound implications for the
processes become
digital communications economy and for society on a global basis. Digitization has transformative and
disruptive implications. Dematerialization (of personal electronics, recorded
music, books, video, etc) alters the economics of many businesses based on
physical goods. As more computers become connected, a fundamental shift
occurs as business processes that were previously handled by human beings
are now being executed electronically. Because these processes usually involve
computers talking to one another, they are unseen.
Digitization turns services Rendering physical goods into digital bits and bytes impacts manufacturers, the
into software; supply chain, distribution, retailers and end users. A prominent example of the
dematerialization turns
gadgets into bits impact of digitization is tax-preparation software. Software that costs less than
US$100 can replace many of the functions previously performed by a certified
public accountant (CPA) or other tax-preparation professionals.
Dematerialization refers to the transformation of physical products into
software. Apps on a US$600 iPhone can replace pocket calculators, cameras,
mobile telephone, video camera, clock radio, portable CD player, video cassette
player and other items that historian Steve Cichon calculated would have cost
over US$3,000 at Radio Shack in 1991. This is a 10:1 compression of value.
The on-demand economy turns products into services

There are over 280 On-demand or sharing business is a large and growing component of the
companies that provide economy. Online platforms where sellers can offer goods or services to
on-demand goods and
services in 16 industries customers are attracting more attention and spending. Data from the 2015
National Technology Readiness survey estimates that over 22 million
consumers spend nearly US$58bn annually in the on-demand economy.
According to Crowd Companies, which tracks on demand platform businesses,
there are over 280 companies that provide on-demand goods and services in
16 industries. This is an increase from just 76 companies and six industries
two years ago.
The on-demand economy The on-demand economy both creates and destroys jobs and businesses. In
both creates and destroys the case of Uber, there were investors that passed on investing in early
jobs and businesses
rounds because they though the market was too small. Before Uber, the size
of San Franciscos taxi market was US$150m per year. In early 2015, Uber
CEO Travis Kalanick disclosed that it had increased to US$650m with Uber
accounting for US$500m. Uber expanded the market by delivering an
experience to customers. However, this still came at the expense of
incumbents - San Franciscos Yellow Cab Co-Op filed for bankruptcy in
January 2016.

Despite disruption, One of the challenges with the advent of digitization is that measuring digital
traditional GDP measures goods and services as a proportion of GDP is difficult, if not impossible. Hours
may not capture change spent on the internet continue to climb (doubling from 2001 to 2011) and
consumers access ever more free goods in the form of Facebook postings,
blogs, online videos, games and other pursuits. As the volume of digital goods
increases, this renders the traditional GDP measure less useful. Erik
Brynjolfsson, professor of management at MIT, and Joo Hee Oh, assistant
professor of management at the Erasmus University Rotterdam School of
Management analyzed how much time people spent on the internet, and
using that method they valued free internet services at about US$106bn a
year. However, economist Tyler Cowen points that that this accounts for less
than 1% of GDP.
The nature of organizations changes with digitization

There is a lot of change There is a lot of change happening in the nature of organizations, as
happening in the nature businesses no longer profit from the frictions of scarcity but find ways to tap
of organizations
into abundance. Examples include Zappos and Valve Software, which have no
organizational hierarchies - teams self-direct their work. Haier makes 55
million refrigerators a year with 80,000 employees, and the companys CEO
created 2,000 independent teams that elect their own leaders and vote on
features, with the resulting successes resulting in tripling the companys
market cap. For big business, transformation is difficult but disruptive
changes are often best developed at the edge of the organizations. Apple is
master of this approach: their real innovation is organizational - creating
small teams that work in stealth to go after new industries.
Exponential organizations Singularity Universitys Salim Ismails 2014 book Exponential Organizations
leverage IT, and highlights organizations with common characteristics - leveraging information
innovative organizations
technologies, massive transformational purpose and innovative organizations.
to create massive value
Information-based industries are the best at leveraging technology to create
value. Singularity University, in conjunction with the Hult School of Business,
developed an ExO Score, and identified a correlation between stock market
performance and the ExO score. The top five exponential organizations are
GitHub, AirBnB, Uber, IndieGoGo and Google.
Figure 19
ExO market-cap improvement

Age (years) 2011 valuation 2014 valuation Increase (x)
Haier 30 US$19bn US$60bn 3
Valve 18 US$1.5bn US$4.5bn 3
Google 17 US$150bn US$400bn 2.5
Uber 7 US$2bn US$17bn 8.5
Airbnb 6 US$2bn US$10bn 5
Github 6 US$500m (est.) US$7bn 14
Waze 6 US$25m US$1bn (in 2013) 50
Quirky 5 US$50m US$2bn 40
Snapchat 3 0 US$10bn 10,000+
Source: Salim Ismail, Yuri Van Geest, Michel S. Malone
The Fortune 100 is In the past only large organizations could drop their transaction costs, but
disruptable with software now small firms can take advantage of forces of technology and innovation.
for the first time Financial services firms lack scalability largely because of regulation, which
perversely protects against startups. Software and information-based
industries are the best adoptors of technology. There are no digitally scalable
industries in healthcare - yet. The measure of performance improvement from
using Exponential Organization principles is powerful:

Figure 20
Exponential Organization ExO performance improvement

realizes enormous Company Business Performance improvement
performance gains from
tech-led innovation Airbnb Hotels 90x more listings per employee
GitHub Software 109x more repositories per employee
Local Motors Automotive 1000x cheaper to produce new car model, 5-22x faster
process for a car to produce (depending on vehicle)
Quirky Consumer 10x faster product development (29 days vs 300 days)
Goods
Google Ventures Investments 2.5x more investments in early stage startups, 10x
faster through design process
Valve Gaming 30x more market cap per employee
Tesla Automotive 30x more market cap per employee
Tangerine (formerly Banking 7x more customers per employee,
ING Direct Canada) 4x more deposits per customer
Source: Salim Ismail, Yuri Van Geest, Michel S. Malone
Because of technology, winners are winning bigger and faster

Whats different now is Technology is accelerating value creation for new companies. Play Bigger
that winners are winning Advisors study, Time to Market Cap: The New Metric that Matters, found that
bigger and faster category kings (Facebook, Twitter and Uber, for example) that dominate
than ever
their markets command over 70% of the total market value in their category,
leaving everyone else to share the remaining 30%. While this dynamic is far
from new, whats different now is that winners are winning faster than ever.
Companies headed for a US$1bn valuation will do so in a third of the time it
took at the end of the first internet bubble. Companies founded in 2009-13
took 2.9 years on average to reach US$1bn valuation versus 8.5 years for
those founded in 2000-03.
Digitization exacerbates divide between haves and have mores

The shift to a technology- The dynamics of the shift to a technology-driven economy favors developed
driven economy favors markets. Emerging markets tend to have under-skilled workers and less
developed markets
flexibility to improve their skills. Developed economies are early adopters of
new technologies and with them, new business models such as on-demand
and platform businesses. There are also differences between industries. The
McKinsey Global Institutes study Digital America: A tale of the haves and
have-mores finds that the US economy is digitizing unevenly. ICT is the most
digitized sector, followed by media, professional services and financial
services. The least digitized sectors include healthcare, hospitality,
construction and agriculture.
McKinsey estimates The McKinsey study finds that as the engine of digitization for the broader
the US economy is economy, the ICT sector accounts for about 5% of 2014 US GDP. Unlike
realizing only 18%
of its digital potential prices for goods and services in most other industries, ICT prices have
declined 63% from 1983 and 2010. Accounting for this price decline and
impact on other sectors, McKinsey estimates the ICT sector represented
roughly 10% of the 2014 US GDP. McKinsey devised an index that quantifies
a growing gap between the most digitized sectors, the have-mores and
the rest - the haves. The study found the gap between digital haves and
have-mores is growing as the most advanced users pull away from everyone
else. The less digitized sectors index accounted for just 14% of the most
digitized sectors. McKinsey estimates that the US economy as a whole is
realizing only 18% of its digital potential; digitization could increase 2015
GDP by over US$2tn based on its impact on labor markets, capital efficiency
and multi factor productivity.

Software - Value migrates upward as it eats the world

Theres a transition from Weve long expounded the view that value migrates upward in the technology
an economy of products stack from hardware to infrastructure software to software applications. The
to an economy of tech-sector business model is in transition from products to products plus
products plus services
services to services. The declining cost of compute and storage allows system
architecture to evolve from optimized, tightly coupled systems (mainframe) to
computationally wasteful, loosely coupled cloud-computing services.
Hardware and services vendors are increasingly moving into software for
technology and business reasons. Technology vendors that have a high
concentration of revenues coming from infrastructure like IBM and Oracle are
increasingly investing in and emphasizing SaaS platforms and applications.
Non-technology Manufacturers and retailers increasingly attach software and cloud services to
companies are compelled their physical products. Non-technology companies are compelled to invest in
to invest in applications applications and services to differentiate their products in a global market. Its
and services
no longer tech and internet companies vying for the most promising startups
in Silicon Valley; companies in other sectors are seeking out investment and
acquisition opportunities. Ford announced in May 2016 it would invest
US$182m in Pivotal, the software development company spun off from EMC.
Non-tech corporations are Companies in retail, agriculture, industrial equipment, automotive, consumer-
investing to compete in a packaged goods, energy, utilities, telecommunications, media and nearly
digitized, connected world
every sector are compelled to embrace digitization, evolve or face disruption.
There are numerous recent examples of non-technology companies making
investments or acquisitions in software:
GE continues to invest aggressively in GE Digital, a separate business
division to advance its vision for software-defined machines.
Under Armour has spent US$710m to acquire MyFitnessPal, MapMyFitness
and Endomondo.
A German automotive consortium of Audi, BMW acquired Nokias HERE
digital mapping business for US$2.7bn.
Conde Nast parent company Advance/Newhouses acquired big data
analytics company 1010data for US$500m.
Defense contractor Raytheon acquired cyber-security firm Websense for
US$1.9bn.
Audio and infotainment manufacturer Harmon International acquired
software engineering and integration firm Symphony Teleca for US$548m
and connected device software management provider Red Bend Software
for US$170m.
Boeing acquired Peters Software, a provider of aviation training content for
commercial and private pilots, as well as 2d3 Sensing, an imagery
software company that processes intelligence and surveillance data.
Non-tech companies are Companies in many industries are seeking to replicate the Silicon Valley
establishing startup innovation model by establishing their own startup incubators and venture
incubators and funds. Hundreds of companies have established innovation outposts in Silicon
venture funds
Valley and other hotspots like Herzliya Israel. According to Global Corporate
Venturing there are over 1,500 corporate venture units responsible for nearly
1,800 corporate venturing deals in 2015, double the amount of 2014 deal
activity, with transactions worth US$75.4bn in 2015, five times the amount in
2012. If software is in fact transforming every industry, investors need to
evaluate non-tech companies based on their command and embrace of these
new technologies.

What the future economy will look like

There are threads that Theres always risk in trying to predict what the future economy will look like,
will characterize the but there are threads that will characterize the coming decade. Many of the
coming decade
changes will be generational, as the digitally native millennials increasingly
exert impact on commerce, culture and innovation. Author Don Tapscott in
Growing Up Digital identified 88 million offspring of 85 million Baby Boomers;
this is a generation larger and more connected than their parents. This next
generation has internalized their digital behaviors with implications for
business models and industries across the board.
The digital economy is The digital economy will continue to be defined by technology-driven business
defined by technology- transformation. Over the past several years the rise of new sharing and public
driven business
transformation
transportation models - exemplified by companies like Uber and Lyft has been
accompanied by a declining rate of teenagers getting their first driver's
licenses. Much of the value in the trade of traditional goods and services is
the friction involved with connecting the asset with demand at the time and
place of need. For companies that seek to compete more effectively, every
company becomes a software company.
With a world of users connected to the internet, this gives rise to services
that intermediate and provide a trusted framework. We believe companies
like Netflix, Uber and AirBnB offer a blueprint for what the next generation of
high-growth businesses will look like. The nature of new businesses is less
asset intensive with more sharing of resources.
There will be growing Products become experiences - with more subscriptions. This also
emphasis on the total touches on a potentially more profound shift away from a consumerist
experience rather than
discrete products
culture based on ownership of physical products. Sharing-economy
businesses like Uber, AirBnB and Lyft address needs through a shared-
asset model. Futurist Paul Saffo sees the economy moving to subscription
models, predicting that users will subscribe to - and not own - robotic cars
among other goods.
Connected products transform development. In How Smart,
Connected Products Are Transforming Companies, an October 2015
Harvard Business Review cover story, co-authors Michael Porter of Harvard
Business School and Jim Heppelman, CEO of PTC, outline how an emerging
generation of cloud-service-enhanced products will change how companies
will increasingly integrate data from customers and the distribution chain
to drive truly interdisciplinary product development.
Creative design is Design drives differentiation. Companies like Apple, Chrysler, Oxo and
paramount for developed- others have embraced the premise that smartly designed computers, cars
market firms to prosper
and kitchen tools can stand out in established categories. While
engineering remains critically important, creative design is paramount for
developed-market firms to prosper in an environment where production is
global, choices are myriad and competition is omnidirectional.
Businesses are finding More value from fewer resources. Businesses are finding ways to
ways to produce more produce more with less energy and materials. Additive manufacturing (3D
with less energy
and materials
printing) reduces manufacturing waste; smart grids and intelligent
thermostats optimize energy consumption; and cloud computing allows
startups and enterprises to innovate faster with lower costs and overhead.
The ability for startups like Instagram and WhatsApp to scale to hundreds
of millions of users with only a few dozen employees is a harbinger of
hyper-efficient organizations.

A view of winners and losers

One of the more insightful Its always challenging to identify the winners over the long term when the
prognostications comes races have barely begun. What weve tried to do is provide a framework for
from author and
entrepreneur Brett King investors to survey the pace of key innovative trends where we see value
creation potential. One of the more insightful prognostications comes from
author and entrepreneur Brett King in his recent book Augmented: Life in the
Smart Lane (with Alex Lightman, Alex Lark and JP Rangaswani) lays out some
distinct categories of long-term winners and losers once the Cambrian
explosion of digital, physical and biological innovation comes to fruition. Some
of the winners might include:
Scale and a strategic Big tech companies. Market leaders like Apple, Google, Amazon and
focus have allowed Facebook have the ability to fund innovation and growth. Scale and a
Microsoft to reverse
course strategic focus have allowed Microsoft to reverse course. For other tech
firms with high exposure to hardware and on-premise infrastructure like
IBM, HP and Oracle there are still challenges ahead.
Artificial intelligence players. We are still at the beginning of the

market but there are a number of public companies that have made big
investments including Google DeepMind, Facebooks Wit.ai, Salesforce with
MetaMind, Microsoft, Baidu, and IBMs Watson. There are a number of
startups including Sentient Technologies, The Grid, Enlitic and x.ai among
others. The relevance of AI in autonomous vehicles, healthcare, finance
and other industries is broad and the industry has barely begun. ]
30 million people will be Next generation/Smart infrastructure. Brett King sees autonomous
involved deploying solar and electric vehicle manufacturers, smart grid operators, consumer
and renewables by 2030
renewables and household battery deployment, nanotech-based water
treatment and desalination, robot and drone delivery networks and general
smart city infrastructure as booming businesses over the next two
decades. He estimates that 30 million people will be involved deploying
solar and renewables by 2030.
Every device that can be Internet of Things. Physical things will increasingly get smarter, starting
turned on or off, or that with appliances, smart cars, smart homes, and smart glasses. This will
needs to be monitored
will be linked to the cloud extend to sensors, screens and algorithms embedded in the world around
us. Over time all sorts of day-to-day applications will be connected
machine-to-machine. This will drive adoption of sensor nets as small
computing devices will be ubiquitous. Every device that can be turned on
or off, or that needs to be monitored will be linked to the cloud.
Wearables, ingestibles and sensors will monitor health and well-being in
real time.
By 2020, 66% of the Connecting the developing world. Emerging regions will see 2-2.5
worlds population will be billion people connected with access to the web predominantly via mobile
connected to the internet,
versus 23% in 2010 devices. With cheap smartphone will emerge internet access followed by
commerce. Facebook, Google, OneWeb and SpaceX have all committed to
provide free internet access. African mobile growth is expected to result in
over 1 billion connections by the end of 2016. The expectation is that by
2020, 66% of the worlds population will be connected to the internet,
versus 23% in 2010.
HealthTech and FinTech. Both healthcare and financial services offer

massive opportunity for new technology expertise. Startups will displace
inefficient and ossified incumbents and partner for core capabilities.

The augmented and virtual reality ecosystem. VR and AR will give

rise to a new generation of entertainment and applications, Content
creators will develop new hybrids of games, live experiences and film.
There will be increasing integration of social and collaborative capabilities,
especially in business.
Over time, materials will Metamaterials and 3D Printing. Development of new composites and
be able to be engineered hybrid materials combined with additive manufacturing technologies will
at the atomic level
give rise to essentially smart manufacturing and construction. Techniques
like nanotechnology will enable development of transparent aluminium,
carbon-fibre nanotubes, smart clothing, reactive and responsive materials
that morph or alter their properties, smart polymers, piezoelectric,
thermoelectric and photomechanical materials. Over time, materials will be
able to be engineered at the atomic level. We will see 3D printers that can
fabricate machines, homes, and appliances.
Losers could include:

Gas and service stations Big energy. King sees four key forces that will challenge fossil fuel
and other participants in producers and incumbent energy systems: ultra-cheap renewables, smart
the ecosystem will go
grids, electric vehicles and energy storage systems (batteries like the Tesla
out of business
Powerwall and fuel cells, etc). Gas and service stations and other
participants in the ecosystem will go out of business. Mining will shift from
extracting fuels to extracting resources to power the new applications.
The new paradigm for Big healthcare and pharma. The new paradigm for healthcare
healthcare businesses will businesses will be data, engineering and models rather than chemistry,
be data, engineering and
patented medicine and surgery time. There will still be hospitals and
models
doctors, but diagnosis will be derived from sensors. Medical emergencies
will decline as self-learning, healthcare-dedicated healthcare application
will prove better than humans at diagnosing and offering treatment
suggestions.
The adoption of Banking, insurance, regulators and finance in general. The adoption
blockchain will eliminate of technologies like blockchain will eliminate the frictions to transactions
transactions frictions that
that banks have capitalized on. AI-based applications will replace many
banks have capitalized on
jobs performed by humans, whether a bank branch teller, financial
adviser, accountant, loan officer or others focused on advising on bank
products or financial rules.
Small- to mid-sized colleges and universities. The US$1.3bn in
student debt and perceived lower value of graduate studies will lead to
consolidation in tertiary education. We are already seeing declines in law
school applications as a harbinger of this trend.

Section 2: The Unicorn Era winds down 2020 innovation
The Unicorn Era winds down

In 2016, funding is Funding and entrepreneurship remain critical to realize value from innovation.
getting tougher for late- In 2016, funding is getting tougher for late-stage private companies and IPOs
stage private companies are harder to come by. M&A remains active as an exit strategy for private
firms however, and as valuation expectations ratchet down (along with mutual
fund markdowns) we anticipate healthy levels of acquisition activity. The pace
of startup creation, while steadily in decline in recent decades, rebounded in
2015 from a more recent five-year slump. Whether this can be sustained is
yet to be seen, but the cost and availability of enabling technologies
continues to be conducive to startups.
Unicorn was a term that Unicorn was a term that entered the broader lexicon in 2015, referring to
entered the broader privately held companies valued at over US$1bn. As a symbol of robust
lexicon in 2015 technology-led innovation propelling a new boom, and also as a symbol of VC
excess, hype around Unicorns peaked in late-2015 and theres been a return
to more measured assessments of valuation and profitability. Unlike the first
internet bubble in the late-1990s, valuations for Unicorns are not being fueled
by a frenzy of IPOs accompanied by lofty valuations in the tech sector. In
contrast, the pace of IPOs has been more measured, and despite some
volatility in the public markets early in 2016, tone of business among public
companies does not appear unsettled. For VC-funded private companies, its a
different story.
2015 ended up being a 2015 ended up being a year of adjustment for the venture-capital world as
year of adjustment for the some of the largest venture-backed businesses struggled to meet their
venture-capital world valuation expectations. As a result, we have seen a weaker IPO and M&A
market. Investors have begun to pull back from overvalued startups,
particularly in the later-stages as they become more discriminate about which
of these companies can succeed in the volatile public markets
2016 is shaping up to be a In January 2015, Fortune magazine heralded the The Age of the Unicorns,
challenging year for noting that there were over 80 startups valued by venture capitalists at
startups seeking funding US$1bn or more. By January of 2016, there were at least 229. In early May
2016, Fortune listed 174 companies with valuations over US$1bn, following a
wave of markdowns. Research firm CB Insights identified 588 US tech
companies backed by venture capital or private equity with valuations over
US$100m in the IPO pipeline in 2015. Of these, 39% raised additional
financing or exited via IPO or M&A, with the remaining 61% still active.
Theres a robust roster of aspiring public companies, with over 500 US tech
companies estimated to be in the IPO pipeline (internet companies account
for nearly two-thirds of these).
Figure 21
Top 10 companies valued at US$1bn or more by VC firms

Company Latest valuation Total equity Last
(US$bn) funding (US$bn) valuation
Uber 51.0 7.4 Aug 15
Xiami 46.0 1.4 Dec 14
Airbnb 25.5 2.3 Jun 15
Palantir 20.0 1.9 Oct 15
Meituan-Dianping 18.3 3.3 Jan 16
Didi Kuaidi 16.0 4 Sep 15
Snapchat 16.0 1.3 Feb 16
Flipkart 15.0 3 Apr 15
Space X 12.0 1.1 Jan 15
Pinterest 11.0 1.3 Feb 15
Source: Wall Street Journal

The bubble begins to deflate

Late 2015 saw the Late 2015 saw the beginning of the end of the Unicorn Era. A couple of Wall
beginning of the end Street Journal investigative articles into Theranos and Zenefits shone a
of the Unicorn Era
spotlight on what could go wrong at highly valued private companies with
lofty growth expectations. There has also been an increase in failures among
startups including Quirky, Secret, Fab.com and others. By 1Q16, the late-
stage financing environment has become more challenging for startups.
Mutual funds also began Mutual funds also began to mark down valuations from private investment
to mark down valuations rounds, and the pace of private investments by large mutual fund firms is
from private investment
rounds slowing as firms found it more difficult to agree on acceptable valuations. In
March 2016, an analysis by the Wall Street Journal found that Blackrock, T.
Rowe Price, Fidelity Investments and Wellington Management valued
investments in 13 of 40 closely held startups valued at US$1bn at an average
of 28% below the purchase price.
2016 could be the year a number of these so-called Unicorns find

themselves unable to continue to operate with losses as they continue to burn
cash and access to funding dries up. Despite the pull-back in late-stage
investment, there has been a recent uptick in early-stage investments as
venture capitalists move away from mature startups with absurd valuations
and look to auspicious companies in their early stages.
For startups, access to As the bar to the capital markets grew higher in the wake of Sarbanes-Oxley
venture capital and angel legislation, the ability to secure returns through IPOs has been increasingly
investors is particularly
important difficult since the number of annual offerings peaked at 650 in 1996. For
venture-backed firms, the past decade has been challenging, as the number
of offerings dropped from 92 in 2007 to just seven in 2008. There is a
difference in 2016 from the first internet bubble in 1999-2000: the number of
IPOs rebounded to 117 in 2014 and 77 in 2015, but ground to a halt, with no
venture-backed IPOs in 1Q16.
Figure 22
Annual US venture-capital exit activity

Year Total M&A M&A deals Total disclosed Average M&A No. Total offer Average IPO
deals (No.) with disclosed M&A value deal size of amount offer amount
values (No.) (US$m) (US$m) IPOs (US$m) (US$m)
2007 488 200 30,745.5 153.7 92 12,365.5 134.4
2008 423 134 16,236.9 121.2 7 765.0 109.3
2009 361 109 12,364.9 113.4 13 1,979.8 152.3
2010 545 151 17,713.5 117.3 66 7,409.5 112.3
2011 500 169 24,093.2 142.6 50 10,441.1 208.8
2012 492 132 22,694.2 171.9 48 21,354.1 444.9
2013 394 95 16,909.8 178.0 80 10,998.2 137.5
2014 485 140 48,139.9 343.9 117 15,512.1 132.6
2015 372 84 16,291.2 193.9 77 9,378.9 121.8
Source: Thomson Reuters, National Venture Capital Association
Venture-backed IPOs In 2015, venture-backed IPOs raised US$9.4bn from 77 listings compared to
were down in 2015 a record year in 2014 where venture-backed IPOs raised US$15.3bn from 115
listings. The decline in venture-backed IPOs was in line with the overall
decline in filings of public exchanges with the 77 venture-backed IPOs
accounting for 42% of total IPOs last year. Increased investment activity by
non-traditional firms has allowed companies to stay private longer - which is

one reason IPO activity has declined However, there are currently 44 venture-
backed companies that have filed with the SEC for an IPO, but it is uncertain
whether there will be a rebound.
Acquisitions prove the exit of choice

Overall 2015 M&A According to the 451 Group there was US$594bn in total M&A transactions in
spending was equivalent 2015, with almost 4,000 deals in telecom media and technology. Overall
to all of 2013-14 combined
spending was equivalent to all of 2013-14 combined. There were nearly 20%
more deals in 2015 than in 2014. Big names stepped back into M&A like HP
which bought Aruba Networks. Microsoft completed over 20 transactions. IBM
completed 15 deals in 2015, 3x the companys yearly average. Divestitures
also accounted for 156 deals worth US$60bn, the highest ever in the US. In
2014 there were 151 for US$43bn.
Last year was stronger for Software accounted for almost half of the number of M&A transactions
venture-backed M&A reported. The average M&A deal size declined to US$194.8m in 2015 from
US$343.9m in 2014, representing a YoY decline of 43%. Despite the decline
from last year, total deal value in 2015 was only down 4% compared to 2013
and up 60% from 2012. A key reason for the decline in M&A is that valuations
had been too high and companies are less willing to pay premiums without
significant revenue generation.
Figure 23
US venture-backed company M&A deal activity

200 (No. of deals) Total deal value (RHS) (US$bn) 40
Total M&A deals
180
Deals with disclosed values 35
160
27.8 30
140 136
120
25
120 109
113
116
100 95
91 20
80
77 15
60
8.6 10
7.6
6.9
40
4.1 3.7 3.6 5
20 2.2
0 0
1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15
The activity of VC-backed exits in 2016 has dropped, as well with only two so
far over US$1bn and not a single deal so far from US$500m-US$1bn this
year. By comparison the previous five years saw between seven and nine
exits between US$500m-US$1bn. There were six exits over US$1bn in 2014
declining to one in 2015.
In terms of sentiment the In terms of sentiment the private market tends to lag the public market. Two-
private market tends to thirds of respondents in 451 Groups 1Q16 survey see private company
lag the public market
valuations declining for M&A. Valuations in the M&A market are polarized as
well with high multiple and low multiple deals and little in between. Ingram
Micro bid US$6bn for a company with US$40bn in sales. Polycom and
Lexmark were valued at 1x trailing 12 month sales. At the high end there are

similarly high multiples. Cisco paid US$1.4bn for Jaspers US$100m in

bookings, Cvent was taken private at 8x sales and Textura was acquired by
Oracle for 7x revenue. A schism like this in the M&A markets is not a healthy
sign. According to 451 Group, deals would normally be 3.5-4x sales. When
pricing is polarized, its feast or famine in M&A.
Down-round exits are coming

Tech bankers expect According to a 1Q16 survey by the 451 Group, tech bankers expect
valuations to decline valuations to decline in 2016 - 64% of those surveyed, with only 14%
in 2016
expecting valuations to increase. About 80% expect valuations for private
companies will decline versus 2% expecting valuations to increase. Some
57% of bankers think VC funding will get less available versus only 7% that
expect more available funding. The only time this sentiment was more
bearish was in 2009. So far in 2016 there have been 13 companies acquired
with eight sold for less than their trading price in 2015. Companies are
getting discounted in the public markets, and this is freezing the market in
terms of venture-backed exits.
Venture capital raising less money and closing fewer funds

Funding decreased 2015 saw 235 US venture funds (13% fewer YoY) raise a total of US$28.2bn,
9% YoY for VC firms down 9% YoY in dollar terms. Despite being down, overall it appears that the
in 2015 but . . .
fundraising environment is healthy with a diverse mix of fund sizes and
almost US$60bn raised for distribution in just two years.
Figure 24
Annual US venture-capital fundraising activity

Year Number of funds Venture capital (US$m)
2008 214 25,054.9
2009 162 16,103.8
2010 176 13,283.6
2011 192 19,080.5
2012 218 19,904.9
2013 209 17,753.4
2014 271 31,094.4
2015 235 28,151.7
The Center for Venture Research found that US angel investors funded
73,400 entrepreneurial ventures worth some US$24.1bn in 2014, down
2.8% from US$24.8bn in 2013. The number of active investors increased
5.9% from 2013 to 316,600, but data showed that the change in both total
dollars and the number of investments brought about a smaller deal size by
6.4% from 2013, indicating that angel investors were active investors but at
decreased valuations than from prior years pointing towards a market
correction in valuation. Angels invested in a variety of sectors, with software
leading at 27%, followed by healthcare (16%), IT (10%), retail (9%),
finance (8%), and industrial (5%).
Putting money to work in 2015

. . . VC investments According to the MoneyTree Report by PwC and the NVCA, startup
increased 22% YoY investments in 2015 were US$59.1bn, up 22% from 2014, making this year
in 2015
the second highest in 20 years. The total number of deals declined 1.3% to
4,380. Although IPO and M&A activity have been down this year as investors

look to make smarter investments, solid VC capital deployment is indicative of

a healthy ecosystem that is committed to supporting entrepreneurs. The
amalgamation of technology across sectors is playing an important role in
companies business models and we are seeing how new emerging tech-
enabled segments are disrupting traditional industries. Over half the deals in
2015 went to seed and early stage companies with more than 1,400
companies raising VC money for the first time.
The software industry The software industry continues to receive the highest level of funding with a
continues to receive the total of US$23.6bn in investments from 1,763 deals down 5% from 2014.
highest level of funding
Internet-specific company investments increased 35% compared to 2014 as
the number of deals remained flat. Of importance to note is that despite a
strong year for VC investment in 2015, the fourth quarter saw the lowest
number of deals worldwide in nearly three years. This drop in deal flow was
most prominent in later stages of venture investing. Expansion stage of
investment was down 53% in dollars and 10% in deals from 2014 and later
investments saw a decline of 33%. The reason for this slowdown - there isnt
much of an appetite to invest in companies with ambitious growth plans that
are burning cash especially during these economically volatile times. However,
this slowdown in funding is not necessarily a bad thing as Silicon Valley
experiences its own soft landing in the venture business. Valuations have
become exceptionally inflated and it is our belief that this normalization is
healthy and also warranted.
Startup activity bounces after steady decline

Entrepreneurial activity has long been a core engine of growth in the US, but
the pace of new business creation has been on the wane. Business startups
exceeded business failures by about 100,000 per year until 2008 according to
Gallup. However, that year the number of failures begin to exceed the number
of startups by 70,000 for the first time since records were kept in the late
1970s. The US startup rate has been falling, a concern for those that view
entrepreneurship as a cornerstone of a healthy economy.
Declines in job creation Declines in both job creation and job losses provide evidence that there is
and job losses provide less risk-taking in the economy. As of 1Q15 the number of jobs created by
evidence that there is
less risk-taking new businesses fell 7% from 4Q14 on a seasonally adjusted basis, an 18%
decline from a decade ago. The number of job losses due to business closures
is also down 21% from 2005. The share of firms less than one year old (a key
measure of business vibrancy) has declined from over 15% in 1977 to 8% in
2013 according to data from the US Commerce Department and analysis by
the Wall Street Journal. According to data from the Labor Department, newly
formed businesses are adding jobs at a much slower pace than a decade ago.
Startup activity in the The pace of new business formation has rebounded after a five-year decline.
US remains healthy By one measure, startup activity in the US remains healthy, with VCs
investing US$59.1bn in 2015. The Kauffman Index of Entrepreneurial
Activity is the leading tracker of startup activity in the USA and a solid
indicator of future innovation. The 2015 report points to the largest YoY
increase in startup growth in 20 years, reversing a five-year downward
trend. This rise in activity is a good sign for job creation, innovation, and
economic advancement as it is an early indicator of new business creation.
Notably, Baby Boomers and immigrants are among the most active starting
new companies.

Figure 25
Entrepreneurial Index Kauffman Index of Entrepreneurial Activity

ticks up after five
0.36 (%)
down years
0.34 0.34
0.34
0.32
0.32 0.32
0.31
0.30 0.30 0.30 0.30

0.30
0.28
0.28 0.28
0.26
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Kauffman Foundation
A couple of interesting trends to highlight from the Kauffman report indicate

that the biggest startup gains have been among men, who make up 63% of
new entrepreneurs. 52.4% of entrepreneurs are over the age of 45 deflating
the hype that most are millennials just out of college - the fact is that
younger people have a harder time securing resources and are burdened with
high student loan payments.
Theres no shortage of One recent study concludes that theres no shortage of entrepreneurs with
entrepreneurs with good good ideas, but they are struggling to transform vision into companies with a
ideas, but they struggle
broader reach. A New View of the Skew: A Quantitative Assessment of the
to grow businesses
Quality of American Entrepreneurship, a research and a policy brief from
Massachusetts Institute of Technologys Catherine Fazio, Jorge Guzman, Fiona
Murray and Scott Stern sought to explain why only a very small fraction of all
new businesses experience the explosive growth in terms of jobs, revenue, or
valuation that propel the economy. They found a divergence between quantity
and outcome based measures of startups.
Quantity and outcome Quantity-based measures indicate a three-decade-long decline in the US rate
based measures tell a of entrepreneurship and business dynamism (the pace at which the economy
different story on
reallocates economic activity). In contrast, outcome-based measures based
entrepreneurship
on early-stage angel and VC financing for new ventures show the rate of
entrepreneurship on a significant upswing in recent years. The authors apply
different criteria, including average growth potential for a group of new firms,
probability of success for regional cohorts and regional acceleration potential -
to derive a qualitative measure of US entrepreneurial activity. They found that
the expected number of successful startups growth outcomes has followed a
cyclical pattern sensitive to capital markets and overall macro conditions. In
their findings its not the number of startups that translate to greater
successful outcomes, but that regional differences may be far more impactful.
Lightweight innovation The increasing capital efficiency of software and internet firms (with the
has reduced capital proliferation of open-source software and public cloud computing) reduces
needs for software
initial capital needs for many startups. This, in turn, lowers barriers to entry
and internet startups
for startups, while altering the value equation. Because the amount of capital

needed is less, a VC investment in itself is no longer a de facto competitive

advantage for startups competing for the same markets to the extent that
capital access itself is strategic. The value that venture investors provide is
management insight, access to executives and customers, mentoring and
other intangibles. Its a combination of external factors, such as the quality of
board, advisors, and regional culture steeped in entrepreneurial success that
determines whether a startup can create scalable value.
R&D spending increases, but US pace is lagging other nations

Global R&D investments R&D investment is still a key indicator of innovative activity. According to the
expected to increase 2016 Global R&D Funding Forecast, sponsored by the Industrial Research
by 3.5% in 2016
Institute (IRI), global R&D investments are expected to increase by 3.5% in
to US$1.95tn
2016 to US$1.95tn in purchasing power parity (PPP) values for the over 110
countries with R&D investments more than US$100m. R&D spending is highly
correlated with sustained revenue growth. We compared leading technology
firms 10-year Cagr for revenues and R&D spend, and what we found was an
R2 of 0.9366. Its not necessarily a leading indicator but undoubtedly a
coincident indicator, reinforcing that tech companies that deliver sustained
revenue growth maintain the pace of investment.
Figure 26
Companies with sustained Growth in R&D investment is highly correlated with revenue growth
growth in R&D also have
40 Sales growth (%)
sustained sales growth R = 0.9366
CRM
35 Apple
30 AMZN
GOOGL
25 AKAM
RHT NFLX
20
15 ORCL
CTXS
CHKP
MSFT ADBE
10
CSCO SAP
5 ADSK
CA
INTC
0
IBM
R&D growth (%)
(5)
(5) 0 5 10 15 20 25 30 35 40 45 50
Source: Factset
The US still accounts for IRI/R&D Magazine forecasts 3.4% growth in US R&D spending to US$514bn.
the largest single After accounting for 2016s expected inflation rate of 1.5%, R&D growth in
countrys R&D investment
real terms will be closer to 1.9%. 2016 was a difficult year to plan for as
enterprises, government and academia struggled to get their heads around
the macro uncertainties of a volatile global economy. Although spending is
forecasted to increase, there are some concerns as a result of Chinas
slowdown, recent US stock market volatility, restrictions on federal spending
due to earlier sequestration programs, and limpid growth in the US in addition
to a strengthening dollar. Despite these drags, the US still accounts for the
largest single countrys R&D investment, representing more than a quarter of
all global R&D spending.

Figure 27
China and Korea lead Change in business expenditures on R&D, 2009-13

in growth of R&D
90 (%)
investment
80
70
60 Calculated in constant dollars and

adjusted for purchasing power parity
50
40
30
20
10
(10)
(20)
China Korea Germany Japan US UK Canada
Source: OECD, Duke Universitys FUQUA School of Business
There is a correlation There is a correlation between a countrys economic growth and innovation
between a countrys investment as measured by GDP and its R&D growth. China has shown a
economic growth and
strong willingness to enhance its research and development despite its
innovation investment
recent slowdown. The IMF forecasts GDP growth for China at 6.3% and a
2.8% increase for the US with smaller increases across many European
countries. For 2016, R&D Magazine forecasts China R&D to increase 6.3% to
US$396bn. In the US, investors weary of high R&D spending without
payback have become activists. In 2015, investor Nelson Peltz tried to wrest
control of DuPont from then-CEO Ellen Kullman arguing that the company
was not moving in the right direction and that cuts to the R&D budget
needed to be made. There are two schools of thought about the value of
R&D investment but the data favors the benefits of stronger R&D spend
promoting growth and value creation.
While R&D spend does not predictably translate into robust earnings, the
greatest companies invest in innovation as it is a primary source of
competitive advantage, efficiencies and productivity. Based upon our
experience, we find there is a positive connection between R&D spending,
sales growth and stock returns. Essentially, R&D is the key to staying ahead
of competition in a quickly evolving landscape.
Software and internet investment outpaces other industries

Software and internet According to PwCs annual study of the 1,000 largest globally publicly traded
were the biggest movers firms based on R&D investment, spending rose 5.1% to US$680bn in 2015
in R&D spend between
versus 1.4% in 2014, marking the strongest increase in the last three years.
2014 and 2015
The top three industries by R&D spending continue to be computing &
electronics, healthcare and auto. Software and internet companies increased
R&D spending by 27.4% from 2014 to 2015 which was the largest increase
among all industries. This reflects the highly dynamic nature of the
competitive landscape and market dynamics for software and internet
companies, compelling aggressive investment in innovation. R&D spending in
China increased 150% to US$55bn between 2007 and 2015. The US remains
the top R&D spender at US$145bn, remaining the number one location for

innovation according to PwC. However, China is increasing the scope of its

R&D investments. In 2007, R&D spend in China accounted for 23% of the US
total, today it is 38%.
There are benefits to a PwC found distinct benefits to a company with a global R&D footprint.
company with a global Companies that distribute spending outside their headquarters country tend
R&D footprint
to outperform companies that are less globalized. Companies that spent 60%
of R&D budgets overseas saw operating margins and return on assets that on
average 30% higher than those companies that kept R&D locally
concentrated. The reason for the outperformance is credited to the payoff
companies receive from the placement of competencies and knowledge on a
global scale as well greater success in understanding local market needs.
Figure 28
Computing and electronics Global innovation spending by industry

invest the most of any
industry in R&D
Telecom Other
Consumer
2.1% 1.7%
3.3%
Aerospace and
defense
Computing and
3.3%
electronics
Chemicals and 25.9%
energy
6.5%
Software and
internet
9.2%
Industrials
10.7%
Healthcare
21.1%
Auto
16.2%
Source: PwC
Innovation benefits from technology enablers

Over the next decade, We identify several technological accelerators of innovation. The convergence
computing will become of enabling factors that reduce innovation cost - open source, cloud
increasingly embedded
computing, mobility and the commoditization of hardware/software and
in daily life
bandwidth - provides a catalyst to create value and accelerate innovation, all
facilitated by software. Key enabling trends include:
Exponential declines in the cost of computing, bandwidth and storage,
which lower barriers to ideation and enable unparalleled scale for new
ventures.
Cloud computing, which enables users to dynamically procure IT resources
and content on an as-needed basis.
Open-source software, which empowers users with flexibility and
increasingly robust functionality at little or no cost.
The mobile internet, which connects users with information and
applications regardless of device, connection or location.
Growing penetration of internet users and social networking, which results
in near-ubiquitous reach of services.

Technology has a Computing overall is becoming more intuitive and pervasive with the
transformative impact, evolution of more powerful software, rapid growth of endpoint devices,
accelerating innovation
availability of instant-on connectivity and declining costs of hardware,
across the economy
bandwidth and storage. We see the continuous elevation of simplicity of
experience to the user as logic controls the underlying systems, processes
and infrastructure with increasing power. These concurrent trends have a
transformative impact, accelerating innovation across the broader economy in
traditionally non-tech as well as technology industries.
Commoditization of computing, bandwidth and storage

Cost of computing, The commoditization of computing, bandwidth and storage has proven to be a
bandwidth and storage continuous dynamic. The principle of Moores Law, which holds that processor
continues to decline
performance can double every 18 months, has held fast since the 1970s,
while price performance of Dram continues to improve along a similar
dynamic.
Exponential cost and In fact, the dynamic of exponential cost and performance improvement is
performance gains occur occurring across a broad range of technologies. While improvement occurs at
across a broad range of
technologies
different rates, the consistent historical trend remains a common dynamic
across different hardware technologies.
Figure 29
Moores Law has held Moores Law

fast since the 1970s
Source: Wikipedia (Wgsimon)
Butters Law (named after Gerald Butters, former head of Lucent's Optical
Networking Group at Bell Labs) posits that the amount of data coming out of
an optical fiber doubles every nine months, essentially cutting the cost of
data transmission in half over that period.

Figure 30
Exponential cost and Time to double (or half)

performance Dynamic Ram memory half pitch feature size 5.4 years
improvement occurs
across technologies Dynamic Ram memory (bits per dollar) 1.5 years
Average transistor price 1.6 years
Microprocessor cost per transistor cycle 1.1 years
Total bits shipped 1.1 years
Processor performance in MIPS 1.8 years
Transistors in Intel microprocessors 2.0 years
Microprocessor clock speed 2.7 years
MIPS = Millions of instructions per second, a measure of processing capacity.
Source: Ray Kurzweil, KurzweilAI.net
Beyond Moores Law

Theres a widely held In 2Q15, Intel CEO Brian Krzanich announced that Moores Law - the principle
view that Moores Law that the number of transistors incorporated in a chip will double every two
will end with the 7nm in years - is slowing to a pace of every two and a half years. At the current pace
2020 or 5nm in 2022
of innovation, theres a widely held view that Moores Law will end with the
7nm in 2020 or 5nm in 2022 and then beyond that, physics will simply not
make it practical to shrink the transistors further. In July 2014, IBM
announced plans to invest US$3bn in R&D for two research programs that will
extend computing capabilities beyond Moores Law. Futurist Ray Kurzweil
believes that photolithography will run its course by 2019, but quantum or
optical computing will continue the exponential growth in computing power.
Some of the most promising research involves graphene, organic transistors,
3D stacking, neurosynaptic chips and quantum computing.
Moores Law has held up Moores Law has held up for over 50 years and many businesses have used
for over 50 years predictable advances to time PC purchases, databases and servers. If chips
are doubling in power every two years then software was being written in
tandem in anticipation of the increase. This law was always considered more
of an economic rule of thumb that helped companies schedule manufacturing
targets. With the move to more centralized cloud computing, chip power is
still important for the capabilities of a cloud data center but the speed of the
processor in client devices is no longer as relevant, as new applications
increasingly rely on compute power delivered as cloud services. Businesses
however are no longer purchasing hardware in regular upgrade cycles as they
have done in the past. Companies like Apple are seeing that sales are
declining as customers begin to hold on to older models satisfied with the
performance improvement they receive from the cloud. Over time, business
models predicated on hardware upgrades eventually give way to
commoditization or reliance on higher-margin services and software.
Cloud computing accelerates incubation of new ideas

Availability of cloud- Cloud computing has lowered barriers for technology adoption, reduced time
based resources is to market and placed unprecedented computing power in the hands of
lowering barriers startups, departmental IT staff and others heretofore lacking access to
for startups
scalable systems. Importantly, the availability of cloud-based resources is
lowering barriers for startups and fuels accelerating innovation. The capital
efficiency that can be applied to developing, introducing and then iterating on
these new applications is declining. The capital efficiency for a venture firm
trying to launch new companies is becoming much better. The Law of
Accelerating Returns on these technologies is at play.
Pricing declines continue Pricing declines continue to benefit users of cloud computing. According to a
to benefit users of cloud report by Tariff Consultancy (TCL), average entry-level cloud computing prices
computing declined by 66% over a two-year period ending in November 2015. In March

2016 Amazon Web Services (AWS) reduced prices for the 51st time since
2006, with Microsoft following close after. Google announced at the beginning
of 2016 that its pricing for compute prices would be 15-41% cheaper than
AWS. While the pace of price cuts has slowed over the past couple of years,
the market has consolidated around AWS and Microsoft, with Google running
fast to catch up, as hyper-scale public cloud service providers.
Cloud computing enables Cloud computing facilitates a range of new use cases around social
social computing, mobile computing, mobile services and high-performance analytics, all of which have
services and high- the potential to create new economic value. Cloud computing reflects the
performance analytics
industrialization of information technology. While this has disruptive effects on
certain providers of infrastructure components and services, there are many
beneficiaries of broad-based adoption of cloud computing.
Businesses benefit from lower costs for technology, IT staff and
overhead, while gaining benefits of agility. Lowering the marginal cost of
failure accelerates innovation and allows for rapid value creation. The
extensible aspects of cloud computing allow businesses to scale online
operations far more quickly than possible on their own, for less capital,
with less risk.
Consumers benefit directly and indirectly from the availability of cloud-
enabled applications. Cloud-enabled search, entertainment, information
services, location-based services and applications democratize access to
culture, knowledge and commerce. Dematerialization of physical goods
(for instance, the digitization of books, music and video) into cloud-
delivered services reduces friction around information flow.
Open-source software and Its our view that cloud computing and related technologies such as open-
higher-level programming source software and higher-level programming languages are analogous to
languages parallel James James Watts steam engine in the first industrial revolution, with compute
Watts steam engine
power substituting for coal. As such, disruption within the IT infrastructure
market is likely to continue along a path of creative destruction as proprietary
infrastructure hardware and software providers see their ability to charge
premium rents and enjoy attractive profit margins steadily erode.
A wholesale economic model disrupts a bespoke industry. We point to the
2006 introduction of Amazons EC2 as the turning point where scalable
compute and storage became available on a self-serve, pay-per-use
model. Amazon Web Services annual run rate now exceeds US$10bn, with
hundreds of thousands of startups using the service.
Native cloud architectures commoditize infrastructure hardware and
software. A mature Platform-as-a-Service (PaaS) layer decouples the
application logic from the underlying infrastructure and makes
infrastructure components increasingly interchangeable and subject to the
forces of commoditization.
Open source - Freeing innovation and enabling cloud computing

Open source has been Open-source principles inherently enable innovation, not just in software,
critical to enable hardware and services, but through the derivative benefits to technology
innovation, not just users in any endeavor. There are over one billion lines of freely available
in software
open-source code that developers and business users can access to create
applications and new businesses. Free open-source software reduces costs for
startups as well as new projects within IT organizations. Even with paid
technical expertise and support, the ROI tends to be overwhelmingly
favorable for open source. Developers looking to for code can choose among
millions of free projects uploaded to GitHub, download what they need and
use it within minutes.

Open-source alternatives to proprietary technologies gain ground

The leading cloud The shift to cloud computing accelerates as open source is increasingly viable
platforms, including for the enterprise. There are increasingly viable open-source alternatives to
Google and Amazon EC2,
proprietary software, all the way up the stack from OS (Linux, Android) to
are built on open source
database (MySQL, MongoDB, Cassandra), Big Data/data-warehousing
management (Hadoop, Talend), content management (Drupal), application
server/ middleware, (JBoss, MuleSoft), analytic tools (R language, Pentaho,
Jaspersoft), customer relationship management (CRM) (SugarCRM) and many
more. It is not unusual for startups, particularly in the internet or e-
commerce arena, to avoid use of proprietary software entirely. Large
technology vendors including IBM and even Microsoft have embraced open
source as a development model, and Microsoft has open-sourced a number of
key offerings including the .NET application framework and Xamarin mobile
application development tools.
The mobile internet: Any device, always on, anywhere

Adoption of smartphones The explosive adoption of internet-enabled smartphones and the growing
and the wireless internet availability of wireless internet provide key innovation vectors for new
helps realize the vision of
services and applications, including micropayments, content streaming,
pervasive computing
multiplayer gaming, location-based services and a plethora of targeted
applications. In the coming decade, the deployment of high-speed 5G and
beyond mobile networks will help advance the vision of always-on high-speed
internet connections and adoption of context-aware, data-based applications.
Figure 31
Smartphone penetration Global IPv6-capable devices will reach 7.7bn by 2020

will connect billions to the
9 Number of devices (bn)
internet for the first time
8 7.65
7 6.47
6 5.38
5 4.44
4 3.53
3 2.67
0
2015 2016 2017 2018 2019 2020
Note: Internet Protocol version 6 (IPv6). Source: Cisco 2016
More advanced mobile The explosion of internet-enabled smart devices has created a need for each
networks will support a device to have its own unique address that can communicate with other
new range of innovative
devices and the internet. IPv4 addresses are the current protocol that devices
applications
use to communicate on the internet. However, these addresses have been
exhausted. Transitioning to the better IPv6 protocol will offer significant
advantages giving every device a globally routable public IP address on the
internet. Cisco estimates that by 2020, 92% of smartphones and tablets will be
IPv6 capable.
Advanced mobile networks will support a new generation of innovative

applications, including virtual reality content streaming, shopping, 4K (ultra-
high definition) television, collaboration, social networking, video
conferencing, robust gaming, additional personalized offerings and Internet-

of-Things applications. This in turn expands the innovation of connected

devices beyond tablets, smartphones and laptops. Increasingly, there will be
wireless-connected audio, video, sensors, industrial equipment, automobiles
and appliances. The availability of greater bandwidth will facilitate adoption of
advanced applications, which should drive further growth of data traffic.
Innovations and New types of mobile applications expected to see healthy growth include
connectivity enable a money transfer by chat-based bots, short message service (SMS), mobile
new class of mobile
search and browsing, location-based services, mobile music and video
applications to emerge
services, near-field communications services, mobile health monitoring and
many others.
Mobile explosion a hotbed for innovation

The 7.1bn mobile According to the International Telecommunications Union, there are
telephone subscribers, approximately 7.1bn mobile telephone subscribers, representing 96.8% of the
represent 96.8% of the
worlds population - up from just 738mn in 2000. The penetration rate for
worlds population
fixed-line telephone service in 2015 was just under 11% of the worlds
population.
Mobile adoption is still growing but at a slower pace than in the early 2000;
developed markets are growing more slowly as they begin to approach
saturation levels. In 2020, GSMA estimates average annual subscriber growth
rate will be 3.9% compared to 7.7% over the last five years with a
penetration rate of 88% of the population. In developing countries, the
current 59% penetration rate suggests room for growth. In 2015, 2.5bn users
throughout the developing world were able to get internet access with a
mobile device. GSMA estimates that 90% of the incremental 1 billion new
mobile subscribers forecasted by 2020 will come from developing markets.
The mobile ecosystem In 2015, the mobile ecosystem accounted for 4.2% of global GDP,
accounted for 4.2% representing US$3.1tn of economic value added. As the mobile sectors global
of global GDP
footprint continues to grow, it provided employment for approximately 17
million people across the world and contributed to US$430bn in taxation.
A major advance for mobile in developing countries is the role in payments

and banking. Mobile money services are currently available to 1.9bn people
globally, bringing financial inclusion to those in developed countries that were
once unable to access banking services. Currently there are 270 live services
in 90 countries and over 100 planned new service launches.
Figure 32 Figure 33
Global smartphone connections Global average mobile network connection speeds

6,000 (m) 7 (mbps)
5,000 6
5
4,000
4
3,000
3
2,000
2
1,000
1
0 0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
Source: GSMA Intelligence Source: Cisco VNI Mobile 2016

More devices, faster By 2020, GSMA predicts there will be 5.8bn smartphones. Data traffic is
connections: more bits expected to achieve a Cagr of 49% from 2015 to 2020. Mobile 3G and 4G
broadband connections accounted for almost 50% of the total connections in
2015. The GSM Association estimates that this could increase to more than 70%
by 2020. Globally, the average fixed broadband connected speed is estimated to
grow 2.2-fold from 20.3Mbps in 2014 to 42.5Mbps by 2019. In the first half of
2015, 47.4% of American homes were considered wireless only compared to
44% one year ago according to the National Center for Health Statistics.
Figure 34
US mobility statistics
Dec 98 Dec 02 Dec 03 Dec 08 Dec 12 Dec 13 Dec 14
Wireless subscribers (m) 69.2 140.8 158.7 270.3 326.5 335.6 355.4
Wireless penetration % of total US population 24.6 48.0 53.6 87.2 102.2 104.3 110.0
Wireless-only households % of US households na na 4.2 20.2 38.2 39.4 47.0
Annualized total wireless revenue (US$bn) 33.1 76.5 87.6 148.1 185.0 189.2 187.8
Annual voice minutes of use (bn) 89.0 619.8 829.9 2,200.0 2,300.0 2,618.0 2,455.0
Annual wireless data usage (MB) na na na na 1,468.0 3,230.0 4,060.0
Source: CTIA
Global mobile data Ciscos Visual Networking Index (VNI) estimates that global mobile data
traffic will increase traffic will increase nearly eightfold between 2015 and 2020 to 30.6 exabytes
nearly eightfold per month (a 53% Cagr), with mobile video increasing 11-fold to 75% of the
between 2015
global mobile data traffic in 2020. Global mobile data traffic grew 74% in
and 2020
2015 and although 4G only represented 14% of total mobile connections, it
accounted for 47% of all mobile data traffic. VNI estimates that by 2020, 4G
will represent 40.5% of all connections and 72% of total traffic. In 2015, 4G
exceeded 3G traffic for the first time as 4G connections are targeted for
higher-end device users where higher speeds encourage the use of high-
bandwidth applications.
Smartphone apps are the nexus of innovation

Adoption of smartphones The broad adoption of smartphones paves the way for rapid innovation of new
paves the way for rapid internet-based applications and services. Apples AppStore has more than
innovation of new 1.5m applications with over 100bn downloads reported as of June 2015. The
applications and services
evolving ecosystem around smartphone platforms has given rise to many
successful new businesses - not just games, but thousands of applications for
productivity, news, lifestyle and other uses. Statista predicts annual mobile
application downloads to reach 269bn in 2017, with mobile applications
revenue of US$41.1bn
Figure 35
Statista forecasts an Free versus paid mobile app downloads worldwide

increasing ratio of free
300 App (bn)
application downloads for Free downloads Paid-for downloads
every paid app download
250
200
150
100
50
0
2011 2012 2013 2014 2015 2016 2017
Source: Statista

Internet adoption expands potential end markets for innovators

Cisco estimates nearly According to Ciscos estimates, the total number of internet users worldwide
4bn internet users was 2.8bn and expected to grow to 3.9bn globally by 2019, representing
worldwide by 2019
more than half of the worlds population. Cisco estimates that in 2014, only
40% of total IP traffic originated with non-PC devices, but by 2019 the non-
PC share of total IP traffic will grow to 67%.
Figure 36
Number of internet users Global internet users by country, 2013

worldwide exceeded
3.1bn in 2015, c.43% of
worldwide population
Source: Wikimedia Commons Author Jeff Ogden, (W163)
Over 43% of the global The International Telecommonications Union estimates that over 43% of the
population was connected global population was connected to the internet in 2015, with the most
to the internet in 2015
dramatic growth occurring in Africa, the Arab States and the former (Russian)
Commonwealth of Independent States.
Figure 37
Worldwide internet usage

Region 2005 2015 2005-2015 Penetration of total
Cagr (%) population, 2015 (%)
Africa 17 193 27.7 19.0
Arab States 26 141 18.3 40.6
Asia & Pacific 344 1,506 15.9 32.4
Commonwealth of 29 170 19.5 55.9
Independent States
Europe 277 487 5.8 74.8
The Americas 316 651 7.5 65.5
World total 1,009 3,147 12.0 43.2
Source: ITU World Telecommunication/ICT Indicators database
Never a straight line - The headwinds to innovation

Americas remains ahead The US has been struggling to sustain its competitive edge, which has slipped
in innovative capability over the past decade but is showing some signs of improvement. The Global
Innovation Index, sponsored by the World Intellectual Property Organization,
INSEAD and Cornells Johnson School, has the United States up one spot from
sixth in 2014 to fifth overall in 2015. Switzerland, the UK, Sweden, the
Netherlands were ranked higher.

The US ranks No.1 in Among high-income economies, the US ranks No.1 in innovation quality,
innovation quality benefiting from its second place slot in top university rankings. The World
Economic Forums Global Competitiveness Report for 2015 has the United
States ranked third, retaining its spot from last year. The US had been No.1 in
2008 and 2009, slipping to No.2 in 2010 and gradually declining since then.
The WEF sees a number of potential risks to US competitiveness such as the
slowdown of accommodating monetary policy, stagnant growth, and a weak
education system at the primary level but believes that the US can recover if
it can improve government efficiency, steady the macroeconomic environment
(including addressing high health and social security costs), and keep its
financial markets sound.
However, US spends more on education while performance lags

In the most recent findings published by the OECD, the 2012 Program for
International Student Assessment (PISA) measured students scores around
the globe. Among the 34 OECD countries, the United States performed below
average in mathematics in 2012 and is ranked 27th. The US ranks 17 in
reading and 20 in science. Mathematics scores for the top performer,
Shanghai-China, indicate performance equivalent of over two years more
formal schooling than students observed in the strong-performing state of
Massachusetts. The US spends more than most countries on education but
unfortunately this has not rendered better performance. In the report, the
OECD claims that the Slovak Republic spends US$53,000 per student as
opposed to the US which spends US$115,000 while both sets of students test
at the same level.
Concerns over the higher-education bubble

One of the greatest One of the greatest challenges for students - and the economy as a whole - is
challenges is the the untenable state of student debt, which now exceeds US$1.3tn in the
untenable state of
aggregate in the US. The average class of 2016 graduate has US$37,172 in
student debt
student loan debt, up 6% from last year. Debt service limits borrowing
capacity for buying a car, home and starting a family, and ultimately could
cause real-estate-asset deflation for retiring baby boomers who fail to find
buyers for trade-up homes. In our view, higher education is the next bubble
to deflate. There are signs of price declines at lower-tier colleges and
declining grad-school enrollment in certain fields, particularly at law schools.
An educated workforce is critical for innovation

The USA ranks No.5 in A highly educated workforce with significant participation in science and
advanced degrees technology is key to drive innovative effectiveness. The USA is one of the
worlds most educated countries, ranking fifth among OECD countries in
terms of tertiary level educational attainment for those aged 25-64, with 44%
holding a degree from an institution of higher learning compared to the OECD
average of 33%. According to Pearson, the US has a cognitive skills and
educational attainment rank of 14th out of 40 countries.
The USA severely lags in However, graduates are not choosing the right majors. The USA severely lags in
STEM achievement science, technology, engineering and math (STEM) achievement, which is
critical for an R&D-intensive workforce. According to the Department of
Education only 16% of American high school seniors are proficient in math and
interested in a STEM career. The US is falling behind internationally, ranking
29th in math and 22nd in science among industrialized nations. The USA ranks
23rd among developed nations in terms of annual STEM graduates per person
aged 20-34. It ranks 32nd in the percentage of its graduates majoring in STEM
fields - just 13% of graduates majored in science, computer science, or
engineering (compared to 27% in South Korea and Germany)

Immigration policy challenges entrepreneurs

Since 9/11, the USA Immigration and innovation are inextricably linked, as many of the most
places onerous creative entrepreneurs, scientists and investors have been attracted to the US
restrictions on entry
environment and culture. Today, the USA places onerous restrictions on entry
into the country
into the country, no matter what the reason. Annual caps and large fees on
visas for highly skilled potential employees (H-1B) limit the number of jobs
available to foreign graduates of Americas university system. Immigration
policy is at the center of the 2016 Presidential race, with presumptive
Republican nominee Donald Trump advocating more aggressive border
controls and deportations to combat illegal immigration. Meanwhile, legal
immigration processes remain inefficient and frustrating for prospective
immigrants and employers alike.
International students According to the Institute of International Education, a record high of 974,976
earn 36% of science and international students were enrolled in US higher education institutions in
engineering doctoral
2014/2015 representing 4.8% of total enrollment. This represented an
degrees in the USA
increase of 12.8% YoY, acceleration from the 8.1% increase the year before.
According to the National Science Foundation, foreign students at US
universities earned 36% of science and engineering doctoral degrees in 2012.
Immigrant inventors Immigrants play a vital role in driving American innovativeness and growth.
contribute to more than a Immigrant inventors contribute to more than a quarter of US global patent
quarter of US global
applications. A study by the National Foundation for American Policy found
patent applications
that immigrants started more than half (44 of 87) of Americas startup
companies valued at US$1bn, and are key members of management or
product development teams at over 70% of these companies. Among billion
dollar startups, immigrant founders created an average of 760 jobs per
company in the US. As many companies are dissuaded by the process of
sponsoring a highly skilled foreign employee (which can be timely, costly and
aggravating), many engineers, scientists and entrepreneurs are choosing to
pack up and return home - often India or China - to work for competitors to
US firms or to start businesses that create jobs abroad.
Patently difficult to fight the trolls

The USA continues to Patent activity remains a key measure of innovative activity. According to
file the greatest share research by Gridlogics, the number of patent applications filed in 2013-2014
of global patents
globally totaled 4.4 million, a 6.2% rise over the previous period 2011-2012.
The US remains the worlds largest patent filer, with over 57,000 patent
applications in 2015 representing 26.3% of global filings. This was a decline
of 6.7% from 2014, a year with an exceptionally high number of filings.
Non-practicing entities - There are ongoing concerns that Americas patent system squelches
Patent trolls file more competition, slows innovation and enables egregious predation through the
than half of US patent
legal system. The Wall Street Journal last year reported that the pace of
lawsuits
patent growth may be decelerating. In 2014, patents did grow 3.3% to 2.15m
but that is compared to 17.7% in 2013 and 20% in 2012. In fact, the growth
of patents is at its lowest point since the financial crisis. US patents are still
growing at an 8% Cagr since 2013. During the recession patents grew at an
abysmal 1% in the US. Japan, usually a leader in patent issuance saw its
patents decline over 4% in 2013 as companies in Japan found holding on to
patents were becoming too costly.
Patent trolls are also known as patent assertion entities (PAEs) and often
come in the form of non-practicing entities (NPEs), which are commonly shell
companies with no operations, just a portfolio of patents used as the basis for
litigation. Most PAEs do not use patents to create products or build

PAEs initiated 62% of all businesses; the great majority exist only as a means to drive revenue
patent litigation in 2012 through litigation. According to RPX Corporation, PAEs initiated 62% of all
patent litigation in 2012. In a modestly encouraging development, the
number of patent lawsuits filed in US courts hit a peak in 2013 at 6,030 and
declined to 5,002 in 2014.
The annual direct cost A May 2014 study by Catherine Tucker, professor of marketing at MIT Sloan
of NPE patent assertions School of Business, finds that VC investment would have likely been nearly
is estimated at
US$22bn higher but for litigation brought by frequent litigators (defined as
around US$29bn
companies that file 20 or more patent lawsuits). The study covered the period
from 1995 to 2012 and estimated with a 95% confidence interval that the
amount of investment was between US$8.1-41.8bn relative to a baseline of
roughly US$131bn of investment that actually occurred during that period. A
2012 study by James Bessen and Michael J Meurer of Boston University
estimated the annual cost of NPE patent assertions at around US$29bn for
defendants direct costs as a result of litigation as of 2011, up to US$80bn if
indirect costs are included.
Companies with less Tech companies were far and away the top targets of litigation initiated by
than US$10m in revenue NPEs, with HP, Apple, AT&T, Sony and Microsoft among the hardest hit. There
comprise 55% of unique
were 171 lawsuits brought against Apple alone between2009-2013. 84% of
defendants
all high tech-tech patent lawsuits filed every year are filed by patent trolls
according to K. Jakel at the IP Counsel Caf Conference in 2015. However, the
big firms are not the only ones hit. Companies with less than US$10m in
revenue comprise 55% of unique defendants to PAE suits. Of the sectors with
the most litigated patents, PatentFreedom (an online community of
companies that share information about NPEs) placed the semiconductor
industry first, followed by software applications, financial services,
communications equipment and system-infrastructure software.
Bipartisan legislation Efforts to reform the patent system were stalled in the 113th Congress (2013-
underway to limit the 2015) largely due to two decisions from the US Supreme Court that made it
damage of patent trolls
easier for district court judges to award attorneys fees in appropriate
circumstances. In 2016, there are four serious proposals for patent reform in
various stages of consideration in the 114th Congress - The Innovation Act;
The Targeting Rogue and Opaque Letters (TROL) Act; the Support Technology
and Research for Our Nations Growth (STRONG) Patents Act; and the
Protecting American Talent and Entrepreneurship (PATENT) Act. This include
efforts to force patent trolls to pay defendants legal fees if they lose a
frivolous lawsuit, limit scope of discovery so targets are not overwhelmed
with costly requests; and require infringement charges to be more specific.

Section 3: Bits flow into currents 2020 innovation
Bits flow into currents

Updating our technology We reiterate the importance of our technology meta-themes - transparent
meta-themes IT, intelligent systems and convergence - to highlight the importance of
platforms for innovation. Transparent IT describes how technology becomes
increasingly ambient, interactions more natural and tools more intuitive and
powerful. The combination of ubiquitous connectivity and big data analytics
linking the physical world with information technologies enables powerful,
interactive intelligent systems. Integration and coupling erase categorical
distinctions between hardware, software, services and content in a process
we refer to as convergence. Software remains at the top of the tech value
chain as the driving force in innovation, gaining strategic importance for non-
technology companies as well.
Simplicity wins Transparent IT. Complexity gives way to simplicity. Powerful capabilities
become accessible and pervasive, while advanced technologies become
subsumed into systems and the environment.
Things get smarter Intelligent systems. Software and technology systems increasingly drive
intelligent automation, decision enhancement, process optimization and
risk management in self-directed, recursive systems. Advancements in
analytics and artificial intelligence create leverage from the exponential
growth of data from users, devices, sensors, applications and systems.
Solutions are neatly Convergence. Software, hardware, services, content and business
wrapped and delivered processes straddle previously discrete definitional and categorical barriers.
We expect vertical and horizontal integration, cross-disciplinary
development and M&A, and organic evolution.
Transparent IT - computing melds into the walls

Technology is dissolving Innovation over the next decade will be characterized by the trend towards
into the walls transparent IT, technology that appears so simple that the underlying
complexity becomes invisible to the user. The early Internet-of-Things vision
advanced the idea of ambient computing, which in many respects is
synonymous with transparent IT. We can see this trend play out in
automobiles, which are increasingly coming to resemble iPads on wheels.
Computing is increasingly embedded in the daily lives of consumers,

businesses and other organizations. It becomes more intuitive and pervasive
with adoption of natural user interfaces, more powerful software, proliferation
of devices, ubiquity of instant-on connectivity and declining costs of
hardware, bandwidth and storage. We expect the continuous elevation of
simplicity of experience to the user as logic controls the underlying systems,
processes and infrastructure with increasing power.
Complexity gets pushed We identify four vectors that drive accelerating innovation towards
down, logic moves transparent IT: cloud computing, mobile internet connectivity, natural user
to higher levels
interfaces and more powerful development tools.
User interfaces - See me, feel me, touch me - think me? Natural
interfaces expand the experience of computing beyond the traditional
keyboard/mouse, touch and speech recognition currently available. Touch
and haptic interfaces enable new types of applications: gaming,
empowering the disabled, medical procedures, industrial processes,
training, simulation and therapy. Haptic interfaces have applications in
virtual and augmented reality (by enabling real touch to operate in
artificial environments) and through tele-operation (using real touch to
operate in real environments via computer). Motion detection has gone

mainstream in gaming, with adoption in retail, healthcare and other

scenarios. Brain computer interfaces (BCIs) are also making strides,
notably to assist the physically disabled. When coupled with self-learning
capabilities and advances in natural language understanding, users will
increasingly see computing as a natural extension of personal intent. A
new generation of augmented reality (AR), virtual reality (VR) and
holographic computing technologies will lead to more immersive
experiences. We cover this topic in more depth in Section 4 of this report.
Moving towards a more Cloud computing - A paradigm shift in computing. Cloud computing
open model built for represents the transition of information technology to a utility model - the
massive scale
industrialization of computing. The emerging cloud software architecture
causes a shift away from the enterprise IT economic model built around
tightly coupled systems, proprietary software & hardware and extensive IT
implementation, development, monitoring and support services towards a
more open model built for massive scale. It emphasizes commodity
hardware, open-source software and more automated processes.
Adoption of smartphones The mobile internet - Any device, always on, anywhere. The rapid
and the wireless internet adoption of smartphones and the growing availability of wireless internet
help realize the vision of
are key vectors for realizing the vision of pervasive computing and a
pervasive computing
wealth of related applications, including micropayments, content
streaming, multiplayer gaming, location-based services, enterprise
applications and Internet-of-Things use cases. High-speed 4G mobile
networks encourage adoption of data-based applications. We expect the
move to 5G wireless to make significant progress towards always-on high-
speed internet connection. Additionally the trajectory of cost declines in
bandwidth follows a corollary of Moores Law known as Butters Law, with
potentially even more profound ramifications for adoption.
Standards such as HTML 5 Development tools & standards - Simpler, more powerful. Higher-
promise to enable a new level software programming languages bring development closer to the
class of rich, interactive
business process and put increasing power in the hands of business users.
and mobile applications
There are over 31 million open-source software projects available on
GitHub, freely available that developers and business users apply to create
applications and new businesses. Standards such as HTML 5 enable a new
class of rich, interactive mobile applications. Broad adoption of
representational state transfer (REST) APIs enables web services to be
combined into Web 2.0-style mashups, giving rise to new business models
in The API economy.
Intelligent systems lead to the cognitive era

Real-time intelligence is Analytics and self-learning are increasingly embedded into systems. Their
increasingly embedded power accrues from the growing predictive strength of software, standards-
into systems
enabled integration, always-on connectivity and the proliferation of sensors
and remote-controlled devices. The concepts behind intelligent systems have
been around for decades, but constraints around limitations of connectivity,
throughput and computational power are falling away. The emergence of big-
data technologies like Hadoop enables a vastly expanded scope of
unstructured data analytics.
More data are available The surge of data generated by applications offers unprecedented visibility
and analytic technologies into operations and businesses. Smaller and more powerful sensors generate
have matured
huge amounts of data, which can be used to improve energy efficiency and
optimize broad functional aspects of the supply chain. Data warehousing,
business intelligence and predictive analytics have matured and are easier
and faster than ever to deploy. Systems will leverage the power of predictive

analytics and advanced techniques to optimize business processes, improve

collaboration, target information flow and reduce risk. New types of devices
that generate data for analysis and receive instructions remotely give rise to
new solutions. The adoption of IPv6 will allow for billions more devices to be
connected to the internet, each with a unique IP address. The Internet of
Things will enable far more pervasive analytics.
Half of all application Breakthroughs in artificial intelligence/machine learning will make it cheaper
developers will and easier for predictive capabilities to be embedded in ever smaller devices
incorporate some form
and systems. IDC predicts that within two years, 50% of application
of AI/machine learning
developers will incorporate some form of AI/machine learning capabilities into
new application.
Prediction and optimization embedded in the walls

The value of predictive Predictive analytics grow in value and effectiveness with increases in
analytics continues to computational power. If traditional analytic apps and business intelligence
grow with increases in
sought to understand the past, predictive analytics looks to the future, to
computational power
calibrate marketing and operational efficiencies and reduce risk of all types.
Predictive analytics (which are the output of artificial intelligence/machine
learning processes) are relevant in many situations including:
Online search and advertising, to improve query results and better target
ads and recommendations. Much of the leading intellectual horsepower in
the analytics community has been focused on web-based analytics.
Google, Facebook, Amazon, Microsoft, Baidu, LinkedIn and other firms are
leaders in this regard.
All types of marketing, to improve effectiveness and revenue lift from
campaigns. IBM, Oracle, Salesforce.com and many other firms are focused
on analytic marketing.
Manufacturing and operations, to anticipate potential safety, maintenance
and quality-assurance issues. GE, Rockwell, Siemens and other industrial
conglomerates leverage new sensor technologies as data inputs to drive
improvements.
Financial-risk management, to help mitigate portfolio or credit risk (a
prominent example is credit scores). IBM, Verisk, FICO and many other
firms address a multitude of different aspects of risk management.
We highlight several manifestations of intelligent systems:

Marketing optimization. The use of analytics is a longstanding part of
marketing and campaign management, where vendors, such as SAS and
IBM, have provided the analytic horsepower to fuel effective campaigns.
Vendors such as Salesforce, Oracle and IBM continue to drive incremental
value through the use of scoring and predictive analysis.
Risk management Risk management, churn analysis and fraud prevention. For
continues to gain financial-services firms, solving the risk-management problem requires
importance in
pulling together multiple sources of data and applying risk analytics to
financial markets
detect potentially consequential changes. Vendors such as RiskMetrics,
Verisk, NICE, IBM, SAS and many others are focused on evolving
challenges associated with detecting electronic fraud.
Smart-grid technologies Smart grid, smart buildings, smart datacenters. The smart grid
employ predictive employs two-way technologies to control appliances and heating,
techniques to
ventilation and air conditioning (HVAC) systems at a home or building,
conserve energy
allowing customers and utilities to keep costs under control. Smart home

thermostats from companies like Nest learn the behavior of occupants and
use this information to optimize energy usage and comfort. Companies
focused on this problem include Google, Honeywell, iTron, EnerNoc, Silver
Spring Networks and privately held GridPoint, among others.
Convergence - Products become solutions

Software offerings Users and consumers of IT are concerned foremost with the experience and
increasingly combine utility, not technology for its own sake. Increasingly, vendors combine
hardware, software,
hardware, software, services, connectivity and content into packaged
connectivity and content
solutions. Advantages include accelerated time to deployment, reduced
integration and implementation service costs and increased efficacy of the
overall solution. This also blurs the lines of product categories.
Apps are top of the tech food chain

As we first discussed in our February 2010 Compubiquity report, its our
consistent view that applications are where ultimate value in IT resides.
Automating business processes, facilitating communications and
collaboration, entertaining and informing users and enabling business models
- the value to the users is defined by their utility. Its a broad generalization,
but the higher the vendor operates up the stack, the better cushioned from
forces of commoditization. Applications can be deployed both as SaaS and on-
premise offerings, and broadly include enterprise and consumer applications
as well as the proprietary code powering e-commerce and internet sites.
Latency and data gravity considerations inform the choice to deploy on
premise or in the cloud.
Applications are no longer just software

Business models will Along these lines, the distinction between discrete software, hardware,
evolve as value creation services and content blends into solutions. Vendors are at once more
accrues in different points
diversified and vertically integrated. Business models blur categories as value
in the delivery chain
creation accrues in different points in the delivery chain. Apple, Microsoft,
Amazon and Google all offer a combination of hardware, software, services
and content. We expect increasing convergence over the next decade across
technology and media sectors as software, hardware and content providers
seek to improve customer stickiness, drive incremental revenue and erect
higher competitive barriers.
Figure 38
Value migrates from Value moves up in stacks

infrastructure to platform
to application
Application
Value
Platform
Infrastructure
Source: Jonathan Murray

The SMAC stack + things = new innovations

Next-generation There is increasing focus on the characteristics of the next generation of
applications embrace applications. In fact, a new acronym has emerged to describe the new
social, mobile, analytics
and cloud generation of apps: SMAC, which refers to social, mobile, analytics and cloud.
Social - Socially enabled applications need global scale, ability to perform
multiple real-time operations, relatively low latency and a distributed
architecture.
Mobile - With mobile applications, more of the application logic resides in
centralized datacenters, delivered as a service to mobile endpoint devices.
Theres increasing importance of location-based services. Mobile smartphones
turn people into sensors, extending the edge of the network to individuals.
Analytics - With the immense proliferation of data, the opportunities to
deliver context-aware, real-time analytics demand scalable data-
management systems with intelligent filtering capabilities. There are many
different types of analytics - in-flight including operational analytics
(trends, statistical variations and calculated metrics), operational insights,
predictive analytics and anomaly detection.
More organizations Cloud - Public and private cloud services increasingly draw from mega
elevate the importance of datacenters that provide massive scalability. The flexible architecture
the software development
function accelerates the forces that commoditize underlying infrastructure
components. A key consequence of adoption of the new cloud computing
architectures is that we will see more organizations elevate the importance
of the software development function. We are seeing large investments
pour into the development platforms for next-generation architecture. GE,
for example, has invested US$100m in the EMC/VMware Pivotal spinout.
When SMAC technologies Adding the T to SMAC - When social, mobile, analytics and cloud
connect to physical technologies connect to physical things, devices become smarter. This is
things, devices become
smarter where the magic happens. Combining location-based services with social
technologies along with mobility and analytics creates new opportunities for
products. We believe theres enormous potential for smart, context-aware
objects and devices enabled by apps built on the SMAC stack.
Figure 39
The SMAC stack The SMAC stack will enable new applications that connect to things
represents a new wave
of application architecture
Source: Cognizant Technologies

Convergence will reshape landscapes of industry and technology

We expect convergence to play out along several vectors over the next
decade:
For those that consume Everything as a Service. Acceptance of Software as a Service (SaaS)
these services, the paves the way for services to reach lower down the stack. Platform as a
experience is what counts
Service (PaaS) and Infrastructure as a Service (IaaS) hide the underlying
complexity of computing and storage infrastructure and allow users,
service providers and application developers to access resources in a
holistic fashion. This is a profound shift (and challenge) for incumbent
technology providers, financially, organizationally and culturally.
Expect the continual Commoditization of IT infrastructure. A corollary to the trend towards

commoditization of Everything as a Service and transparent IT is the continual
compute, memory,
bandwidth and storage commoditization of compute, memory, bandwidth and storage. The next
generation of cloud architecture is heavily based on open-source software
- and with the rise of open-source hardware and software defined
networking, this trend extends into networking and datacenters.
Content integrates into the IT ecosystem. This is a longer-term trend,

as proprietary content and information services become increasingly
integrated into solutions. Proprietary content includes not just industry
data, but also data collected from social applications, IT systems and
internet traffic. Its possible proprietary or exclusive content could be used
as leverage for the platform players, though content providers are likely
to prefer to retain a certain amount of leverage.
Physical facilities and Physical and logical control systems converge. Rising interest in the
logical systems controls industrial Internet of Things shifts focus on the need for integration
are converging
between physical and IT systems. A notable area has been energy
management in the datacenter around IT power management. Internet-of-
Things uses are extending this to public infrastructure, automotive and
industrial uses.
Figure 40
Software, hardware, Converging IT ecosystem

connectivity and content
will converge into
holistic solutions Solutions
Software Content
Hardware
Connectivity
Source: CLSA

The directions of convergence

We summarize the broad directional convergence trends as follows:
Software vendors move into hardware and content.
Hardware vendors move into software and services.
Services vendors move into software and content.
Content vendors move into hardware and software.
Software vendors move into hardware and content

We expect application Technology vendors increasingly deliver hardware and software bundled with
appliances to become services, both at the consumer and enterprise. Apple is a prime example of
more common along with
vertically integrated solutions for the consumer. Google offers Nexus phones
hybrid cloud offerings
and tablets, Microsoft offers Lumia phones, Xbox, the Surface tablet and
laptop hybrids and Amazon offers the Kindle reader, Echo, Fire phone and TV.
Enterprise-software vendors (particularly in infrastructure, security and
networking) deliver integrated appliances. Oracles Exa-systems, IBMs Pure
Systems and Check Points security appliances reflect increasingly
sophisticated hardware/software systems. There are divergent trends,
however. Microsoft has written down much of the Nokia phone business,
Googles divested Motorola Mobility and IBM divested its x86 server business,
both to Lenovo.
Expect vendors to blend Software vendors also seek to diversify their revenue streams from products
software, hardware, to product and service models. Microsoft is making the transition with Xbox
content and services
Live, Office365 and Azure. Oracle is increasingly offering its portfolio with on-
premise and cloud options that incorporate its engineered systems. Many if
not most of the enterprise software perpetual license vendors are moving
towards additional subscription-based businesses and/or hardware via
acquisitions and partnerships to reinforce the value of an integrated portfolio
and reduce reliance on a single-business model.
Hardware vendors move into higher-margin software and services

For hardware vendors, the appeal of softwares margins and recurring
revenue streams is compelling. We expect continuing development and M&A.
This trend has been so consistent we would expect hardware vendors to
continue to drive consolidation in the software sector. The past decade has
seen a growing number of software companies acquired by firms for which
hardware had been a predominant focus.
IBM: SoftLayer, Cleversafe, Kenexa, Weather Channel Data, SPSS
HP: Eucalyptus, Vertica, Voltage, ArcSight, EDS (services)
Cisco: Jasper, Sourcefire, Composite Software, JouleX, WebEx
Dell: Quest Software, Boomi, Perot Systems (services), EMC
EMC (pre-Dell): Virtustream, Pivotal Labs, Greenplum, RSA (software)
Intel: Mashery (SaaS), McAfee, Wind River (software)
Services vendors move into higher value software and content

Pressures from cloud IT services vendors such as Accenture, CSC, Cognizant, Infosys and others
computing and SaaS force specialize in customized solutions that incorporate proprietary IP, packaged
IT service providers
software and hardware. With adoption of cloud computing and SaaS, the
towards higher value
diminished need for technology-implementation services pressures many
traditional types of engagements. As a result, we are seeing value-add
resellers (VARs) and consulting firms move into managed services. Over

time, the large business process outsourcing (BPO) and IT outsourcing

vendors need to provide increasingly differentiated, higher-value solutions.
Infosyss 2015 acquisition of SaaS ERP vendor Panaya will be followed by
more in our view. We expect more IT services vendors to move into SaaS
and other offerings.
Content vendors move into hardware and software

Watch more content Content companies are increasingly looking for new ways to monetize their
companies build business assets, in particular publishers and entertainment companies whose models
models from web APIs
have been undermined by digitization of books, periodicals and music. The
two most common approaches currently include writing custom apps for
smartphones (all of the major media companies have done this) or
alternatively opening up access to content through web-service application
programming interfaces (APIs). Content retailers, including Amazon and
Barnes & Noble, use devices (Kindle and Nook) to promote proprietary
ecosystems enhanced with digital delivery services. Apples iPad has
boosted magazines and other periodicals in digital form. Even the DVD kiosk
rental service RedBox has moved into online video streaming offerings that
compete with Netflix.
From publishers to Publishers of textbooks and scholarly journals are under significant
information brokers pressures from digitization and easy availability of used books. Providers of
proprietary data, such as Bloomberg, Acxiom, Dun & Bradstreet, Experian
and others, already sell raw data, provide benchmarking services and offer
analysis for structured data. Increasingly, these providers of proprietary
content are using APIs to turn their content into services that can be
delivered over the internet.
Value grows as businesses evolve from products to platforms

Connecting products to Weve discussed in the past how the convergence of enabling forces gives rise
services provides to a new type of economy, and convergence is occurring because vendors
promising opportunities
seek to become platforms rather than components. Marshall van Alstyne of
for existing businesses
the MIT Center for Digital Business has produced a body of insightful work
focused on how and why platforms are so valuable. Its our view that the
trend towards connecting things or products to services provides promising
opportunities for existing businesses to evolve.
Platform strategies drive convergence of technologies

Platforms have been enormously important in the IT industry since the
introduction of IBM's System360 mainframes in 1964. The ecosystem of
complementary hardware, software and services made System360 the
leading enterprise computing platform until the 1980s. The Microsoft and
Intel duopoly around the PC attracted an enormous ecosystem of hardware
and software developers. With the growth of the internet and world wide
web in the 1990s, internet-based platforms could connect larger numbers
of PC users.
Platforms can harness The advantage of platforms is that they can harness innovation from
innovation from ecosystems of partners, creating aggregate value far greater than could be
ecosystems of partners
developed by a single company itself. Apples success against Nokia, Sony
and Microsoft in phones and music players can be attributed to the breadth of
reach. Instead of a linear value chain where users purchase a product in a
razors and razor blades model through a single provider, Apples support of
music, video, books and applications created a virtuous cycle where the more
devices it sold, the more developers were attracted to write apps for the
platform, attracting more consumer demand.

Figure 41
The Internet of Things Platform strategies create additional value by leveraging third parties
creates opportunity for
more businesses to
pursue platform strategy
Source: Marshall van Alstyne, MIT Center for Digital Business
A platform is a system A platform can be defined as a system that must provide a useful function or
that must provide a useful service and allow third-party access, according to van Alstyne, Geoffrey
function or service and
Parker and Sangeet Paul Choudary in their book Platform Strategy. MIT
allow third-party access
Professor Michael Cusimano defines a platform this way: A platform or
complement strategy differs from a product strategy in that it requires an
external ecosystem to generate complementary product or service.
Innovations build positive feedback between the complements and that
platform. The effect is much greater potential for innovation and growth than
a single product-oriented firm can generate alone. Venture capitalist Marc
Andreessen says, A platform is a system that can be . . . adapted to
countless needs and niches that the platforms original developers could not
possibly have contemplated . . .
The dynamics of The dynamics of platforms are similar to those of network effects: the more
platforms are similar to products or services offered the more users it'll attract - the greater the scale,
those of network effects
the more users. This attracts more complementary offerings and in turn,
more users - creating a virtuous cycle of value creation.
With billions of mobile internet users and the advent of cloud computing,
platforms have gained even greater scope and value creation. Platform
companies are major drivers in innovation with the top companies like
Google, Amazon, Facebook and Apple blazing trails for digital transformation.
A recent report, The Rise of the Platform Enterprise: A Global Survey by Peter
Evans and Anabelle Carr from the Center for Global Enterprise analyzed 176
platform companies with valuations over US$1bn. Their work identified four
major types of platforms:
Innovation platforms help 1) Innovation platforms provide a foundation for developers to create
developers create complementary products and services. They can attract a large community
complementary products
of external innovators to create an innovation ecosystem. Examples
and services
include IBM System360, Wintel and more recently Apple's IOS and Google
Android which have established large innovation ecosystems of developers.

2) Transaction platforms connect individuals and institutions. The first

generation of e-commerce platforms in the 1990s with companies like
Amazon, eBay, Ticketmaster and others have given way to a new
generation of on-demand platforms like Uber, Lyft, Airbnb and others.
3) Integration platforms combine characteristics of both transaction and
innovation platforms. Both Apple and Google have innovation platforms for
developers which can then be made available in their transaction
platforms, the App Store and Google Play.
4) Investment platforms are for investors managing a portfolio of platform
companies like the Priceline group, which includes Priceline, kayak and
OpenTable.
Three of the top five Brand consultancy Interbrand highlights the top global brands in an annual
brands (Apple, Google survey. In 2013, three of the top five brands (Apple, Google and Microsoft)
and Microsoft) are
were platforms. According to van Alstynes analysis, platform companies
platforms
share of market cap out of the top 20 firms has increased from 10% in 2001
to over 25% in 2013.
Figure 42
The top platform brands Twelve of Interbrands top 30 brands are platforms
all have active strategies
for the Internet of Things
Source: Geoffrey Parker, Marshall van Alstyne and Sanjeet Paul Choudary

Section 4: 10 themes from digital to physical 2020 innovation
10 themes from digital to physical

A key thread across each We profile 10 innovation themes with potential to create new value, disruption
category is the essential and investment opportunities. A key thread across each category is the
role of software
essential role that software and notably analytics plays in enabling innovation.
and analytics
These are longer-term themes that could profoundly reshape markets, the
economy and society at large. As is typical of long-term technology evolution,
activities in the early stages of markets represent little revenue, but with
exponential progress, inflection points are likely to surprise. We segment
these innovations into the digital sphere and the physical world.
The digital sphere

1. Artificial intelligence comes of age
Artificial intelligence Artificial intelligence (AI), machine learning and cognitive computing are
is seeing another different terms that all refer a similar range of technologies. AI powers
resurgence - this time as
everything from speech recognition to search software, airplane navigation
foundational technology
and auto-pilot systems, video image recognition systems and intelligent
assistants for smartphones. A new generation of self-learning computing
algorithms will be integrated into applications of all kinds and integration with
advanced robotics will power a new generation of autonomous and semi-
autonomous machines.
Figure 43
Artificial intelligence/ Artificial intelligence Advertisers, businesses, Jobs across a wide range Google (GOOG),
cognitive computing governs everything from consumers, government, of capacities from blue- Microsoft (MSFT), IBM
speech recognition to society at large collar drivers, security (IBM), Baidu (BIDU),
search, airplane guards and others to Facebook (FB), Amazon
navigation and auto-pilot knowledge workers like (AMZN), LinkedIn
systems, motion- translators, paralegals, (LNKD),Salesforce
detection systems and medical professionals, (CRM), many startups
intelligent assistants for investment analysts
smartphones
Source: CLSA
2015 saw growing 2015 saw growing interest and investment in machine learning/artificial-
interest and investment intelligence technologies, even as luminaries such as Elon Musk and Stephen
in artificial-intelligence
Hawking sounded alarms about the potential risks from uncontrolled AI. The
technologies
combination of increased computing power, massive influx of data and a new
generation of research drives innovations and new applications of the
technology. In the most significant test of machine intelligence since IBMs
Deep Blue defeated Garry Kasparov in chess in 1997, Googles AlphaGo won
two of the first three games against grandmaster Lee Sedol in a Go
tournament in March 2016.
Artificial intelligence The terms artificial intelligence or cognitive software describe a set of
technologies can be technologies that automate the processes of prediction. Artificial intelligence
known by several
technologies can be known by several monikers, including cognitive agents,
monikers
cognitive computing, cognitive reasoning, deep learning, intelligent fabric,
machine intelligence, neural automation, neuralytics and other terms. IBM
has popularized the term cognitive computing, which has been adopted by
industry analyst firm IDC as well.
Cognitive/AI software Cognitive/AI software can support decision making more rapidly, with higher
can support decision confidence based on applying deeper analytics to more data. Characteristics
making more rapidly
of cognitive software include the ability to perform natural language

processing for input and information ingestion. These systems perform

learning in real-time as new data arrives into the system, applying past
experiences and data to generate and predict possible outcomes. Potential
outcomes can be scored for human analysis.
Deep learning has While AI brings to mind dystopian science-fiction movies like Terminator and
emerged as the HAL 9000 from 2001: A Space Odyssey, the current realities are more
hottest area of AI
mundane - for now. AIs value up until now has been less as horizontal
technology or tool set, but in its application to specific problems.
A new generation of self- AI software is omnipresent - it governs everything from speech recognition
learning computing to search, airplane navigation and auto-pilot systems, motion-detection
promises to instrument
systems and intelligent assistants for smartphones like Apples Siri, Google
the physical world
Now and Microsofts Cortana. A new generation of self-learning computing
promises to instrument the physical world and integration with advanced
robotics will power a new generation of autonomous and semi-autonomous
machines. AI technologies are a core competency for companies including:
Google, Baidu, Facebook and Microsoft, which have helped boost interest
and startup activity in the field.
Figure 44
Cognitive systems learn Advances in AI are fueled by declining cost of compute and storage
and interact with humans
using real language
Source: Tej3478 (Wikimedia Commons)
What is cognitive software (or AI)?

AI startups have received According to CB Insights, AI startups have received a total of US$867m in
a total of US$867m in funding since 2010. Funding for AI startups has increased sevenfold from
funding since 2010
US$45m for six deals in 2010 to US$310m for 54 deals in 2015. 2014 was the
high water-mark for deals and investments in AI, with US$394m invested
across 60 deals.

Over 200 AI startups have By several estimates, over 200 AI startups have received venture funding.
received venture funding Vicarious Systems has raised US$67m, after demonstrating that it can solve
Captchas, the visual puzzles that are used by websites to distinguish humans
from computers. Sentient Technologies has raised total funding of US$144m
with investors including Access Industries and Tata Communications. Sentient
develops technology to distribute artificial-intelligence software to millions of
graphics and computer processors around the world. Ayasdi raised US$98m
to further its platform for automated insight discovery. Kensho has raised
US$15m to train computers to replace expensive white-collar workers, such
as financial analysts. Context Relevant has raised US$44m for its advanced
hosted and on-premise analytics software.
The pace of investment remains active

Both large and small companies are active in the market. Acquisitions of AI
startups included Whetlab by Twitter, Vocal IQ by Apple, Wit.ai by Facebook
and Coldlight by PTC. In October 2015, Intel announced it had acquired
cognitive-computing platform provider Saffron Technology for an undisclosed
price. Saffrons cognitive systems technology uses statistics-based
continuous learning that generates recommendations that can be used to
anticipate market trends, optimize processes, mitigate risk and personalize
customer experiences. According to CB Insights, over 45 corporations and
corporate venture capital firms have invested in artificial intelligence startups
since 2010.
Growth forecasts for The market for predictive analytics is a subset of the broader data analytics
AI-related technologies market, but is likely to outpace growth for other categories of analytic
are in the 20-25%
software, which is generally expected to grow around 10% YoY in the
range through 2020
aggregate. Research firm MarketsandMarkets forecasts the predictive
analytics market to reach a Cagr of 27.4%, from US$2.7bn in 2015 to
US$9.2bn in 2020. Transparency Market Research forecasts predictive
analytics software (including customer intelligence, decision support systems,
data mining and management, performance management, security
intelligence, risk management and financial intelligence) to see a 17.8% Cagr,
from US$2bn in 2012 to US$6.6bn in 2019. IDC forecasts that the market for
cognitive software platforms will grow at a 35% Cagr to $3.7bn by 2019.
Figure 45
Cognitive Software Worldwide cognitive software platform forecast

platforms are forecast
5,000 (US$m) (%) 45
to grow at a 35% Cagr Revenue Growth (RHS)
through 2019 4,500 40
4,000 3,683 35
3,500
30
3,000 2,644
25
2,500
1,916 20
2,000
1,419 15
1,500
1,075
1,000 827 10
500 5
0 0
2014 2015 2016 2017 2018 2019
Source: IDC

A robust cognitive software market

The challenge for The challenge for companies, large and small, is capturing the talent from a
companies is capturing pool of experts estimated to be only a few dozen top experts worldwide.
the talent from a small
Google has been particularly aggressive in acquiring and hiring technologies
pool of experts
with deep-learning expertise. Theres growing interest in extending access to
AI for developers, given the relative dearth of available experts.
Microsoft announced it will be offering AI-based vision, speech and language

APIs from its Project Oxford. The tools include spell check, video analytics for
tracking faces, detecting motion and stabilizing imaging, speaker recognition,
customized speech recognition and facial detection. Microsoft recently unveiled
a new platform, dubbed AIX, which is specifically designed to harness the
power of Minecraft to accelerate the development of AI applications. AIX will
enable scientists to use Minecraft to test AI technologies.
Figure 46
More data, powerful Microsofts Project Oxford recognizes emotions

computing and new
algorithms drive a
resurgence of AI
Source: Microsoft
IBM has launched its IBM has launched its Watson partner program to work with developers,
Watson partner program service providers and ISVs to make its capabilities accessible to cloud-based
apps. There is a growing cadre of cognitive software platform vendors
including IBM, Palantir, Digital Reasoning, IPSoft, Numenta, Cognitive Scale,
Intel/Saffron, Tata Consulting Services, Cycorp / Lucid AI, Loop AI, MindMeld,
Nervana Systems and others. Other companies working on cognitive
systems/AI/deep-learning include Lockheed, SAIC, Google, Facebook, Fujitsu,
Baidu, Microsoft, Apple, Amazon, Walmart, Yahoo, Hitachi and others.
From data to insight to prediction to action

Analytics and Big Data trends have been top of mind for businesses and
investors for many years. After the business intelligence (BI) market
underwent consolidation of leading players, Business Objects (by SAP),
Cognos (by IBM) and Hyperion (by Oracle) in 2007 with all three vendors
approaching or exceeding the US$1bn annual revenue mark, a new
generation of vendors has emerged including QlikTech, Tableau and a large
number of startups focused on Big Data analytics using the open-source
Hadoop data management technology.

Artificial intelligence While BI is typically historical facing, predictive analytics is forward looking
is an extension of and powered by statistics and mathematics. The largest predictive analytics
predictive analytics
vendor in privately-held SAS with annual revenues in excess of US$3bn. IBM
acquired the only publicly traded predictive analytics pure-play SPSS in 2009.
Artificial intelligence is an extension of predictive analytics, applied to specific
tasks or problems.
AI has experienced Since it was initially conceived at a conference in 1956, AI has experienced
waves of excitement waves of excitement and periods of disfavor. Interest has been gradually
and periods of disfavor
picking up in the past several years and in 2014 momentum accelerated. AI
research saw initial commercial success in the early 1980s in the form of
expert systems, which simulated the skills of human experts. With the
collapse of the Lisp Machine market in the 1980s, AI fell out of favor. The late
1990s and early 2000s saw a resurgence of AI for logistics, data mining and
other areas in technology. In 1997, IBMs Deep Blue became the first
computer chess-playing system to defeat world chess champion Gary
Kasparov. In 2011, IBMs Watson DeepQA system defeated the two all-time
champion contestants of the Jeopardy quiz show game. Googles AlphaGo
won two of the first three games against grandmaster Lee Sedol in a Go
tournament in March 2016.
Figure 47
IBMs Watson has been Its tough to beat the machines

spun into an independent
business unit at IBM
Source: CLSA
Use cases for AI continue to expand

AI powered computers With the increasingly powerful and cheaper computing and storage resources,
are getting better than its getting easier for AI/cognitive systems to be applied to new scenarios. AI
humans at many tasks
powered computers are getting better than humans at many tasks. Some of
the most common applications of AI include speech and image recognition.
The annual ImageNet competition measures who automatically classify
100,000 photo databases within 1,000 object categories at the lowest error
rate. Microsoft won in 2015 with an error rate of 3.5% and a localization error
of 9%. In comparison, humans achieved an estimated error rate of 5.1% on
the ImageNet dataset.

A growing range of use cases for AI/cognitive computing includes autonomous

vehicles, health care (including diagnosing illness, researching cancer and
pharmaceuticals), managing power grids, protecting against cyber threats,
monitoring credit card systems for fraud, high-frequency stock trading, logistics
optimization, real-time translation, facial recognition and other uses.
Deep learning emerges at the cutting edge of AI

Deep learning became Deep learning became one of the hottest disciplines in computing over the
one of the hottest past decade, largely due to the work of Geoff Hinton, now at Google. The
disciplines in computing
principle is that if one feeds a computer a lot of images of cats, for instance,
over the past decade
the computer will eventually learn to recognize cats from video and pictures.
Extrapolating this further is the view that machines will be able to
understand language and images, with the hope that these techniques can
be applied to helping spot tumors, avert financial risks and gauge the mood
of a restaurant, for instance.
Deep learning refers to an The term deep learning refers to an approach to building and training neural
approach to building and networks, an essential component of artificial intelligence. Neural networks
training neural networks
are essentially algorithms that take different inputs such as words, pixels or
audio waveforms, run a series of tests, then generate output in the form of
predictions (such as the identification of a word or type of image). Whats key
is that the networks are trainable. They improve their accuracy the more data
is fed through the function. Certain problems involve complex algorithms and
involve large amounts of data - with millions of numbers in the case of image
recognition - so the increasing speed and power of computation is a key
enabling factor. Speech recognition is a real-world example of how multiple
iterations and more powerful processing can improve accuracy over time.
Deep learning involves In theory, neural networks should be teachable, but scaling problem solving
an enormous number requires the calibration of an enormous number of inputs, weightings and
of inputs, weightings
iterations. In 2012, there was a breakthrough as researchers Alex Krizhevsky,
and iterations
Ilya Sutskever and Geoff Hinton showed in their ImageNet paper (ImageNet
is an ongoing research effort to provide researchers with easily accessible
image database with 15m images currently) that in a few weeks they could
train a very complex network to a level that outperformed conventional
approaches to computer vision, similar to what had been accomplished with
natural language processing and speech recognition.
Teaching computers to solve problems on their own

Deep learning takes Deep learning takes neural networks to a new level of automation, using the
neural networks to a new training process to discover useful patterns. Automatic feature discovery
level of automation
enables the ImageNet network to recognize classes of objects on which it was
never trained. This approach is relevant to many kinds of data including
audio, seismic data or language. Daniel Nadler of Kensho described deep
learning as a paradigm shift from putting commands into a box to a time
when computers watch you and learn.
Googles DeepMind Googles DeepMind has expertise in reinforcement learning, which involves
has expertise in getting computers to learn about the world even with limited feedback.
reinforcement
DeepMind recently published a paper showing that its software could learn to
learning
play 1980s-era video games using only the information visible on a video
screen as inputs, such as the score. The software gets an instruction such as
maximize the score then learns the steps on how to get the highest score.
The Google DeepMind AlphaGo Project defeated Korean Go champion Lee
Sedol for the first two of three games. DeepMind analyzes human moves and
gets smarter each time it plays.

Ethical questions enter the picture

During 2015, concerns over the potential dangers of AI were thrust into
public discourse with high-profile calls to alarm from the likes of entrepreneur
Elon Musk and physicist Steven Hawking, who called AI our biggest
existential threat. Specifically, these concerns centered on the risks if AI is
applied to warfare. Its not clear who would be responsible for autonomous
systems that are capable of selecting targets and operating autonomously
without human control. Elon Musk has donated US$10m to the Future of Life
Institute, which will run a research program aiming to keep AI beneficial to
humanity. In July 2015, over 1,000 AI experts and leading researchers
signed a letter calling for a ban on offensive autonomous weapons in order
to avert the dangers of a military artificial intelligence arms race.
For now, investments in AI are concentrated in smaller private companies or

as part of larger, diversified tech firms. Google, Facebook, Microsoft and IBM
have made arguably the most extensive investments in AI to date, but much
of the technology is being applied within different offerings rather than sold
as standalone components or services (IBMs Watson is the exception).
Figure 48
Artificial intelligence/cognitive computing related stocks

Company Ticker Rating Currency Last EPS (US$) PE (x) Market cap
close (US$m)
FY15CL FY16CL FY15CL FY16CL
Google GOOGL-US BUY US$ 732.77 29.58 34.47 24.77 21.26 462,020
Microsoft MSFT-US O-PF US$ 49.81 2.63 2.70 18.94 18.45 391,687
IBM IBM-US O-PF US$ 151.02 14.92 13.44 10.12 11.24 145,021
Baidu BIDU-US BUY US$ 160.82 15.26 5.09 10.54 31.62 43,539
Facebook FB-US BUY US$ 114.90 2.28 3.71 50.39 30.97 265,734
Amazon AMZN-US O-PF US$ 719.15 1.25 6.39 575.32 112.48 339,386
LinkedIn LNKD-US BUY US$ 191.65 2.84 3.78 67.48 50.70 22,611
Salesforce.com CRM-US BUY US$ 81.05 0.75 0.95 108.07 85.32 54,938
Source: CLSA, FactSet
2. Virtually real - the next computing platform

Augmented reality and Augmented-reality and virtual-reality technologies are coming to mass
virtual reality devices markets in 2016. The technologies have captured public imagination and the
are coming to mass
first generation of applications and viewing devices have made their debut.
markets in 2016
Virtual-reality is making its entrance first with Facebooks OculusVR, the Sony
PlayStation VR and HTC Vive. Next up is augmented reality, with Microsoft
HoloLens and offerings from Magic Leap and Meta paving the way for a new
generation of applications and entertainment.
Figure 49
Virtual Gaming, entertainment, Consumers, game na Facebook (FB), Microsoft
reality/augmented commerce, travel developers, content (MSFT), Samsung (5930),
reality creators HTC (2498), Sony (6758),
Google (GOOG), private
firms Meta, Magic Leap
Source: CLSA
In 2016, interest in In 2016, interest in virtual reality surged as users begin to get the first
virtual reality surged tastes of the potential. With the Oculus headset slated to ship to consumers
this year, virtual reality is poised to enter the mainstream, with offerings
from Sony and the partnership of HTC and Valve Software also expected to
come to market.

Figure 50
Augmented and virtual Worldwide augmented and virtual reality hardware forecast, 2016-2020
reality hardware units
are forecast to grow at
186% through 2020
Source: IDC, April 2006
Industry forecasts vary There have been a number of divergent estimates about the potential size of
widely, but no one really the virtual and augmented reality markets. Deloitte Global estimates VR will
knows how big the have its first billion-dollar year in 2016, with roughly US$700m in hardware
market can be . . . yet
sales and US$300m from content, with 2.5m VR headsets and 10m game
copies sold. Industry analyst firm Statista forecasts a market of US$5.2bn in
2018. Research firm Digi-Capitals forecasts are far more optimistic,
estimating AR/VR could reach US$150bn in revenue by 2020, with AR
accounting for around US$120bn and VR US$30bn. Market research firm
KZero estimates the total revenue from virtual-reality hardware and software
is at US$2.3bn in 2015 increasing to US$5.2bn in 2018 (with US$2.3bn from
device sales). Considering the early stage of the technology, it's tough to
handicap the accuracy of medium- to long-term projections.
IDC forecasts total annual hardware unit shipments for both tethered and
untethered VR and AR growing from roughly 600,000 units in 2015 to 100.4
million units by 2020, a Cagr of 170%. IDC estimates 2-3m head-mounted
devices (HMDs) will be sold this year. IDC forecasts standalone HMDs will
ship around 45m units in 2021. And tethered VR will probably top out
around 20m a year. Unit sales will not approach anything near smartphone
volumes. The yield on some of the hardware needed is particularly low at
this early stage of the market. There will be verticals that get disrupted if
they do not embrace VR and AR.
Mobile headsets are likely While discrete HMDs such as the Oculus Rift and HTC Vive (devices that need
to become a bigger part an attached power source such as a PC to operate) will be used in settings
of the VR market where the users experience are limited to a room, mobile headsets (such as
the Samsung GearVR) are likely to become a bigger part of the VR market
due to usage flexibility. A portable unit enables people to share experiences
on the go, which could stimulate industry adoption.

VC investment continues at a rapid pace

Investments are pouring Investors and corporations are seeing the potential of VR and AR. In March
into virtual-reality 2014, Facebook purchased Oculus VR, a creator of the Oculus Rift headset for
technologies US$2bn. The size and scope of the deal created huge waves and have
catapulted a new generation of VR technologies to the forefront. Since then
Oculus, Google, Apple and Microsoft have each acquired small AR/VR
startups. 3D Systems (DDD) acquired Simbionix, a 3D virtual-reality surgical
simulation and training company for US$120m. PTC in October 2015 acquired
the Vuforia augmented-reality assets from Qualcomm for $65mn.
Venture investment Venture investment continued to flow into VR/AR startups in 2015 with
continued to flow into US$658m in equity funding across 126 deals, according to CB Insights. Most
VR/AR startups in 2015 prominently, Florida-based augmented reality startup Magic Leap raised
US$794m bringing its total funding to US$1.4bn. Mark Linao of Technicolor
Ventures has tracked roughly 290 companies that have taken in a total of
~US$2.3bn in disclosed funding to date across six categories: commercial
and industrial applications, content (including education and gaming),
discovery and distribution, social, hardware, and infrastructure and tools.
Segment differentiation
There are three primary markets for applications and hardware, all depending
on the user: consumer, recreational and simulation.
Consumer: This market includes technology for the consumer using either
a discrete HMD at home (eg, Oculus Rift, Sony PlayStation VR) or a mobile
HMD on the go (eg, Google Cardboard, Samsung GearVR).
Recreational: This market includes experiences that exist in a social
outlet (theme parks, malls, sporting events and expos) where systems
may consist of either consumer hardware or custom hardware. Consumers
do not need to own the hardware and the experience will often be
controlled by the exhibitor to ensure quality.
Simulation: This market includes custom systems (including software and
hardware) for enterprise clientele to solve specific problems, increase
productivity and potentially lessen cost.
Virtual reality is about the immersive experience

Virtual reality describes a computer-simulated environment with similar
physical presence in real or imaginary worlds. While the vision and concepts
have been around for decades, virtual reality technology has become viable
only in recent years as the Moores Law advances in processing have powered
the technology necessary for tracking along six degrees of freedom, an
expanded field of view, instantaneous image refresh rates and haptics.
The basic idea of virtual The basic idea of virtual reality has been around since the 19th Century
reality has been around stereoscope that combined two images taken from slightly different angles to
since the 19th Century render a three-dimensional illusion. Virtual-reality environments have been
displayed on a computer screen or specialized monitor (such as a headset).
Virtual reality is the immersive cousin of augmented reality, which refers to
displays that overlay information and images over the physical world.
There is a new generation of headsets that includes the Oculus Rift, HTCs
Vive, Samsungs Gear VR (a headset that uses the Samsung Note 4 as a
display) and the Sony PlayStation VR. The new generation of devices benefits
from declining cost of processing, memory and advances in 3D design and
rendering software. Whats critical is to offer an experience with minimal
image latency so that viewers see different images when looking up, down or
around a virtual environment.

The experience really does live up to the hype

Using the VR headset Facebook CEO Zuckerberg described his first time using the VR headset as
is revelatory revelatory. Following the announcement of the Oculus deal, he described the
technology as one of the few candidates to be the next major computing
platform. This analyst shares the sentiment that virtual reality is one
technology that is not overhyped.
Figure 51
The VR experience is This is your brain on Oculus

completely immersive
Source: Marco Verch (Wikimedia Commons)
Over time, there will be increasing integration with gesture recognition, haptic
interfaces and enhanced sound (Oculus touts its 3D-sound technology as
essential to the immersive experience). Its important to understand a few
basic technological concepts that help in understanding the platform:
Two of the more common Tracking: One of the most crucial aspects of VR is the ability to track
types of tracking are movement in space with six degrees of freedom (6DoF). This enables the user
inertial tracking and to look and move around in a virtual world and interact with objects with their
optical tracking
hands just as they would in the real world. Two of the more common types of
tracking are inertial tracking and optical tracking.
Figure 52
Tracking allows the user Visual tracking needs six degrees of freedom
to look and move around
in a virtual world
Source: GregorDS (Wikimedia Commons)

Inertial tracking Inertial tracking uses a combination of components (including a gyroscope for
uses a combination calculating orientation and rotation, an accelerometer for measuring acceleration
of components
and a magnetometer for absolute direction) usually found in an inertial
measurement unit (IMU). Because IMUs are increasingly commonplace in
smartphones, prices have declined and quality has improved to a level thats
made VR technology possible.
Optical tracking uses markers (sometimes LED or IR lights) that can be

tracked by cameras to locate objects in space. If the shape of the object
being tracked is already known, its possible to do marker-less tracking by
having the camera pick up the shape of the object.
Field of view (FOV). This is simply the angle of degrees available to a user
within a headset. The greater the field of view, the more the user can see
around in the virtual world - and subsequently the more immersive it feels.
Figure 53
The greater the field of Visualizing field of view

view, the more the
user can see around
in the virtual world
Source: Oculus (Wikimedia Commons)
A low refresh rate may Refresh rate. This is the rate at which images change on a screen, which is
result in blurriness important because a low refresh rate may result in blurriness that could lead
to motion sickness. This is also why OLED panels are ideal for screens.
Haptic technologies Haptics. Simply put, haptic technologies provide the ability to receive tactile
provide the ability to feedback, whether its touching an option on a screen or feeling tension.
receive tactile feedback
Haptics are an additional dimension of the immersion experience puzzle that
truly helps a user feel like theyre in a virtual world.
The key components for capturing video in VR are the cameras and rig as well
as the stitching algorithms that assemble disparate images into one cohesive
experience. Jaunt (which has raised over US$100m so far, including an
investment from Disney) has led the race in the market with its own custom
cameras, but has now started to focus more on content.
Meanwhile, companies such as GoPro have entered the market to build rigs
and supply cameras. Others like Lytro are investing in light field cameras that,
instead of taking traditional video, capture all the data available that allows
significantly more flexibility during post-processing.

NextVR wants to make Arguably the most interesting company in the video market is NextVR, a
users feel like they are company whose sole goal is to make users feel like they are attending live
attending live events
events, whether a Coldplay concert or the Super Bowl. The idea of sitting at
center court and almost feeling basketball player Stephen Currys sweat is an
idea that can scale on broadcast rights, product placement and the ability to
sell the same seat over and over again, a million times.
Seeing the world in new layers

The concept of Augmented reality describes a direct or indirect view of a physical, real-world
augmented reality has environment where elements are augmented by computer-generated input,
existed for decades
such as sound, video, graphics or GPS data. The concept of AR has existed for
decades, notably in cinema where visuals are augmented with vibrations,
smell and sound. AR applications have been used in the aerospace industry
and in military, helping workers assemble aircraft and assisting pilots with
navigation. Augmented reality differs from virtual reality, which replaces the
real world with a simulated experience.
The Terminator and Wearable AR applications for military and emergency services can provide
RoboCop films employ information such as instructions, location of enemy fire and maps. Many
augmented-reality
examples of this type of AR application have been represented in movies. The
systems to see
Terminator and Robocop films employ augmented-reality systems to see.
Figure 54
Entrepreneur Loic LeMeur on Google Glass
Source: Loc Le Meur, by Rijans007 (Wikimedia Commons)
We believe the future of The Google Glass Explorer program charged users US$1,500 for the device
Google Glass will be more (with a bill of materials that ran around US$300), and after enormous interest
commercial applications
around the device, the lack of applications and unfavorable public reaction
caused enthusiasm to wane. Google has folded the program into its Google X
initiative, and there is likely to be another iteration over time.
There will be a high initial cost for AR but the business ROI will be compelling.
Here is an increasingly broad range of applications that employs smartphone
camera and GPS functions to overlay rich data on the users view - with

Smartphone applications relevant, topical or even promotional information. Virtual fitting-room apps
such as Yelp Monocle that enable shoppers to try on different styles of clothing are increasingly
overlay information on
common, with several tied to Microsofts Kinect interface.
the users camera view
AR offers significant promise across industries

In healthcare, AR will impact everything from patient care, to surgery and
education. Doctors will be able to assess patient vitals without picking up a
book. Medical instruction will also be transformed, and can help replace
cadavers. Hololens will enable people to look at walls that havent been built
yet then help architects figure how to design better. Education offers
enormous opportunity enabling students to see examples of places and art.
Logistics design can benefit from the use of AR to improve process flows.
Field service will benefit from AR as an early use case. AR goggles will be able
to walk mechanics through the process of servicing cars. A mechanical
engineer can supervise multiple production lines at the same time.
One of the notable One of the most promising use cases for AR is in field service. PTC has
use cases for AR is demonstrated integration of its Vuforia augmented reality in a joint connected
in field service
field service offering with privately held ServiceMax. AR technology can train
and guide remote service people and enable customer self-service, improving
safety, reducing service time and manual involvement, reducing costs and
optimizing results across the board. PTCs AR technologies enable technicians
to access digital schematics by scanning a VuMark encoded graphic. AR
applications can visually walk technicians through complex service/repair
workflows with digital images projected onto views of the physical world.
When combined with predictive maintenance functions, the AR technology can
shrink time and labor involved to diagnose and service products in the field.
Microsofts holographic computing platform comes to market

Microsofts HoloLens is a headset with dark lenses that allows the users to see
(and most importantly) interact with holograms overlaid across the physical
environment. Hololens hardware incorporates a CPU, a GPU and holographic
processing unit (HPU).
Figure 55
A look at HoloLens
Source: CLSA

Microsoft highlights HoloLens is not the all-immersive virtual reality of Oculus Rift, nor the mild
holographic computing augmented reality of Google Glass, but an entirely different approach closer
as a fundamental
to Minority Report than either. The company demonstrated how users could
capability of Windows 10
interact with holograms in scenarios such as an architect walking around a
building design for his clients watching the holograms. HoloLens projects
game images onto the physical world, enabling a gamer to play Minecraft in
the living room in 3D, for example. Microsoft management highlights
holographic computing as a fundamental capability of Windows 10, which
should appeal to developers from both the Xbox and Windows platforms. The
production version is slated to launch sometime this year.
Figure 56
Hololens projects The Microsoft Hololens augmented reality experience

digital images over
the physical world
Source: Used with permission from Microsoft
Successive AR technologies will ride down the cost curve

In an earlier generation of the technology, Canons MReal AR headset is
tethered to a PC used mostly for manufacturing and design. It costs $150k
but it replaces multi-million dollar digital caves. This has been shipping for a
couple of years. The Microsoft Hololens is looking to displace the MReal - the
$3k SDK seems like a lot but theres a lot of technology and Hololens will be
able to integrate with Windows 10. Other AR startups include Meta and Magic
Leap. Meta is tethered to a PC and the new unit looks a lot like Hololens. Meta
is targeting business not consumers. Another company, DAQRI offers a smart
helmet for construction workers. This is a wearable human/machine interface.
Magic Leap has not disclosed much about its products other than a few
videos, but an April 2016 story by author Kevin Kelly in Wired highlighted its
tremendous potential.
As AR/VR software is still in nascent stages of the market, the financial

impact on Facebook, Sony and Microsoft is small given their relative size and
scope. CLSA Analyst Skye Chen recommends HTC based on the potential for
the Vive, and this may represent the most direct way for investors to play the
theme in the near term.

Figure 57
AR/VR related stocks

Company Ticker Rating Currency Last EPS (lc) PE (x) Market cap
close FY15CL FY16CL FY15CL FY16CL (US$m)
Samsung 005930-KR BUY won 1,380,000 121,491 152,165 11.36 9.07 188,491
Sony 6758-JP BUY 2,941 119 91 24.63 32.46 35,055
HTC 2498-TW BUY NT$ 93.50 (18.71) (10.63) na na 2,387
3. Blockchain - the real revolution of Bitcoin

Blockchain technologies Blockchain, the distributed ledger that powers Bitcoin and other
have the potential to cryptocurrencies, is emerging as a transformative technology for the financial
upend the financial
services sector services sector in particular. The combination of advanced mathematics,
access to massive computing power through peer-sharing, the open-source
ethos and powerful new software enables a new universe of applications for
managing transfer of value. There is an explosion of new blockchain startups
targeting health care, media, finance, insurance and other industries.
Figure 58
Blockchain and Blockchain technologies Startup businesses, low- Banks, credit card and Microsoft (MSFT), IBM
cryptocurrencies provide a cheap, income workers, citizens money transfer firms (IBM), many private
distributed ledger. in unstable countries, companies - Ripple,
Open-source currencies investors Ethereum, CoinDesk,
provide alternative Coinbase, BitPay, many
payment systems not others
tied to governments
Source: CLSA
2015 saw growing 2014 was the year that media and speculative frenzy around Bitcoin reached
recognition of the its peak, but 2015 saw broad recognition of the disruptive power of
value of blockchain
blockchain, the underlying technology. The technology underlying Bitcoin has
promise for a range of different types of applications, and the acceptance of
Bitcoin by traditional merchants is growing steadily. In late 2015, The
Economist ran an article on blockchain saying it could potentially have the
same impact on business as two other profound inventions from the early
days of capitalism, double-entry accounting and the joint stock corporation.
Interest in blockchain Interest in blockchain as a foundational technology has increased even as the
as a foundational price of cryptocurrencies has been volatile. Coinmarketcap.com tracks the
technology increased
as the price declines market value of 100 top currencies representing a total market cap of
US$8.2bn as of 19 April 2016, almost double the US$4.2bn as of 23 February
2014. Bitcoins total currency value represents the predominant share at
US$6.7bn, far greater than Ethereum at US696m, Ripple at US$258m and
Litecoin at US$148m.
At the end of 2015, over Meanwhile, acceptance of Bitcoin continues to grow: at the end of 2015, over
100,000 merchants 100,000 merchants accepted Bitcoin as a form of payment, including
accepted Bitcoin
Microsoft, Overstock.com, Dell, Dish Network, Expedia, Intuit and others.
Daily transactions occurring with Bitcoins amount to about US$289m per day.
VC investments in Bitcoin-related companies continued to grow in 2015, with
over US$496m, up from US$326m in 2014, resulting in US$927m total VC
investment in cryptocurrency startups to date, according to Crunchbase.

What is Bitcoin and blockchain?

Cryptocurrencies are The creation of blockchain technologies, Bitcoin and other modern
digitally generated cryptocurrencies is made possible by the combination of advanced
alternatives to
traditional currencies mathematics, connectivity and the availability of massive (often distributed)
computing power used to run cryptographic algorithms.
Bitcoin, Ethereum and other similar systems are composed of several core
elements:
The blockchain. This is a database that functions as a distributed ledger,
with copies maintained by all the participants in the network.
A cryptographic token. This token represents a store of value in
cryptocurrencies like Bitcoin and Litecoin and in systems like Ethereum. The
token is a string of numbers and letters with cryptographic properties that
are essentially an address that enables people to store and transmit value.
A peer-to-peer networking system. Peer-to-peer networks are a mesh of
users and processing nodes that are decentralized - everyone is a
consumer and server of resources on that network.
A consensus-formation algorithm. This is a mathematical algorithm that
validates a transaction is acceptable by having a majority of participants
agree.
Validation. In the Bitcoin system, there is computational work to come to
consensus approximately every 10 minutes regarding storage and
transmission of value in the form of a Bitcoin token.
Holders use digital Unlike a traditional banking network where transactions are maintained, with
signatures to unlock Bitcoin/blockchain applications every node sees everyone elses transaction.
their Bitcoins
Transactions are conducted between two strangers. Holders use digital
signatures to unlock their Bitcoins. The system is designed so no trust is
needed. The integrity of the Bitcoin protocol prevents any duplication of
Bitcoins, so theoretically theres no opportunity for fraud, as is the case with
credit cards.
To arrive at a balance To arrive at a balance requires analyzing all transactions ever made and tallying
requires analyzing all up the unspent inputs. No records of account balances are kept; instead
transactions ever made
balances are aggregated by tracking prior transactions to ensure there are
enough inputs to cover an output. For each input, nodes check every other
transaction in what is call the blockchain. To speed things up, Bitcoin nodes
keep an indexed list of transaction. Sources and inputs are validated by the
owner using a digital signature to assert ownership of the key.
Bitcoins are essentially Bitcoin is a peer-to-peer payment system that was introduced as an open-
long digital addresses source system by an unknown developer(s) using the pseudonym Satoshi
and balances
Nakamoto. Bitcoins are essentially long digital addresses and balances that
are stored in a shared ledger called the blockchain. The software for Bitcoin is
designed to run across a large number of machines, dubbed Bitcoin miners.
Bitcoin miners track all transactions and add them to the blockchain ledger.
Bitcoin has a reputation Bitcoin has captured an enormous amount of publicity and press interest,
as being a rebel wand after a crash in 2014, the alternative currency has seen gains in 2016.
currency

Figure 59
Bitcoin as an investing Bitcoin price - Bubble, crash, recovery

vehicle remains
1,200 (US$)
highly volatile
1,000
800
600
400
200
0
May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 16
Source: Investing.com
More organizations Despite the controversy, Bitcoin is gaining usage by the day, and there are
now accept over 100,000 merchants that accept payments in Bitcoin, including PayPal,
payments in Bitcoin
Microsoft, Time Inc, Dell, Overstock.com, TigerDirect, NewEgg, Virgin
Galactic, Dish Network and Zynga. In August 2015 Barclays announced it
would become the first UK bank to start accepting Bitcoin, with plans to
enable users to make charitable donations using the currency.
Figure 60
Bitcoin employs Bitcoin transaction visual

cryptographic hash
functions to validate
transactions
Source: Graingert (Wikimedia Commons)
Owning a Bitcoin equates Owning a Bitcoin equates to owning a private cryptography key associated
to owning a private with an internet address that contains a balance in the public ledger. This
cryptography key
address and the private key are what enable holders to conduct transactions.
For a user to send Bitcoins to someone else, they need the addresses for the
sender and receiver as well as the private cryptography key used to authorize
a payment. Based on these keys and addresses, the Bitcoin miners (the peer-
to-peer computer network running the systems software) check every
transaction that happens on the network. If the math is not correct, the
transaction is rejected.

Managing addresses and Managing these addresses and keys is complicated. A wallet is one of a
keys is complicated and number of software programs that handles and manages these transactions.
can be managed by
These can be web, desktop, hardware or smartphone apps. There are a
wallet software
number of services that enable people to buy and sell Bitcoins. Coinbase is a
website that links to a customers bank account and charges a 1% fee to buy and
sell Bitcoins on an exchange. There are now over 571 Bitcoin ATMs around the
world, predominantly located in restaurants, retailers and coffee shops.
There are risks to Bitcoin There are risks to Bitcoin users that are not characteristic of other currencies
users that are not and payment systems. Theft is one - if someone gets access to a Bitcoin
characteristic of other
wallet or private key, the Bitcoins can be stolen for good. There have been
currencies
successful hacking attempts to services that store Bitcoins.
Figure 61
There were over 571 Bitcoin ATM on display in Toronto

Bitcoin ATMs globally as
of March 2015
Source: Wikimedia Commons (KryptoNatasha)
The Blockchain: creating an internet of value

Blockchain takes the business and transaction logic from large, slow-moving
institutions and moves it to the network level. Blockchain is a distributed,
secure platform - essentially an immutable database running on billions of
devices - purpose built for money and value and also for storing data and
building applications. Its a large distributed and transparent ledger - just like
the internet is usable by everyone and owned by nobody, the blockchain is
the same way.

Promising uses for The more promising uses for blockchain technology occur in the area of
Bitcoins blockchain contracts and settlement (where the Ripple protocol is emerging as a
technology are in
contracts and settlement potentially disruptive threat to the role of foreign-exchange correspondent
banks). For financial institutions there are a number of ways where blockchain
technology creates new business opportunities. These include:
There are 2.5 billion Serving the unbanked. Identity verification is a big stumbling block for
people without access to financial institutions. With a public blockchain, two parties can enter into a
formal banking or
financial institution transaction of any kind without necessarily knowing the other's identity,
because the blockchain enables a trustless transaction. There are 2.5
billion people in the world without access to any kind of formal banking or
financial institution. One of the reasons banks are reluctant to service
those customers is because they can't attest to their identity.
Back-office cost savings. The blockchain network both clears and settles
peer-to-peer transactions continuously so that the ledger is always up-to-
date. By essentially automating processes normally managed by
intermediaries, blockchain offers big cost-saving opportunities.
The Bitcoin network takes Faster transactions. In the case of about trade settlements, in can take
an average of 10 minutes up to four days (T plus three) for equity trades, seven days for remittances
to clear a transaction
sometimes and correspondent bank settlement times can take weeks. The
Bitcoin network takes an average of 10 minutes to clear a transaction and
other blockchains that can do it even faster.
Improved risk management. The speed and efficiency of blockchain
reduces settlement risk (the risk that a trade will be bounced back),
counterparty risk (that a counterparty will default before settling a trade)
and systemic risk, which is the sum of all the counterparty risk.
Open source innovation. The open source nature of these technologies
engages more developers than any single company could, and this
advances capabilities quickly and effectively.
A broad array of uses for blockchain technology

The R3 banking The most apparent uses for blockchain are in financial services and theres
consortium is a group been a rush to embrace the technology. The R3 banking consortium is a
dedicated to advancing
the use of blockchain group dedicated to advancing the use of blockchain. It was founded in
September 2015 with initial members including Barclays, BBVA,
Commonwealth Bank of Australia, Credit Suisse, Goldman Sachs, JP Morgan,
Royal Bank of Scotland, State Street and UBS. It is now composed of over
40 banks and financial institutions that compete both directly and indirectly
with each other.
There are many potential uses enabled by this lower-cost infrastructure.

Micro-payments on the internet are an example. Blockchain-based micro
payments can allow publishers to charge users or readers per article or per
minute of YouTube viewing. Stem is a startup that helps music and video
content creators to determine the economic split among participants.
The international remittance market is one of the areas targeted for

disruption: this is a US$50bn-a-year market dominated by legacy players
like MoneyGram and Western Union. Blockchain technology promises to
send a vast amount of money in a short period of time for very low fees
from any mobile phone in one jurisdiction to a mobile phone in a jurisdiction
halfway across the globe.

Blockchain also holds Blockchain can be used in healthcare to track information in clinical trials so
promise as foundational that doctors can see certain information without seeing the overall efficacy
architecture for Internet-
rates of a given drug in a Phase Three clinical trial. The technology can also
of-Things applications
be used in next generation energy grids, tracking the exchange of credits and
debits among networks of solar and battery enabled participants that both
produce and consume energy. Blockchain also holds promise as a
foundational architecture for next-generation Internet-of-Things applications.
Increased interest and investments from big players

Major vendors are Microsoft has announced Ethereum-based blockchain services on its Azure
exploring blockchain public cloud targeted to the financial services industry. IBM is conducting trials
based offerings
of blockchain based supply chain tracking applications with its partners and has
been active in advancing research on the topic. Red Hat has announced that
financial startups can experiment with blockchain technology on its OpenShift
platform as a service. BNP Paribas has announced it will launch blockchain
crowdfunding tools in 2016. Hyperledger is an open source project to
accelerate blockchain technology, attracting major players including IBM, Intel,
JP Morgan, CME Group, and DTCC into the consortium. For now, revenues from
blockchain related technologies are de minimus, but what investors should
monitor closely is the potential disruptive effect to established public financial
services firms. CLSA analyst Mike Mayo continues to track the implications of
blockchain technologies across the financial services sector.
Figure 62
Blockchain related stocks

IBM IBM-US O-PF US$ 151.02 14.92 13.44 10.12 11.24 145,021
Source: CLSA, Factset
4. Open-source is eating software is eating the world

Open-source everything Open-source principles inherently enable innovation, not just in software,
hardware and services, but through derivative benefits to technology users in
any endeavor. The open-source model has transformed software development
and is increasingly being applied in hardware, networking, crowdsourcing,
media and new business models.
Figure 63
Open-source everything The open-source model Entrepreneurs, operators Traditional proprietary Red Hat (RHT),
is transforming software of cloud datacenters, hardware and software Hortonworks (HDP),
development, corporations and service vendors including HP, Microsoft (MSFT),
crowdsourcing, providers, SaaS Dell, Oracle, IBM, Facebook (FB), Google
prototyping, datacenters independent software Microsoft, VMware, (GOOG), Intel (INTC),
and the replacement of vendors (ISVs), Cisco, EMC, Juniper, etc AMD (AMD), many
proprietary systems consumers, industrial private firms including
designers, military, DataStax, MongoDB,
consultants Acquia
Source: CLSA
Open source has been Open-source software is a key disruption vector particularly for cloud
critical to enable computing - as much of the infrastructure in the new cloud-based
innovation, not just
architecture is based on open-source components. Open-source principles
in software
inherently enable innovation, not just in software, hardware and services, but
through the derivative benefits to technology users in any endeavor - and we
are seeing the ethos and methodologies spread beyond technology.

Open source is a double-edged sword for software vendors

Reduces overall IT costs, Open source commonly refers to intellectual property, most commonly
accelerates collaboration software that can be freely shared and modified by users and programmers.
and development
The open-source ethos is fundamentally collaborative, with modifications and
contributions from developers occurring concurrently, contributed back to the
project. The open-source model allows users to reduce overall IT costs,
accelerate collaboration and development across the organization, ultimately
lowering barriers to innovation and facilitating value creation.
The role of the user/developer community is self-reinforcing as enhancements

shared with the community accelerate the pace of technological innovation.
Under the GNU Public License (GPL), the most common open-source license,
software can be copied or given away without requiring a fee; the source
code (essentially the operating instructions for the software) can be modified
by anyone and any derivative works must be subject to the same license.
Flexibility of open source offers significant value to users

Primary advantage to One of the primary advantages of the open-source model is the ability for
open source is the users to make changes, modifications and additions to the code at will - and
flexibility to make
these changes often find themselves incorporated as enhancements in newer
changes and
modifications at will versions of the software. Customers of traditional closed-source vendors
typically must wait for upgrades from the vendor and are limited in the ability
to modify, integrate and extend the software according to how open the
vendor decides to be.
Open source is a highly Open source has proven a highly disruptive force in technology, not just in
disruptive force not just software but increasingly in hardware and other businesses (like
to software but hardware
manufacturing, medicine, digital content, robotics and even beer). Proprietary
and even manufacturing
standards allow vendors to focus on tight integration and the close coupling of
hardware and software create frictions that allow an enormous amount of
value to accrue to vendors. With Googles support, open source Android has
become the leading global operating system for smartphones.
Investors still pouring money into open source

Open source attracts Venture investments in open source continue to grow. Investors are staking a
new investment lot on open source with VCs investing US$3.3bn in 188 open source deals
from 2011-14. According to Accel Partners, 110 private companies have
received a cumulative total of US$7bn in venture funding as of 2015, double
the funding total in 2013. Just nine open source companies had risen venture
funding in 2004. Many of the most prominent open source companies are
focused on big data, with database vendors DataStax, Cloudera and MongoDB
commanding valuations over US$1bn. The highest profile deal was in March
2014 when Intel led a US$900m round of investment in Hadoop vendor
Cloudera. The December 2014 IPO of Hadoop specialist Hortonworks was the
first major open-source software company to go public in the last decade.
The challenge of making money from open-source software

Its been tough to The obvious downside to giving away software for free is that its hard to
invest in open source build businesses of meaningful scale quickly. Red Hat has built a business
model around providing certified versions of its products along with extensive
support. After nearly 15 years as a public company, revenue exceeded
US$2bn in 2015 and the company consistently posts operating margins in the
low- to mid-20s. In contrast, the next largest publicly traded open-source
software company Hortonworks reported just US$166m in gross billings for
2015. Stock performance has diverged as well. Since its IPO, Hortonworks

has seen its valuation decline from over US$1bn to US$686m as of 13 April
2016. Red Hat has seen its shares gain 20% in the same period and sports a
US$13.5bn valuation.
Figure 64
Red Hats scale is an advantage but Hortonworks shares have underperformed

160 (Dec 2014=100)
RHT HDP Nasdaq
140
120
100
80
60
40
20
Dec 14 Apr 15 Aug 15 Dec 15 Apr 16
Source: FactSet
Concern over Hortonworks valuation is an overhang for investors in open

source startups concerned that the open source business model does not
work. According to Dow Jones VentureSource, three of MongoDBs mutual
fund investors have written down valuations by 26-58% since their
purchases. Cloudera has fared better, seeing its shares increase by 75% over
the past two years according to Matt Asay at ReadWrite.
Open source - great for users but dont expect another Red Hat
While open source is Peter Levine of VC firm Andreesen Horowitz has advanced the argument that
great for users, the while open source is great for users, the business model breaks down
business model
because it takes too long to grow revenue to scale to fund investment in the
breaks down
products. As CEO of XenSource (acquired by Citrix), Levine saw other
companies take advantage of the benefits of his companys code with no
revenue benefits coming back to them. Companies like DataStax (Cassandra
database), Cloudera (Hadoop), Big Switch (network controller software) and
Acquia (Drupal content management) have built their business models around
selling proprietary add-on software that extends functionality of the
underlying open-source projects.
Proprietary software margins are a target for open source deflation

Profit margins in open Profit margins in open source companies tend to be narrower, because of the
source tend to free nature of key components of the technology offering. The main objective
be narrower
of open-source projects is to undercut proprietary technology vendors. The
net effect is deflationary to the total market opportunity. Mike Volpi, former
Cisco executive with Index Ventures, believes that open-source competition
from the likes of Big Switch will diminish the total switching market from
US$18bn to US$10-15bn with much narrower margins.
Open Source shipments A key example of the dynamics in the market is the relation between market
result in far less revenue share and revenue share in the x86 server market. Linux servers are
outpacing Windows server growth, and could reach parity by 2020.

Figure 65
Worldwide server shipments by OS, 2014-2019

(000 units) 2014 2015 2016F 2017F 2018F 2019F 2014-2019
Cagr (%)
Windows 5,589 5,675 5,681 5,794 5,879 5,970 1.3
Linux 3,525 3,879 4,270 4,591 4,919 5,271 8.4
Unix 104 89 89 82 78 75 (6.3)
Source: IDC, 2015
However the revenue contribution from Linux servers is far less than that
from Windows. Open source is a highly effective development model for
software, but monetization is a different story. Converting free users to paid
customers takes a lot of work - Red Hat has been the most effective at this
but still most constantly works to convert free JBoss and Linux users.
Figure 66
Windows server Revenue share of the server market

represents over 60%
(%) Windows Server Linux Server Unix Server
of x86 server market 1.6 1.5 1.3 1.2 1.2
8.7 5.8 3.5 2.5 1.8
revenues 100
31.9 31.8 33.8

80 30.7 32.1 34.6 34.9 36.1 36.9
32.4
60
40
63.5 64.4 65.6 66.4 64.6 64.0 63.7 62.7 61.9
58.9
20
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: IDC, 2014
Enterprises increasingly embrace open source

Open source has become According to the 2016 Black Duck/North Bridge 10th annual future of open
the go-to approach for source survey of over 1,300 respondents, 65% of respondents reported that
corporate IT usage of open source software increased in their organizations, up from 60%
in 2015. Its not just cost; 90% say that open source improves efficiency,
inter-operability and innovation. 78% of 2015 respondents said that open
source helps improve margins, with 75% saying it helps grow revenues. More
are starting their own projects with 39% planning to start an external project,
up 9% from 2014.
Free (like a new puppy) Even with the shift to lower-cost open source, companies are choosing to
but taking spend from keep IT budgets intact but shift spend away from proprietary software. Whats
traditional software happening is that investment that previously went to licenses and
maintenance goes to development and maintenance of open source. Free
open-source software reduces costs for startups as well as new projects
within IT organizations. Even with paid technical expertise and support, the
ROI tends to be overwhelmingly favorable for open-source users.
There are over 1.8bn lines There is an enormous amount of open source software available, with over 30
of freely available open- million projects currently available on GitHub. Black Duck Software estimated
source code in 2015 that there are over 1.8bn lines of freely available open-source code in 2015
that developers and business users can access to create applications and new
businesses. Almost two-thirds of companies look for open-source alternatives
before they invest in proprietary software. According to one respondent,
theres a generation dynamic as well: You cant find a developer under 25
who doesnt look at open source as the first choice.

Open source software powers the cloud

Open source is eating Open source is eating the infrastructure software world. Open-source
the infrastructure databases like Hadoop, Cassandra, MongoDB, MariaDB and others provide
software world alternatives to traditional data warehousing and transactional databases.
CloudFoundry has displaced many of the proprietary Platform-as-a-Service
software offerings, while projects like MuleSoft and Red Hats JBoss have
displaced traditional application server software. Its our view that the PaaS
layer is the dividing line; infrastructure software and hardware below this
layer are being steadily commoditized by open source and Everything as a
Service. The inherent business logic in applications and analytics provides
cushion against commoditization.
Open source is Open-source software is also foundational for the current generation of
foundational technology applications built on the de facto standard LAMP stack (Linux, Apache Web
for the cloud server, MySQL database and PHP programming language). Key foundational
technologies for cloud computing are open source: the Linux OS, the Xen
hypervisor for server virtualization, CloudFoundry PaaS software, the
OpenStack cloud computing software platform, and most recently Docker (the
application container software) and Kubernetes (container management). It is
not unusual for startups, particularly in the internet or e-commerce arena, to
avoid the use of proprietary software entirely.
Leading the charge into new technology areas

The leading edge of More significantly, open source alternatives are moving from infrastructure
infrastructure software into desktop applications like image editing (competing with Adobe
innovation is open-source Photoshop, for example). SugarCRM is an open source alternative to
Salesforce and Microsofts Dynamics CRM. Open source analytic tools
include the R language (which competes with SPSS and SAS), Pentaho and
Jaspersoft. The implications appear far-reaching: every enterprise vendor
must co-exist, compete with and integrate with open source. For companies
like Oracle, IBM and others with large infrastructure software businesses,
we believe open source continues to create a headwind. The leading edge of
technology innovation in infrastructure software is happening with open-
source projects. OpenStack has been embraced by VMware, IBM,
Rackspace, Red Hat and other vendors. Docker is supported by Microsoft,
Red Hat, VMware and others as well, and the pace of innovation appears to
be accelerating.
Microsofts evolution: Open source is a first-class citizen on Azure

Microsofts anti-Linux When Linux first emerged in the 1990s, top executives at Microsoft were
vitriol is a thing of the vehemently opposed to open source software, regarding Red Hats
past as the company ascendance as an existential threat to the business. Microsoft was so intent
embraces open source
on hurting Red Hat that it paid US$600m to its rival SuSE Linux so that SuSE
could give away free support vouchers to prevent customers from adopting
Red Hat subscriptions. This has changed dramatically. Microsoft has embraced
support for the open source model, adopting key projects in favor of its own
proprietary efforts where user adoption showed a preference. Notably
Microsoft abandoned its Cosmos project for Big Data storage in favor of
Hadoop because of broad adoption.
Microsoft has prominently Microsoft has prominently embraced support for Red Hat Linux and other
embraced open source open source technologies like Cassandra, MongoDB, Hadoop, Redis on the
software Azure cloud. Microsoft has made its .NET developer framework open source
and cross platform. The company established a .NET foundation to curate
various open source projects. Recently the company acquired Xamarin (which
enables developers to port Windows apps to Android and iOS) then made it
free and open source to developers using Microsofts Visual Studio
development tools.

Extending open-source vision into hardware

The business case for Open-source hardware extends the concept of open source to hardware
open-source hardware devices. The open-source principle applies not just to related software, but
is more straightforward also to design elements such as mechanical drawings, schematics, printed
than software
circuit board (PCB) layout data, hardware description language (HDL) source
code and integrated circuit layout. The business case for open-source
hardware is in many ways more straightforward than software because
vendors make money by directly selling the hardware. Other potential
revenue streams include support and maintenance, related services (such as
wireless and GPS) and project-based consulting. Open-source hardware
initiatives encompass input/output (I/O), circuit boards (Arduino), 3D printers
(RepRap), DJ mixers (Aurora 224) and video-game consoles (Uzebox).
Open Compute project promotes the Silicon Valley sharing culture

Open Compute originated The Open Compute project was founded in 2011 by a team of Facebook
among a team of engineers who spent two years designing a datacenter from the ground up,
Facebook engineers with the goal to scale and manage in the most efficient manner possible. The
project produced custom-designed servers, power supplies, server racks and
battery-backup systems, which were designed with datacenter needs in mind.
The team decided to make the specifications available to everyone and
launched the Open Compute project.
Google joined the Open Open Compute publishes open specifications and CAD drawings for virtual
Compute consortium I/O, hardware management, Intel and AMD motherboards and power
in March 2016 supplies, datacenter electrical and mechanical designs, a rack standard,
battery cabinet and storage. Manufacturers working on Open-Compute-
compliant components include Applied Micro, Delta, Emerson and Hyve
Solutions, Microsoft, IBM, Yandex, VMware and Box.
Open Compute moving The Open Compute consortium as grown to include hundreds of participating
into networking companies, with over 2,000 attendees at the recent Open Compute Summit.
The designs are tailored for those building hyper-scale data centers but
theres strong adoption in the financial sector. According to a Bloomberg
estimate, 80% of new servers at Goldman Sachs and Fidelity follow Open
Compute specifications. The Open Compute project has so far focused on
servers, storage, cooling and physical design, but the project has moved
into networking with the goal of developing along similar principles of
open, disaggregated technologies. The aim to produce a switch that
could threaten Cisco is coming from Facebook, Intel and Broadcom.
Figure 67 Figure 68
Open compute datacenter design Open CloudServer
Source: OpenCompute.org

Open-source business models work outside of pure technology

The open-source model The open-source model extends beyond information technology.
proves a good way to Crowdsourcing is a form of open-source product development at companies
identify global
engineering talent
like Local Motors, where potential customers vote on products and designs to
be produced. Teslas CEO Elon Musk effectively open sourced the companys
battery patents, promising to share the technology and not seek any
compensation for other automakers that seek to incorporate Teslas
developments into their models.
3D Robotics is an open-source drone company making quadricoptors. The

open-source model allows 3D Robotics to compete on quality and price
against competition using the designs in China because the global cost of
materials is the same. Because of the open-source nature of the designs, 3D
Robotics has been able to incorporate contributions from Chinese competitors,
who became active participants in the open-source community.
We highlight Red Hat as a top software pick but also as a business that has
been able to successfully harness open source as a development model.
Figure 69
Open-source related stocks

Red Hat RHT-US BUY US$ 77.14 1.91 2.25 40.39 34.28 14,001
Intel INTC-US N-R US$ 32.14 2.33 2.39 13.79 13.44 151,765
AMD AMD-US N-R US$ 4.39 (0.54) (0.28) na na 3,484
Hortonworks HDP-US N-R US$ 10.31 (3.08) (2.46) na na 597
5. Staying secure in a connected world

Security is an ongoing Trust is the basis for essential functions of commerce and society. With the
arms race between bad explosive growth of connections, applications, communications, information
actors and security
professionals
and systems, threats continue to become more pervasive, driven by
technological advances and growing involvement of organized crime and
governments. As such theres growing need for security to facilitate e-
commerce, electronic money transfers and modern conveniences such as
ATMs. The IT security market is a dynamic market, conducive to startups
offering fertile ground for innovators and investors.
Figure 70
Security Trust is paramount in a Consumers, businesses, Everyone and everything AVG (AVG), Barracuda Networks
connected world. Rising government, society at connected to the (CUDA), Check Point (CHKP),
levels of increasingly large internet, including CyberArk (CYBR), FireEye (FEYE),
complex IT security consumers, businesses, Fortinet (FTNT), Imperva (IMPV),
threats compel utilities, governments Imprivata (IMPR), MobileIron
increasingly innovative (MOBL), NQ Mobile (NQ), Palo
defenses Alto Networks (PANW), Qihoo360
(QIHU), Rapid7 (RPD),
SecureWorks (SCWX), Symantec
(SYMC), Qualys (QLYS),
Proofpoint (PFPT), Cisco (CSCO),
IBM (IBM), CA (CA), EMC (EMC)
and many others
Source: CLSA

Security becomes Security is essential to establish and sustain trust in an increasingly hyper-
increasingly challenging connected world. With the surge in connections, applications, communications
with the exponential
growth of users and commerce, information and systems remain increasingly vulnerable to
threats. With the exponential growth of users, connected devices and
applications, securing systems becomes increasingly challenging as
architecture becomes more distributed. Threats continue to become more
pervasive, driven by technological advances and the growing involvement of
organized crime and governments. Given the cybersecurity is one industry
whose fundamentals are likely to remain robust for the foreseeable future.
Criminals have used advanced technology for years and the future of
cybercrime is exponential and automated.
Attacks are primarily The growing prevalence and complexity of threats to data compel businesses
motivated by and individuals to defend their devices, networks and information. Attacks are
financial gain
primarily motivated by financial gain as cybercrime has become a multibillion-
dollar pursuit. Security has become a sine qua non for anyone seeking to use
the internet as vendors engage in an arms race with hackers. Regulatory
mandates drive organizations of all sizes to implement policies to protect,
back up and archive ever-increasing volumes of data. Proliferation of
smartphones, tablets and other connected devices will drive the need for
solutions that protect users and data.
Strong VC funding and M&A in 2014-2015 show signs of tightening

Hundreds of companies, The security market is enormously broad and complex, with hundreds of
both public and private, public and private companies offering solutions. According to CB Insights,
offer security solutions
cybersecurity venture funding has increased over the past five years from
US$1.1bn across 166 deals in 2011 to US$3.8bn in 332 deals in 2016.
There are so many startups that it can be difficult to keep track - various
industry analysts that track the market have identified between 1,200-
1,400 active companies.
Figure 71
Major security industry segments
Source: IT-Harvest

The value of cybersecurity M&A continues to fuel investors interest in cybersecurity. According to consulting
M&A activity more than form EY, the value of cybersecurity M&A activity more than doubled from
doubled from US$10.3bn in US$10.3bn in 2014 to US$26.8bn in 2015 with the number of deals increasing
2014 to US$26.8bn in 2015
46% YoY to 287. Coming off a period of elevated (and at times seemingly
indiscriminate) VC funding and M&A for cybersecurity, there are signs in 1Q16 of
tightening in funding for all but the most mature cybersecurity firms with
established revenues. IPO activity has slowed a bit, with the SecureWorks IPO
from Dell the first IPO of 2016. Prior offerings included Rapid7 in 2015 and
Cyberark, MobileIron and Imprivata in 2014.
Secular demand fueled by human-led innovation

IT security demand is IT security is different from other technology sectors because demand is
driven by external forces driven by external forces - human-led innovation. Whatever metrics one
- human-led innovation measures threats are getting more fierce, more difficult to detect, more
difficult to combat and more numerous. The business of IT security will suffer
only when the bad actors decide to go home and the likelihood of this is slim
to none. For the foreseeable future, high-quality IT security vendors will
continue to see strong sales.
Security spending Market forecasts vary across different firms but security spending remains a
remains a top priority in top priority in corporate IT budgets. Respondents to the 2016 PWC Global
corporate IT budgets State of Information Security Survey increased their IT security budgets by
an average of 24% in 2015. Gartner estimates that global spending on IT
security grew 4.7% in 2015 to US$75.4bn increasing to US$101bn in 2018.
IDC forecasts the global IT Security Products market growing at a 7% Cagr to
US$46bn by 2019. According to IDC, the most promising areas for growth are
security analytics SIEM, threat intelligence, mobile security and cloud security
Figure 72
Worldwide IT security products forecast, 2014-2019

(US$m) 2014 2015 2016 2017 2018 2019 2014-2019
Cagr (%)
Endpoint security 9,032 9,174 9,579 10,012 10,458 10,912 3.9
Identity and access management 5,052 5,470 5,925 6,413 6,907 7,430 8
Security and vulnerability management 4,722 5,392 6,039 6,680 7,320 7,935 10.9
Messaging security 2,071 2,018 2,043 2,078 2,114 2,156 0.8
Network security 9,251 10,445 11,400 12,342 13,276 14,230 9
Web security 1,912 1,992 2,099 2,219 2,345 2,474 5.3
Other security 774 758 776 801 826 833 1.5
Total 32,814 35,248 37,861 40,545 43,245 45,969 7
Growth (%) 7.3 7.4 7.4 7.1 6.7 6.3
Source: IDC
Most industry analysts In the view of industry analyst Richard Stiennon, most industry analysts have
have historically historically underestimated growth. In 2003 the market was about US$2.5bn
underestimated growth and forecasted to grow ~11% over the next decade but actually ended up
in the sector
growing at a 34% Cagr. Steinnon estimates industry growth at 24% from
US$68bn in 2013 to US$640bn by 2023 versus mid-teen industry forecasts.
Losses impact consumers and businesses

The impact of attacks and theft of data is widely felt. Juniper Research
predicts that cybercrime will cost businesses US$2tn by 2019. 80% of
hackers work for an organization with an average age of 35.
In 2015, 429 million Symantec reported that 429 million total reported identities were exposed in
total reported identities 2015, a 23% increase from the prior year. According to the PWC Global State of
were exposed Information Security Survey of 2016, 38% more security incidents were detected
in 2015 than in 2014, while intellectual property theft increased 56% YoY.

According to Symantec there were 54 Zero-Day vulnerabilities discovered in

2015, a 125% increase from the year before. Small businesses are facing
growing challenges. The last several years have seen a steady increase in
attacks targeting businesses with less than 250 employees. The proportion of
spear-phishing or highly targeted attacks directed against small businesses
increased from 18% in 2011 to 43% in 2015. Globally, one billion data
records were compromised in 2014, according to security firm Gemalto.
Median annual cost of According to the PWC US State of Cybercrime Survey, 79% of survey
cybercrime for 252 respondents said they detected a security incident in the past 12 months,
companies was US$15.4m
with 76% more concerned about cybersecurity threats this year than in the
previous 12 months, up from 59% a year earlier. The 2015 Ponemon Institute
Cost of Cybercrime report found that the median annual cost of cybercrime
for 252 companies was US$15.4m, an increase from US$14.7m in 2014 and
US$11.6m in 2013. The Ponemon Institute also determined that the mean
number of days to resolve cyber-attacks is 46 with an average cost of
US$21,155 per day (a total cost of nearly US$1m) over the remediation
period. In fact, PWC forecasts that revenues in the global cyberinsurance
market will increase from US$2.5bn in 2015 to US$7.5bn by 2020.
Figure 73
IT security causes Internet crime complaint center statistics, 2014

significant dollar losses
Total complaints received 269,422
Complaints reporting loss 123,684
Total loss (US$m) 800.1
Median dollar loss for those reporting a loss (US$) 530
Average dollar loss overall (US$) 2,971
Average dollar loss for those reporting loss (US$) 6,472
Source: FBI
No silver bullet and a robust market for cyber-security companies

The nasties grow more sophisticated
Security is an ongoing Cyber threats have become increasingly complex and financially motivated
arms race between bad and security is an ongoing arms race between bad actors and security
actors and security
professionals professionals. There are growing challenges involved in protecting private
data, transactions and intellectual property. Trust becomes essential as more
individuals and businesses rely on connected services online.
Online threats continue to proliferate, with increasing frequency and
complexity of new attacks forcing innovation.
Increasing number of connections to the internet, including smartphones,
tablets, PCs, servers, automobiles, sensors, industrial equipment and other
devices create more vectors for attacks.
Threats are financially motivated, as an increased focus on subterfuge and
social engineering makes detection increasingly challenging.
A growing tangle of regulations requires organizations of all sizes to take
measures to ensure the integrity of systems, processes, networks and data.
The growing number of users and applications creates more data, which
need to be protected, tracked, audited and archived according to business
needs and regulatory requirements.
There is a chronic shortage of trained cybersecurity professionals.

Security firms face Crime is being committed by software and therefore it scales. The complexity,
more than 500,000 persistence and damaging impact of malicious attacks are similarly growing
new threats each day more difficult to combat. Over the past 15 years, the nature of the most
prominent attacks has evolved from simple pieces of code designed for a
single function (to disrupt or steal a password) into sprawling, coordinated
attacks known as advanced persistent threats (APTs) that harness multiple
vectors to steal personal data, financial information and proprietary
intellectual property. According to Chris Young of Intel, 10 years ago security
firms faced roughly 25 new threats each day - today its more than 500,000.
We have reached the industrial age of cybercrime

Technology enables Technology enables cybercrime to scale - a data theft can encompass 100
cybercrime to scale million such as the accounts compromised from the Target data breach.
Cybercrime is also becoming internationalized: there was a US$1bn online
bank heist from 100 banks in 30 countries; teams were targeting banks 24
hours a day. A group of Russian organized criminals removed limits from
prepaid debit cards in 27 countries and carried off 36,000 transactions and
US$25m. Criminal software is sold in Brazil for aspiring identity thieves -
Black Shades is crime in a box for US$2500 - it enables a whole range of
hacks. A hacked Associated Press tweet caused a panic drop of US$160bn
from the stock market in minutes and forced the White House to produce the
President to prove he was unharmed. Some cryptocurrencies like Dark Coin
are designed for criminal activity. The average bank robbery in the US nets
US$4,300 and Mt. Gox was a US$460m theft.
One particularly nasty type of attack is Ransomware, software that

encrypts a users data, forcing them to pay ransom to retrieve the key. In
2014, 13% of PWC Cybercrime Survey respondents reported they had been
victims of ransomware.
Figure 74
Ransomware is an Ransomware - Pay up or lose your files forever

emerging threat for
consumers and
businesses
Source: Motormille2
Architectural transitions compel new thinking

Mobile and cloud The adoption of mobile and cloud computing creates challenges for security
computing create and compliance. Cloud computing impacts multiple areas of concern for
challenges for security businesses: governance (how can organizations ensure that cloud-service
and compliance
providers comply with corporate and regulatory requirements); data (where is

the data physically stored, how is it protected); identity (how to federate

authentication and access controls across different hosted environments);
communications (how to ensure that data in transit is kept secure) and other
considerations.
IT security at the IT security at the enterprise is analogous to physical security, demanding a

enterprise is analogous broad-based approach with multiple layers of protection. The market
to physical security remains dynamic, with new innovations emerging to address constantly
evolving threats as maturing sub-segments are subsumed into broader,
converged offerings.
Data breaches target organizations of all sizes

Cybercriminals target personal information of customers stored in the
systems of websites and business, and regulations typically require that
companies disclose incidents that have resulted in the theft of data. This can
be a lucrative enterprise for criminals - as the result of a large data breach
at Verizon Communications that involved 1.5 million stolen records, the
thieves priced the entire package at US$100,000 and selected portions of
records for US$10,000 according to data security website KrebsonSecurity.
The Identity Theft Resource Center (ITRC) which tracks data breaches, sees
the pace of breaches in 2016 tracking 10% ahead of 2015. The ITRC
counted 5,810 breaches from 2005 through December 2015, involving
nearly 848 million records.
What are the security implications of connected devices?

Target was hacked by criminals hacking the air conditioning system.
Samsungs Smart TV used 3rd party voice recognition, so no conversation is
private. Cars have over 250 microchips. Airplanes are also hackable - a
computer security expert hacked an airplane to make it fly sideways.
Cybercrime is going 3D with robots. Drug dealers are flying drones to find
other dealers they can steal from. Drones in swarm formation can be a threat
if they are armed. Drones can also be hacked as well.
Security is a critical component for IoT applications

Security becomes The Internet of Things (IoT) will see an exponential rise in connections,
increasingly challenging applications, communications and commerce, information and systems that
with the exponential are increasingly vulnerable to threats. Trust is critical. Securing systems
growth of connections
becomes increasingly challenging with the exponential growth of connected
devices and applications as architectures become more distributed. Threats
continue to become more pervasive, driven by technological advances and the
growing involvement of organized crime and governments.
Of applications, 35% A recent survey by HPs Fortify division found that 35% of applications
exhibited at least one scanned exhibit at least one critical or high-severity vulnerability. Additionally
critical or high-severity Fortify found an average of 25 vulnerabilities per internet-connected device, a
vulnerability
sample that included TVs, webcams, thermostats, remote power outlets,
sprinklers, door locks, home alarms, scales and garage openers. One of the
biggest issues gating adoption of consumer IoT solutions will be the need for
users to be comfortable their privacy and personal data are secure. Trust
becomes essential as more individuals and businesses rely on connected
services online. For organizations including corporations, utilities and the
public sector, the risks of network intrusions, denial-of-service attacks,
sabotage and theft of intellectual property rise as operational systems
increasingly become connected to the internet.
The security market The security market offers rich opportunities for innovators and investors by
offers rich opportunities its dynamic nature. New vectors are constantly emerging for vulnerabilities
for innovators including Android, industrial control systems and other connected devices.
Increasingly, theres the realization that attacks cannot be completely

prevented - rather strategies need to focus on rapid mitigation and risk

management instead. Theres a lot of work currently on incorporating
machine learning and artificial intelligence to detect and remediate threats.
The markets dynamism has given rise to several publicly traded companies
with over US$1bn in annual revenues including Check Point, Palo Alto
Networks, Fortinet, Symantec and Trend Micro. Many of the larger technology
vendors have built out and/or acquired security businesses of scale, including
Cisco, IBM, Juniper Networks, HPE and Microsoft.
Notable publicly traded security companies include AVG, Barracuda Networks,

CyberArk, FireEye, Gemalto, Imperva, Proofpoint, Qualys, LookingGlass,
Rapid7, Varonis and others. Notable private companies include Cylance,
Carbon Black, Kasperskey, Crowdstrike, ZScaler, Okta, Tanium, Webroot,
CyberArk, LogLogic, Ping, SailPoint, Veracode and many others. We would
also highlight that while security represents a minority of their businesses, for
BUY-rated Akamai and Splunk security is a key growth driver.
Figure 75
Security related stocks

close (US$m)
AVG AVG-US N-R US$ 19.49 1.81 1.94 10.77 10.05 990
Barracuda Networks CUDA-US N-R US$ 14.84 0.42 0.47 35.33 31.25 774
CyberArk CYBR-US N-R US$ 45.53 1.00 0.92 45.53 49.69 1,527
FireEye FEYE-US N-R US$ 15.42 (1.61) (1.24) na na 2,567
Fortinet FTNT-US N-R US$ 33.73 0.51 0.70 66.14 47.94 5,794
Imperva IMPV-US N-R US$ 39.08 0.11 0.26 355.27 152.06 1,261
Palo Alto Networks PANW-US N-R US$ 130.24 0.86 1.66 151.44 78.46 11,666
Symantec SYMC-US N-R US$ 18.78 1.03 1.08 18.23 17.37 11,493
Proofpoint PFPT-US N-R US$ 63.37 (0.35) (0.14) na na 2,631
Qualys QLYS-US N-R US$ 32.07 0.70 0.79 45.81 40.83 1,121
Rapid7 RPD-US N-R US$ 14.04 (1.46) (0.91) na na 588
Secureworks SCWX-US N-R US$ 14.96 (0.66) (0.32) na na 159
Trend Micro 4704-JP N-R 3,585 157.71 141.70 22.73 25.30 4,748
VASCO VDSI-US N-R US$ 17.00 1.06 0.42 16.04 40.96 683
Qihoo QIHU-US N-R US$ 73.66 1.58 3.89 46.62 18.94 6,723
Source: CLSA, Factset
6. Clean disruption of energy and transportation approaches

The energy and The energy and transportation sectors are poised to undergo massive
transportation sectors are disruption as the combination of increasingly cheap solar, advances in energy
poised for disruption form storage and adoption of electric vehicles will disrupt the traditional oil, gas,
solar and energy storage
utilities and automotive industries - without regulatory intervention. There are
increasing signs that solar energy is on the verge of becoming the cheapest
source of power, without any subsidies. Innovations and economies of scale in
battery and other energy storage technologies pave the way for large scale
adoption of utility-scale solar and electric vehicles.
Figure 76
Clean disruption of The declining cost of Consumers, businesses, Carbon-based fuel Tesla (TSLA-US); ADAS:
energy and solar, advances in energy entrepreneurs, cities, businesses (oil, coal, Mobileye (MBLY-US);
transportation storage lower the cost of society at large gas), utilities, some Battery:
energy and make electric automakers Panasonic (6752-JP);
vehicles the default choice Sony (6758-JP)
by 2030
Source: CLSA

Energy and transportation Information technology is not the only domain where exponential cost curves
as well are poised to see are having an impact. Energy and transportation as well are poised to see
massive disruption massive disruption from the declining costs of solar panels, energy storage and
the consequent declines in cost of electric vehicles (EVs). Author Tony Seba in
his 2014 book Clean Disruption has outlined the case that that we are on the
cusp of a US$12tn disruption of energy and transportation. His work suggests
that the cost of solar will drop so much that by 2030 all new energy will be
solar. By 2025 all new vehicles will be electric and all new vehicles will have
driverless capabilities. Over time, the energy grid will become an Internet of
Energy. Customers will upload and download energy on the grid, with
transactions likely tracked on applications running on blockchain architecture.
Industries are headed for disruption

Nuclear, coal, gas, diesel, The technology driven disruption resulting from a confluence of new
gasoline and internal technologies and new business models puts at risk conventional electric
combustion engines will utilities, the traditional automobile industry and many other peripheral
become obsolete
businesses. Solar has zero marginal cost of energy, EVs are basically tablet
computers on wheels, technologies are improving exponentially - and there
are no breakthroughs required for disruption. Nuclear, coal and gas power will
become obsolete as well as diesel, gasoline and the internal combustion
engine for automobiles. Meanwhile, there will be investment opportunities in
battery materials and technology, energy storage services, software, estate,
and a panoply of new business models.
Solar technology costs Solar technology costs have fallen sharply over the long term and by 90%
have fallen by 90% just since 2008. Capacity installed is doubling every 2.5 years with 66% of PV
just since 2008 capacity installed globally connected in the past two and a half years. The
beneficiaries of declining costs are consumer of energy of course, while
investors have struggled to make money investing in solar. Solar PV
(PhotoVoltaic technology) has increased its price/performance along a 22%
learning curve since 1970 and this keeps improving every year. Total PV
installed capacity is growing at a 42% Cagr and this has continued since the
year 2000. Every source of energy has seen prices increase by a factor of 6-
16X since 1970; this includes oil, coal, nuclear and natural gas. Solar PV has
improved on a unit basis over 3165X compared to oil, 2600X relative to
nuclear, 2965X relative to natural gas.
Figure 77
Solar growth is on pace Forecasting solar domination by 2030

to provide nearly 100%
of energy needs by 2030
Source: Tony Seba

Solar - great technology, rough for investors

Massive increases in Massive increases in production, led by China, have been key to driving
production, led by China, continuing price declines. Over the past decade China has displaced Europe as
have been key to driving the leading producer of solar PV panels and this has resulted in a decline of
continuing price declines
both job and clean energy investment in Europe. Bloomberg New Energy
Finance (BNEF) estimates that Europe represented 45% of global clean
energy investment in 2010, but this has declined to 18% of the global total,
or US$58bn, in 2015.
Solar is reaching grid parity today in many markets (unsubsidized)

One measure that can mark a tipping point in solar is achievement of grid
parity which refers to the cost of solar equaling the cost of energy from a
utility (of course costs vary widely based on the amount of sun in a given
area). Residential electric rates average US$0.12 per kilowatt-hour in the US,
while wholesale electric rates (the price utilities pay to power generators) is
around US$0.04 per kilowatt-hour on average.
In several countries, In several countries, solar generated energy is cheaper than energy
solar generated energy generated from nonrenewable sources. In Germany, Solar went from 5% of
is cheaper than total electricity production to 16% in the eight years ending in 2014. Solar in
nonrenewable sources
Chile is already cheaper than wholesale. Today the average cost of energy
from solar PV in US is around US$0.12 cents per kWh, about the same as the
average retail rate. GTM Research estimates that 20 US states are currently
at grid parity, with 42 states expected to reach this by 2020.
Figure 78
Utility scale solar farms First solar desert sunlight solar farm
are on the way to
displacing carbon
based power
Source: US Department of the Interior
Regulations are helping Regulations are helping advance utilities adoption of solar. In the US, the
advance utilities Public Utility Regulatory Policy Act (PURPA) mandates that utilities have to
adoption of solar buy power from the lowest cost option. This benefited gas for a while as the
marginal cost of natural gas is lower than other carbon-based sources.
However, utility scale solar has come down to US$0.06/KWh and no new plant
can replicate this. Tony Seba articulates the concept of God Parity - this is
when the cost of unsubsidized rooftop solar generation is lower than the cost
of transmission. He predicts this will happen by 2020 and this will be the
tipping point where solar wins.

Solar as a service accelerates consumer adoption

Whats making solar adoption take off is a business model innovation: Solar
as a service. Zero money down solar PPA (Power Purchase Agreements) and
leasing started in 2009. In these agreements, consumers or businesses agree
to purchase power at an agreed rate from the owner/installer of PV panels,
who bears responsibility for installing and maintaining the panels. Third-party
financing started with companies like SunEdison and SolarCity.
Batteries the key to the story

Electric vehicle battery Battery innovation is reshaping conventional auto and utility industries and
costs (which currently the way vehicles and grid systems operate. Electric vehicle battery costs
account for about 40% (which currently account for roughly 40% of the cost of an EV) could halve by
of the cost) could
halve by 2020
2020 due to scale from mega investments, innovation breakthrough and
higher energy density. Car makers will launch more competitive mass-market
EV models to meet government-mandated carbon-emissions targets.
Battery improvements complement solar advances

New innovations in batteries and declines in cost have the potential to disrupt
many industries as scale builds. The use of batteries can enable both business
and residential consumers to harness and use solar energy in a way that was
not possible before. Batteries and energy storage are critical to harnessing
the power of solar energy, allowing businesses and consumers the ability to
store energy when costs are low (off-peak hours or when the sun is shining)
and use energy when needed.
The markets are expanding for batteries as well

Lithium Ion Battery Lithium ion battery costs are declining at 16% per year and this is
costs are declining accelerating across the industry. There is a race to scale up the energy
at 16% per year storage industry to serve autos, utilities and electronics. When this
investment occurs this will accelerate the cost curve. Investments in battery
technologies are increasing.
Production poised for inflection with GigaFactory

Tesla GigaFactory in The upcoming Tesla GigaFactory in Nevada will give scale to the industry and
Nevada will give scale help continue the cost decline curve. It will be able to supply 50 GWh per
to the industry year of production - enough for 500,000 when it opens in 2020. This is not
included in Tony Sebas 16% price decline projections. This is a US$5bn
investment with 6,500 jobs that will double world battery production and
reduce battery pack costs by over 30%. According to Reuters, BYD plans to
add six GWh every year. This could ramp up to 34 GWh by 2020 matching
Tesla's 35 GWh. Together, Foxconn and LG could add a combined 22 GWh.
Advances in energy storage will help utilities manage peak load

There are also different There are also different types of storage facilities under development that are
types of storage facilities used to reduce or eliminate the need for utility peaker capacity. Eliminating
under development the need for expensive capacity increases the efficiency of existing utility
plants and lowers the use of carbon fuels since the plants can now take
advantage of solar and wind generation. In Spain theres a new storage
technology that uses potassium nitrate (salt). Molten salt is 60% potassium
nitrate and 40% sodium nitrate. It stores heat at about US$50/KWh vs
US$500/KWh for lithium ion storage. The Solar Reserve designed Solar Plant
in Tonopah NV, has 100MW and 10 hours of storage. There is a 25-year PPA
(power purchase agreement) with Nevada Power that will power Las Vegas.
Storage as a service combines software and energy storage

There are a number of new companies such as Stem and GreenCharge
Networks offering storage as a service to reduce demand charges for
businesses. Businesses can charge up industrial scale batteries (or other
types of storage) when costs are low or the sun is shining then consume the
power when costs are higher or theres no sun.

Stem combines big data, Stem combines big data, predictive analytics and advanced energy storage to
predictive analytics and help customers reduce demand charges. The solution is storage plus
energy storage to help
reduce demand charges predictive software, which can help customers save 25% on battery storage
charges. Use cases include demand management, load optimization,
participation in utility programs, anomaly detection, additional demand
response and increased customer engagement. The Stem battery systems are
sold on a monthly lease and customers benefit from cost reductions. The
financing partner takes 100% of the financing, Stem takes 100% of the SaaS
portion of the business. GreenCharge Networks offers customers a
percentage of savings model with zero money down.
Figure 79
Vendors like Stem enable Stems commercial/industrial power storage systems

businesses to store
energy and save costs
Within five years solar

plus storage will be at
lower cost than current
retail price for power
Source: Stem
Off the grid will not mean a log cabin anymore

Andrew Birch, CEO of Sungevity predicts that within five years we will be
able to buy solar plus storage at lower cost than current retail price for
power. As the 30% tax credit steps down, demand may slow down but this
is likely to be temporary. By 2020, assuming li-ion batteries are at
US$200/kWh in a battery pack, it will be possible for average US home to
store electricity for just US$1.20 a day (based on the average Americans
energy consumption of 903 kWH per month. This threatens electricity
generating companies pricing power. By 2018 Tony Seba forecast all new US
Solar installations will include some form of energy storage which will be
disruptive. By 2020, storage will be inexpensive enough for millions of
people in the US and Australia and other markets to get off the grid. By
2030 all generation and all storage will be distributed.

Electric Vehicles poised to displace traditional autos

True EVs have been There are two major disruptions in transportation technology - electric
slower to see adoption vehicles and self-driving cars (covered elsewhere in this report). Electric
vehicles have a long and mixed history, but with the declining cost of
batteries (which account for roughly 40% of the cost of a new care) the cost
equation is becoming more attractive by the day. While hybrid cars (internal
combustion engine enhanced by electro power) have gained steady
acceptance over the past decade with the Toyota Prius the most popular, true
EVs have been slower to see adoption. The Nissan Leaf and Chevy Volt have
seen underwhelming sales numbers, but it was Teslas high-end cachet and
high quality vehicle that provided a cool factor for EVs. Tesla approach
where it started off with a premium product and rode the cost curve down to
mass market levels appears to be working with the announcement of the
Model 3 expected in late 2017.
Figure 80
Cost curves make EVs EVs ride a compelling cost curve

increasingly cost
competitive
Source Tony Seba
There are many reasons why EVs are disruptive:
The electric motor is The electric motor is five times more efficient than internal combustion
five times more efficient engines. Internal combustion engine cant improve on 17-21% efficiency
than internal
combustion engines vs electric motors which convert 90-95% of energy.
The EV is ten times cheaper to fuel, as electrons are easier to move than
atoms (gas). It costs only US$5 to charge a Tesla to travel 200 miles.
Consumer Reports estimated that the cost to fill up a gas Jeep liberty over
five years is US$15,000. An electric Jeep Liberty would cost US$1,565 in
electricity.

Cars can have 2-3,000 Cars can have 2-3,000 moving parts, the EV has roughly 20. This is a 100x
moving parts, the EV difference that translates to lower maintenance costs. Tesla offers an
has roughly 20
eight-year infinite mile warranty.
Wireless charging is another benefit. Tesla is building a network of

hundreds of wireless charging stations around the country.
The modular architecture is a big advantage. Dual motors can be

independently adjusted thousands of times per second. MIT has developed
a robotic wheel that includes a drive motor, brakes, steering and
suspension.
Rapid agile product development enables continuous improvement of the

product and maybe even with software downloads.
EVs can provide grid services by both consuming and producing energy.
Cars can be a power source for houses.
Figure 81
Adoption of EVs is Tesla supercharging station in Gilroy, CA

coming out of
Silicon Valley
Source: Steve Jurvetson (Wikimedia Commons)
How long will it take for EVs to go mainstream?

Tony Seba predicts all If we assume a mass market car will need 200 miles of range and a 50 KWh
new mass-market cars battery, Tony Seba estimates the industry could build a 200 mile range SUV
will be EVs by 2030
for US$35-40,000 by 2017-2018, and US$31,000 (the average sticker price
of a car in the US) by 2020. Teslas Model 3 was announced with a $35,000
base price for delivery in late 2017 and the company received 300,000
reservations within the first week. By 2022-2023 the price could be $22,000.
New players from the tech industry are targeting the auto market: FoxConn is
targeting a US$15,000 car. Xiaomi is targeting a US$6400 super-mini car. The
prediction is that mass migration to EVs will occur in 2017-2018 and all new
mass-market cars will be EVs by 2030.

Figure 82
There are now more Signs of inflection at hand

charging stations than
gas stations in Japan
Source: http://newsletter2.statista.com/l/K892xG2YwuMRGWhLxtEEyQoA/aEad0n4wwHSIZZcSa1CaIA/
AYoyV3wC5ssvaqvtST2uAg
For investors, clean disruption offers a broad array of opportunities and risks
(see our solar ETF performance chart in section 1 of this report). CLSA
analyst Charles Yonts has done extensive work in this sector on solar, battery
technology and other clean energy investments.
Figure 83
Clean disruption related stocks

close (US$m)
Tesla TSLA-US U-PF US$ 214.96 (2.30) 1.00 na 214.96 31,359
Panasonic 6752-JP BUY 894.50 83.40 113.70 10.73 7.87 20,716
Sony 6758-JP BUY 2,941 119.40 90.60 24.63 32.46 35,055
First Solar FSLR-US N-R US$ 47.89 5.37 4.33 8.92 11.06 4,897
SunPower SPWR-US N-R US$ 15.13 2.17 1.39 6.97 10.90 2,089
7. Vehicles that drive (and fly) themselves

Autonomous vehicles and The fundamental nature of transportation is changing as autonomous vehicles
robotics will remake prove technological viability and sensor-based vehicle communications
transportation and
manufacturing systems promise to ease traffic jams and improve safety. The first generation
of self-driving prototypes is being tested on public roads, with all of the major
automakers and several technology companies investing in research. The
technology is also being extended to trucks, other commercial vehicles and
unmanned aerial vehicles (UAVs). The bigger challenges to adoption lie ahead
with laws, lawmakers and insurance companies.

Vision becoming In 2015 momentum around autonomous vehicles accelerated in a big way.
reality to improve There is a broad range of technologies including artificial intelligence and
safety and access
robotics that go into poweringc self-driving cars, trucks and other vehicles.
Investment is pouring into automotive technology. According to CB Insights,
investors funded US$374m into 32 deals for the first 10 months of 2015.
There has also been a wave of venture investments in self-driving tech
startups in 2016 including Comma.ai, nuTonomy, and Nauto.
PWC has estimated that PWC has estimated that M&A by automotive suppliers in 2015 was nearly $50
M&A by automotive billion, three times the levels in 2014. GM spent a reported US$1bn to acquire
suppliers in 2015 was
acquisition of self-driving car startup Cruise Automation. Toyota hired the
nearly US$50bn
entire staff of Jaybridge Robotics, an MIT autonomous vehicle spinout. Auto
supplier Continental AG acquired a 3D laser-sensor business from Advanced
Scientific Concepts. In 2015, auto parts maker Delphi Automotive made two
significant investments, acquiring a stake in Quanergy, which is developing a
low-cost LiDAR system and Ottomatika, an autonomous-driving software
company developed out of Carnegie Mellon University.
Self-driving cars are becoming a reality

All major automakers The market opportunity is expected to be significant. IHS Automotive
are in the process of forecasts annual sales of self-driving or driverless cars reaching 21 million
developing vehicles with
within 20 years. Over the past year, all of the major automakers have made
autonomous features
progress toward developing autonomous features. Google has been
extensively testing autonomous vehicles since 2009, which have logged more
than 1.4 million driverless miles. Tesla has introduced semi-autonomous
software updates to its vehicles and the company has stated that technology
to support autonomous capabilities will be built into every new vehicle with
software updates in the future needed to enable functions.
Other automakers have been getting into the act: Audi, BMW, Cadillac, Ford,
GM, Mercedes-Benz, Nissan, Toyota, Volkswagen and Volvo all been testing
driverless systems. Googles prototypes are often seen on the streets around
Mountain View, CA, while Audi, BMW, GM, Nissan, Toyota and Volvo have all
targeted the introduction of autonomous cars by 2020.
The self-driving concept The concept extends beyond passenger vehicles to trucks, busses and other
is being tested in other vehicles. As of October 2015. Mining company Rio Tinto is currently operating
capacities such as ore
69 self-driving ore trucks at mines in Australia, with plans to expand to 150
trucks for mining and
shuttle busses for vehicles within four years. A company called Navia is developing a self-driving
students electric shuttle. In the US there are several companies developing self-driving
shuttles to serve campuses and areas where the speed limit is capped at 30
miles per hour because vehicles that do not exceed these speeds do not fall
under the auspices of the Federal Highway Administration.
Figure 84
Smarter moving Self-driving cars, Consumers, Transportation based Google (GOOG), Toyota Motor (7203),
machines trucks, buses, businesses, automobile employment (taxi, Ford Motor (F), General Motors
(autonomous drone aircraft manufacturers, auto truck drivers, logistic) (GM),Mobileye (MOBL), Raytheon (RTN),
vehicles, drones) supply chain, military AeroVironment (AVAV), Boeing (BA),
Northrop Grumman (NOC), Textron
(TXT), BAE Systems (BAESY), Adept
Technology (ADEP), Amazon (AMZN),
Lockheed Martin (LMT), General
Dynamics (GD), SAIC (600104), GoPro
(GPRO), Ambarella (AMBA), IXYS Corp,
(IXYS), InvenSense (INVS) and others
Source: CLSA

Potential safety innovations have the power to be transformative

Autonomous vehicles Autonomous vehicles have the potential to solve many of the driving-related
have the potential to problems that occur as a result of human error or negligence. In theory,
solve many driving-
autonomous cars are safer than driver-operated vehicles because they have a
related problems
360-degree range of vision, can react more quickly than humans, cannot be
distracted (for instance, by text messaging) and are unable to drive under the
influence of alcohol. One of the primary goals is to reduce traffic accidents to
zero and Volvo has announced plans for a zero-fatality car by 2020. Its easy
to come up with scenarios where technology would help, in case of the
elderly, impaired or inexperienced drivers.
Many of the technologies In a world of driverless, connected cars, the road system could be transformed
necessary to produce an into something akin to a smart grid, where all vehicles are tapped into the
intelligent highway
system, monitoring traffic patterns and other vehicle movements. This is called
system are in place
platooning where trucks follow closely behind each other autonomously on
using Wi-Fi connectivity and vehicle-to-vehicle communications. Platooning
trucks can reduce fuel consumption by 15% and can also alleviate traffic
congestion. In April 2016, a fleet of self-driving trucks built by Daimler and
Volvo traveled over 1,000 miles across Europe. Such a system could
conceivably obviate the problems of traffic congestion, as well as the accidents
that tend to accompany it. Many of the technologies necessary to produce an
intelligent highway system are already in place, from traffic monitoring sensors,
fiber optic networks, wireless technologies, motion detectors, etc.
A wealth of technologies at work

Cost is no longer the issue with autonomous driving as processing power
becomes increasingly cheaper. One of the most important technologies is light
detection and ranging (LIDAR), an optical remote sensing technology that
measures distance and other properties by illuminating an object with light. A
LIDAR system cost around US$70,000 in 2012, by end-2013 this fell to
US$10,00 and by 2015 the cost fell to around US$1,000. It is led today by
private company Quanergy and costs are expected to fall further.
Self-driving cars also Self-driving cars also benefit from the exponential declines in the cost of
benefit from the computing power. In 2000, the first Teraflop (a measure of computing
exponential declines in
speed, referring to a trillion floating point operations per second) computer
cost of computing power
cost US$46m. NVIDIAs Drive PX GPU (graphics processing unit) built for
autonomous vehicles offers 2.3 TerFlops with 15 Watts power consumption
for US$59.
New cars include New cars increasingly include sensor-based technologies such as automated
automated parking parking assist and adaptive cruise control. Coming generations of driver-
assist and adaptive
assist systems will provide greater vehicle autonomy. On the horizon are
cruise control
sensor-based solutions that employ stereo cameras, software and complex
algorithms to compute the geometry of situations in front of the vehicle. Like
all predictive algorithms, the efficacy will improve with more data. Theres
increasing research into connected-vehicle systems that use wireless
technologies for real-time vehicle-to-vehicle (V2V) and vehicle-to-
infrastructure (V2I) communications. V2V and V2I technologies promise to
advance crash avoidance and traffic optimization.
Ten-percent adoption of The adoption of V2V and V2I communications could significantly reduce traffic
autonomous vehicles in congestion. A report from the Eno Transportation Institute estimates that
the USA could create
10% adoption of autonomous vehicles in the USA could create US$38bn in
US$38bn in cost savings
comprehensive cost savings from reduction of crashes, improved fuel
efficiency, lower travel time and parking savings.

Current prototype autonomous driving systems employ, for instance, video

imaging, GPS, laser scanner, radar and ultrasound technologies that enable the
vehicle to recognize everything from surrounding vehicles to traffic light colors
and move accordingly. Most systems have built-in redundancies that act as fail-
safes and also allow the human driver to override the system at any time.
Automotive active safety suppliers are best positioned for the future
Automotive suppliers of In Emmanuel Rosners view, automotive suppliers with the best current
active safety technologies portfolio of active safety technologies are likely to benefit most from the
are positioned to benefit increased vehicle content in autonomous vehicles. In particular, Mobileye is a
from autonomous vehicles
pure-play on the active safety and autonomous trends. The automotive
industry is migrating to monocular (single) camera based ADAS and Mobileye
is the unmatched leader, with 15+ years of validated data and contracts to
work with nearly every major automaker. In addition, road experience
management (REM), Mobileyes new real-time mapping technology will
eventually be used for autonomous capabilities and creates a moat around
the core camera algorithms technology. We expect Mobileye to hold a
dominant position, with share rising from 44% today to 64% in 2020 before
leveling to 45% in 2025 as competitors join.
Figure 85 Figure 86
Mobileyes OEM customers Mobileye market share

70 (%)
BMW Jaguar Land Rover SAIC
60
Fiat Chrysler MAN SE Scania
50
Ford Mazda Ssangyong
40
GM Mitsubishi Tesla 30
Honda Nissan Volvo 20
Hyundai Kia PSA VW 10
0
IVECO Renault Yulon 2015 16CL 17CL 18CL 19CL 20CL 21CL 22CL 23CL 24CL 25CL
Source: Company Source: Company, IHS Automotive, CLSA
While not a pure play on the active safety/autonomous trend, Delphi is also
well positioned for this high-growth trend. It is partnered with Mobileye on
vision based ADAS while also offering collision warnings and avoidance systems
that can incorporate radars and other types of sensors. One of its differentiated
products in this field is the RACam, which combines radar sensing, vision
sensing and data fusion in a single sophisticated module. Adoption of these
technologies should see strong growth as automotive manufacturers and
regulators advance towards the ultimate goal of zero accidents. Below, we
summarize the active safety technologies offered by key suppliers.
Figure 87
Technologies offered by key active safety suppliers

Autoliv Bosch Continental Delphi TRW Valeo
Forward radar X X X X X
Side/360 radar X X X X X X
Forward camera X X X X X X
Rear/surround camera X X X X
Laser X
Ultrasonic X X
Night vision X X
Source: Companies

Figure 88
Prototypes include no Google self-driving car at intersection in Mountain View, CA

pedals or steering wheel
Source: Grendelkhan (Wikimedia Commons)
Offering benefits of better space utilization

Adoption of autonomous Parking requires large investment of space and money in areas where there
vehicles could reduce are not a lot of mass transportation options. Parking lots cover between 13-
need for land for parking
14,000 square miles in the US, and accounts for an estimated 20% of the
usable land in Los Angeles. One of the potential benefits of a self-driving car
is the ability for the car to drop off a passenger then circle around rather than
park if theres a short errand, or pick up another passenger in a sharing
scenario. Broad adoption of autonomous vehicles could significantly reduce
the need for parking in urban areas.
Bringing on the sharing economy

From file sharing to As the world becomes more interconnected through an increasingly mobile
Everything as a Service internet and cloud-based services, this facilitates a transition away from an
ownership to a rental, or sharing economy. The terms peer economy,
collaboration economy or sharing economy are gaining currency as virtual
communities drive new business models and disrupt incumbent industries.
The trend towards sharing and collaboration has been concurrent with the
digitization of content.
BMWs Drive-Now service Companies like Zipcar, Uber, BlaBlaCar in Europe, Lyft and Park 24 (the
is a new example of an biggest car park owner in Japan) are moving the market towards car sharing.
IoT-enabled on-demand
BMWs Drive-Now service is an example of an IoT-enabled on-demand mobile
mobile service
service. Launched in several German cities and San Francisco initially, the app
allows customers to rent from a fleet of cars by the minute or the hour. The
cars can be parked in reserved street spaces and users can monitor the
electric charge or gas tank levels, mileage and other diagnostics.
With the addition of autonomous capabilities its only a few steps to sharing
autonomous car services, with fleets of cars serving users. In extreme
scenarios, this could potentially shrink the new car market by 80%, as the
concept of car ownership and car insurance fade away while rendering 80% of
parking and highway space obsolete.

A younger generation disconnects from driving

Younger people are The longer-term vision for connected cars will involve rethinking
driving less, as sharing transportations role in society. We are already seeing a generational shift
services gain traction
related to driving. According to a study by US Public Interest Research Group
(US PIRG) Education Fund and the Frontier Group there was a 23% decline in
the average number of miles driven by 16- to 24-year-olds between 2001 and
2009. Car sharing is also growing at a rapid rate. According to DOT, there
were 1.6 million members in 24 active programs in the US in 2014, over a
tenfold increase in seven years.
The future vision of The future vision of connected cars promises more sharing, as transportation
connected cars promises options depend less and less on owning a vehicle. Fleets of shared vehicles,
more sharing
taxis or buses could travel the streets responding to requests from Uber-like
services. Campus-based transportation systems could help business, schools
and the elderly. Reduction in the amount of parking required could drive
redesign of urban spaces for greater efficiency and more open space. Even
vehicles themselves could see radical redesign to be adapted where there are
no human drivers. Beyond the automakers, potential beneficiaries include
Bosch, STMicro, InvenSense, Skyworks Solutions and chipmakers like Nvidia,
Qualcomm, Broadcom, Infineon and Texas Instruments.
The biggest challenges are human not technology

Regulations and liability Regulations and liability remain the bigger challenges ahead. Google has been
remain the bigger actively lobbying lawmakers in the US to legalize operation of self-driving
challenges ahead
vehicles with some success. California and Nevada (AB 511) have legislation
allowing autonomous vehicle licensing, while Florida and Washington, DC allow
testing. Some of the bigger questions concern liability and the role of human
operators in conjunction with the technology. For now the proof of concepts
have been a success. The bigger challenges lie ahead with laws, lawmakers and
insurance companies. The Vienna Convention on Road Traffic and the Geneva
Convention on Road Traffic are two major international treaties that may need
to be changed for cars to be used in Europe and the United States, as both
require that a driver must be in full control of a vehicle at all times.
Autonomous vehicles in the air: the rise of drones

Most commercial aircraft Automobiles and trucks are not the only types of vehicles that can operate
have auto-pilot autonomously. Most commercial aircraft have auto-pilot capabilities that
capabilities that
automate most flying except for takeoff, landing and taxiing. There has been
automate most flying
a dramatic increase in awareness around consumer and commercial drones,
technically known as unmanned aerial vehicles (UAVs), as growing availability
of cheaper and more powerful systems makes the technology ever more
accessible. Consumer units have steadily made their way into the
marketplace with the cheapest DIY kits starting at just a few hundred dollars.
Promising consumer and commercial market opportunity

According to the Consumer Electronics Association, consumer demand is
expected to drive the global drone industry to exceed US$1bn with one
million units sold within five years. Research firm Radiant Insights estimates
that the worldwide unmanned aerial systems (UAS) market will grow from
US$609m in 2014 to US$4.8bn by 2021. ABI research forecasts that the
small UAS market will reach US$8.4bn by 2018 with the commercial sector
dominating the market in 2019 with revenues of US$5.1bn.
MarketsandMarkets forecasts the global market for small drones to reach
US$1.9 billion by the end of 2020. The Association of Unmanned Vehicle
Systems International estimates that than 70,000 jobs will be created in the
United States with an economic impact of more than US$13.6bn.

Figure 89
Hi-end consumer drones 3D robotics X8-M quadracoptor

for photography can run
several thousand dollars
Source: 3D Robotics
Commercial UAVs will transform industries

Currently, military applications dominate the global UAV market, but
commercial applications are poised to see robust adoption over the next
decade. There is a broad range of commercial uses currently being explored
for drones:
Precision agriculture. Sensors can be attached to ground vehicles and

UAVs to scan crops with multi-spectral imaging for health problems, track
growth rates and hydration and locate disease outbreaks. Potentially,
UAVs can be used for the precision application of pesticides and fertilizer
in the appropriate amount and location to save cost and reduce
environmental impact.
Product delivery and logistics. Quick turnaround product delivery is a

key use case. UPS and Dominos Pizza are exploring ways that UAVs can
be used to deliver products and food to customers. Drones can deliver
items such as medications and supplies to remote areas in emerging
countries where there may not be road infrastructure for cars.
Oil and gas. Oil companies such as BP are using drones to generate 3Dl
maps of roads and pipelines to identify problems and strategize repairs.
Drones can help move large equipment in difficult weather by providing
real-time surveillance and 3D models of terrain.
Public safety, security and emergency response. Drones can conduct

searches to find lost vehicles or identify situations that are too difficult for
humans. UAVs can survey locations to help firefighters and emergency
responders obtain information to inform tactical and operational decisions
that can help ensure the safety of firefighters.
Journalism, filmmaking and photography. Filmmakers are already

using drones for aerial shots, particularly for extreme sports content.
Reporters are using drones to capture footage for sporting and other
media events.

Construction, architecture and civil engineering. 3D Robotics CEO

announced a partnership with Autodesk to perform 3D building scanning
that can be integrated into digital workflow and CAD systems. Drones will
be able to perform 3D scanning that can be easily deployed or even
automated on construction sites and private property.
Figure 90
Autonomous vehicle/drone related stocks

close (US$m)
Toyota Motor 7203-JP BUY 5,393 741.36 631.00 7.27 8.55 169,957
Ford Motor F-US O-PF US$ 12.83 1.93 2.10 6.65 6.11 50,062
General Motors GM-US O-PF US$ 28.83 5.02 5.70 5.74 5.06 44,764
Mobileye MBLY-US BUY US$ 34.87 0.48 0.69 72.65 50.54 7,644
AeroVironment AVAV-US N-R US$ 31.32 0.10 0.30 308.79 105.91 732
Boeing BA-US N-R US$ 130.50 7.72 8.51 16.90 15.33 83,130
Northop Grumman NOC-US N-R US$ 216.81 10.39 10.68 20.87 20.31 39,124
Textron TXT-US N-R US$ 37.57 2.50 2.72 15.03 13.83 10,100
BAE Systems BA-GB N-R 4.75 0.40 0.39 11.85 12.22 21,271
Lockheed Martin LMT-US N-R US$ 239.56 11.46 11.85 20.90 20.22 72,935
GoPro GPRO-US N-R US$ 9.71 0.76 (0.91) 12.78 na 989
8. Robotics: replacing and working with humans

and industry market. The top-three drivers of the market are increased processing,
Beyond nanorobotics, drones and autonomous vehicles are transforming
industries like manufacturing, warehousing and distribution, healthcare, retail
and other areas.
Figure 91
Robotics Automated Manufacturers, Labor, especially Amazon (AMZN), iRobot (IRBT), Google
manufacturing, healthcare, employees doing (GOOG), Raytheon (RTN), Moog (MOG),
surgical robots, consumers, military repetitive tasks in Intuitive Surgical (ISRG), Cognex
trainable robotic manufacturing, service, (CGNX), Accuray (ARAY), AeroVironment
assistants, domestic etc (AVAV), Northrop Grumman (NOC),
robots Rockwell Automation (ROK), General
Dynamics (GD), Boeing (BA), Teledyne
(TDY), Textron (TXT)
Source: CLSA
Robots will be taking over

and industry market. The top three drivers of the market are increased processing,
Beyond nanorobotics, drones and autonomous vehicles (covered robots are
transforming industries like manufacturing, warehousing and distribution,
healthcare, retail and other areas.

Figure 92
Robots to become as Global robot population growth

plentiful as motors
Source: Stuart Staniford Early Warning Blog 2012
Welcome our new Evolution and advancement of artificial-intelligence software and robotics is
AI-enhanced robot having a profound impact on society and the economy at large. Beyond
overlords nanorobotics, drones and autonomous vehicles (covered elsewhere in this
report), robots are transforming industries like manufacturing, warehousing
and distribution, healthcare, retail and other areas. Much of what we see today
is an extension of the multi-century trend towards automating human tasks
and the acceleration of progress in technology will have outsize impact on the
future economy. Robotic technologies and concepts will be increasingly
integrated into mechanical and industrial systems, and combined with self-
learning software capabilities we expect to see advances in the field accelerate.
In 2015 over 240,000 The International Federation of Robotics (IFR) estimated that in 2015 over
industrial robots were 240,000 industrial robots were sold, representing 8% YoY growth. In its most
sold, representing 8% recent World Robot Statistics report the IFR states that by 2018, 1.3 million
YoY growth
industrial robots will be installed in factories around the world with China
accounting for more than one-third of the industrial robots installed
worldwide. They estimate that the market value for robotic systems hovers
around $32 billion. Between 2015 and 2017, IFR forecasts robot sales to grow
at a 6% pace in the Americas and Europe, and 16% in Asia and Australia.
End-2017, IFR estimates China in particular has a booming market expected to reach a Cagr of 25%
two million industrial through 2017. By end-2017, IFR estimates that about two million industrial
robots will be installed robots will be installed in factories worldwide. Industry analyst firm Tractict
worldwide
forecasts annual worldwide shipments of consumer robots (which includes
vacuums, lawn mowers, pool cleaners and social robots, will grow from 6.6
million units in 2015 to over 31 million units by 2020, a cumulative total of
nearly 100 million during the period.
VC funding for robotics According to CB insights, VC funding for robotics doubled in 2015 with the
doubled in 2015 volume of deals doubling from 45 to 83. Investments grew 115% to US$587m
compared to US$273m a year ago, excluding investments in drones. The first
three months of 2016 has seen funding rebound but deals to startups have
dropped now for three straight quarters. Since March of 2016, 15 companies
including Restoration Robotics, Savioke, and 5D Robotics have raised US$89m
in funding across 15 deals and since 2011 have raised more than US$1.4bn in
funding. Innovation Works was the most active investor in robotics this year
with Intel Capital and High-Tech Grunderfonds tied for second.

Chinese firm Midea has As of the writing of this report, Chinese firm Midea has made a US$5 billion bid
made a US$5 billion bid to to acquire German robotics firm KUKA. If completed, this would be the largest
acquire German robotics robotics related acquisition ever. The Robot Report, which tracks startup
firm KUKA
fundings, acquisitions, IPOs and failures most recently reported the General
Motors acquisition of Cruise Automation for US$1bn, giving robotics its first
startup unicorn. Cruise develops autopilot systems for existing cars. Airware,
a San Francisco UAS autopilot maker, raised US$30m in a round that included
former Cisco CEO John Chambers as an investor and board member. The Robot
Report tracked 55 fudings totaling US$1.32bn, 32 acquisitions worth
US$2.27bn, and one IPO. Corindus Vascular Robotics raised US$42m in 2015.
New funds target robotics opportunity

Dmitry Grishin, CEO of Russias largest internet company the Mail.Ru Group,
personally launched Grishin Robotics in 2012, a US$25m seed-investment
fund. In April 2016 Grishin Robotics launched another fund with US$100m
from European and US institutional and individual investors to focus on
companies involved in the "hardware revolution." Kazakh petrochemical mogul
and entrepreneur Kenges Rakishev founded Genesis Angels, a US$100m fund
dedicated to robotics and artificial intelligence and launched a second US$102m
fund in January 2015.
Service robots are Industrial robots account for 86% of the US$30bn market, with service robots
forecast to grow 25-30% (which perform lighter tasks such as picking and packing, cleaning and
annually over the assisting in surgery) accounting for the remaining 14%. Industrial robots are
next few years
expected to grow by 5% a year while service robots should grow 25-30%
annually over the next few years.
By 2023 revenue from Author of the Robot Report, Frank Tobe, estimates that by 2023 revenue from
robots used in services robots used in services will be greater than those used in industry. According
will be greater than those to Tobe, Industrial-related robot revenue Cagr stands at 5.3% through 2023
used in industry
versus a 27% Cagr for service-related robots. Collaborative robots revenue
could be as high as US$1bn by 2020 compared to the current US$95m as
these robots find new applications in the 6M SMEs worldwide which represent
70% of the worlds manufacturing.
The US has been investing heavily in its domestic manufacturing sector in

order to be more competitive abroad. The 2016, the Presidents Economic
Report to Congress highlighted the view that increased deployment of robots
will be a critical factor in growing production in the US. The automotive sector
accounts for 40% of total robot shipments worldwide with consumer
electronics the second largest sector at 20%. 55% of the total demand for
industrial robots comes from the auto sector currently. Almost one quarter of
these robots are at car makers allowing car manufacturers to produce the
greatest number of cars after China.
Big tech firms double down on investments in robotics

Amazon, Apple and Amazon, Apple and Google have all made significant investments in robots
Google have all made and robotics. Companies like Coca Cola, Walmart, Nike, Ikea, FedEx and
significant investments in UPS are using a variety of automation technologies. Amazon spent
robots and robotics
US$775m in 2012 for Kiva Systems and renamed it Amazon Robotics. In
October 2015 the firm disclosed that it currently uses 30,000 Kiva product-
picking robots in its warehouses.
Kivas army of Kivas warehouse solutions consist of an army of small forklift robots that lift
forklift robots and move inventory shelves around and bring them to human packers,
eliminating the need for human pickers. Meanwhile, a central computer
coordinates the robots moves and customers orders using complex

algorithms. Kivas robots know where they are by scanning barcodes set on
the floor using technology from machine-vision leader Cognex (CGNX), which
has been providing Kiva with barcode readers since at least 2011.
There is a new generation There is a new generation of ecommerce robotics startups emerging as well.
of ecommerce robotics Fetch Robotics is a provider of mobile-picking robots that support freight
startups emerging robots and received US$23m from SoftBank in equity funding to scale up
operations. GreyOrange is a Singapore based startup with robots similar to
the Kiva systems that recently received a US$30m investment to fund
expansion to Japan and China. Harvest Automation is a startup focused on
moving potted plants from one location to another in the nursery segment of
the agriculture industry.
Google established a Google appears to be retreating in part from robotics. According to reports
robotics division after from Bloomberg in March 2016, the company has put Boston Dynamics up for
acquiring eight robotics sale after tensions were report hindering the teams ability to collaborate with
companies
Googles other robot engineers in California and Tokyo and a failure to come
up with products that could be released in the near term. Prior interviews
with Googles Andy Rubin suggest that its initial markets would be in
manufacturing and logistics, potentially to compete more aggressively against
Amazon for home delivery. Apple is in the process of investing US$10.5bn in
technologies that include assembly robots, milling machines and equipment
to polish the iPhone 5C, according to Bloomberg.
Surgical robots revolutionizing the operating room

One area where robots One area where robots are adding great value is in the operating room where
are adding great value is there is low tolerance for errors. According to Alec Ross in The Industries of
in the operating room the Future, 1,300 surgical robots were sold in 2013 for an average of US$1.5
million each, representing 6% of unit value and 41% of sales value for
industry robotics. Robotic procedures are growing at around 30% per year;
with over 1 million Americans having undergone robotic surgery. The Da Vinci
surgical system translates a surgeons hand movements into tiny
micromovements, assisting in over 200,000 complex surgeries per year
such as cardiac valve repair. The Da Vinci systems cost US$1.8m each
however, and a newer system designed by the US Army called the Raven cost
far less at US$250,000. The systems are not flawless, there have been 174
injuries and 71 deaths related to the da Vinci surgeries according to The
Journal for Healthcare Quality.
Personal robotics - Making progress, still dont do windows . . . yet

Housecleaning robots Housecleaning robots, such as from Roomba or Neato are already several
are already several generations into the market, with price points under US$300 making adoption
generations along accessible to the middle class. One of the big challenges with robotics is to
get people and robots to work together. Safety (and liability) is a major
concern where machines are programmed to perform fixed and repetitive
tasks, while humans tend to perform tasks with more variation.
There are expanding use cases for robots for telepresence. Systems from
companies like VGo and Beam allow users to participate in meetings and even
in school lectures, with video and audio streaming. Users can maneuver the
wheeled robots from a remote location. In education, a French company
Aldebaran has developed the NAO, a two-foot tall humanoid robot that serves
as a teaching assistant in math and science classes in 70 countries.
Robotics emphasizes An important development in robotics is the emphasis on open-source

open-source software software and hardware projects like Arduino. This is driven by dual motives.
Free open software encourages adoption and innovation, but also avoids

potential issues of liability in case of accidents or property damage. There are

two main open-source efforts: a project called Open Source Computer Vision
(OpenCV) Library and Robot Operating System (ROS), which is sponsored by
the Open Source Robotics Foundation.
There is also a growing category of the personal-assistant robots. In

collaboration with Fellow Robots, Lowe's Innovation Labs has placed robots
(dubbed the OSHbots) in an Orchard Supply Hardware store in San Jose,
California, in order to study the benefits of using robotics to assist customers
and employees. The OSHbots can help shoppers navigate the store by
providing the in-store location of a product, scan physical objects for
identification (useful for screws, connectors and other parts), provide real-
time information on product promotions and inventory and communicate via
multiple languages.
Where the action is: collaboration, perception and agriculture

There are three areas of significant near-term change in the field:
collaborative robotics; advances in perception; and robotic products in
agriculture. Weve excerpted from the February 2016 CLSA U Blue Book by
CLSAs Morten Paulson and Editor and Publisher of The Robot Report Frank
Tobe: Renaissance bot: Perceptive, Collaborative, out in the fields.
Co-bots coming together

The robots are breaking Collaborative robots (also called co-bots) are designed to work jointly on a
out of their cages and project. To do so, they must be able to communicate and be safe to operate
new breeds are born in proximity with humans. There are many reasons for the tremendous
amount of buzz around the emergence of collaborative robots, particularly
using them to handle ergonomically challenging tasks, using them alongside
humans in electronics assembly lines, using them because they are
affordable, using them because they are plug and play, using them to offload
repetitive and boring jobs, and using them because they are significantly less
expensive than their larger robot cousins.
Figure 93 Figure 94
Where are collaborative Co-bot machine tending Collaborative robot assembly

robots used today
Source: CLSA

Market poised At present, co-bot sales represent 5% of the overall robot market but with
to grow tenfold strong growth expectations. The collaborative robotics sector stands to
increase roughly tenfold between 2015 and 2020, reaching over US$1bn from
approximately US$95m in 2014. Insiders suggest more rapid expansion with
lightweight co-bots becoming the top seller in the industry in about two
years, posting sales in the hundreds of thousands and prices falling to
US$15,000-20,000.
SMEs are the new The small & medium-sized enterprise (SME) marketplace is huge: six million
addressable market companies worldwide and almost 70% of global manufacturing. A few lowcost
plug-and-play robotics tools can easily fit into the manufacturing process in
many of these companies. It is easy to imagine co-bots for SMEs reaching our
hundreds-of-thousands unit-sales mark beginning as early as 2018.
Companies are rushing As robots move from fixed and caged locations to work alongside us and as
to get in position the metrics of robot ownership and deployment change and become more
affordable, companies of all types and sizes are finding strategic reasons to
acquire or invest in robotic ventures to add to their arsenal of products and
services. They dont want to be left behind and they are paying high prices for
their acquisitions.
Figure 95
From left to right: Four collaborating co-robots at IAS in Shanghai 2015

Rethinks Baxter, Kukas
LBR iiwa, ABBs Yumi
and Universals UR10
Source: CLSA
Universal Robots is the Market leader Universal Robots has a big headstart. This year it is likely to
current market leader maintain its lead but Kuka, ABB, Fanuc and Yaskawa will begin to make
inroads and experiment with different prices. By the beginning of 2017, the
competition will become even more intense as the number of co-bots sold
approaches 15,000 units or US$0.5bn in sales revenue. Its still too early in
the evolution of co-bots for provider consolidation, but some systems are
sure to be preferred because of their flexibility, ease of training and support
network.

3D vision getting closer

Vision is a significant Machine vision has been a continuing challenge in robotics. Key advances in
bottleneck for robot sensors, CPU power and software are changing for the better, particularly in
deployment
the area of 3D perception. Vision systems have become integral in countless
applications in factory robotics but also in computer gaming, medical
diagnosis and quality control. Emerging today are low-cost vision solutions for
logistics and materials handling, for mobile devices of all types as well as for
an ever-increasing need in factory robotics. These newer low-cost vision
systems offer value in the form of improved product quality, manufacturing
flexibility and high throughput.
Low-cost 3D vision Research reports covering 2D and 3D vision technologies all forecast a 9-12%
is a game changer Cagr or higher and project the market will reach US$10bn or more by 2020.
Low-cost 3D perception is the game changer. There are other methods of
machine vision but low-cost 3D solutions are disruptive because of cost,
capabilities and software . . . and because we live in a 3D world.
Figure 96 Figure 97
Machine vision Cognex camera on a UR robot Nachi robot with Keyence laser scanner
and laser scanners
Source: CLSA
Analytics are getting a lot Capturing and processing camera and sensor data and recognizing various
better, cheaper and faster shapes to determine a set of robotic actions is conceptually easy. To emphasize
the difficulty, however, Amazon recently challenged the industry to select and
pick shelved items robotically. Twenty-eight teams from around the world rose
to the competition; none of them could perform as fast as a human.
Agricultural robotics growing

Productivity With the global population on track to reach nine billion by 2050, agricultural
must increase production must double to meet the demand. And because of limited arable
land, labor shortages and water considerations, productivity must increase
25% to help meet that goal.
Farmers, ranchers and Farmers, ranchers and growers the world over are transitioning to precision
growers transitioning agricultural methods, ie, subdividing their acreage into many unique subplots,
to precision agricultural
and in some cases right down to the individual plant, tree or animal, thereby
methods

enabling increased productivity, traceability and lower overall costs. Unmanned

aerial vehicles are integral to the process and are being used to map, observe,
sense and spray. Agriculture employs more than 1bn people and generates
over US$1.3tn worth of food annually. The subset of precision agricultures data
capture and analytics market size is estimated at US$25bn per year.
BIS Research, a Minnesota-based company, recently predicted that the

precision-farming market will experience a Cagr of 13.09% from 2015 to
2022 and reach US$6.43bn by 2022. Tractica, a Colorado research company,
reported that the agricultural robotics market will reach US$3bn by the end of
2015 and US$16.8bn by the end of 2020.
Figure 98
Kubota presented new Kubotas automated CSAS fertilizing system

automated equipment at
the annual dealers
conference in Kyoto
Source: CLSA
Addressing farmers Robotics technology is on the path to impact ag with a multitude of

constant struggle to applications which will address farmers constant struggle to keep costs down
keep costs down and
and productivity up. Many factors are precipitating these changes in addition
productivity up
to global population growth and the cost and availability of labor: the
diminishing availability and increasing cost of water; political and regulatory
procedures (and hold-ups); limited tillable acreage; better, cheaper and faster
technological automation products; and climate change, to name just a few.
Most Western farmers Digitally controlled farm implements are already in use in developed countries
and ranchers are and most Western farmers and ranchers are already high-tech to some
already high-tech
extent. Farmers use software systems and aerial or satellite survey maps and
data to guide their field operations and are transitioning from satellite and
small plane photos to those provided by drones with sophisticated sensors.
Farmers are also using optional auto-steer kits in most new tractors that
follow RTK/GPS and digital guidance.

Figure 99
Robotics related stocks

Rockwell Automation ROK-US U-PF US$ 116.13 6.40 5.91 18.15 19.65 15,128
Cognex CGNX-US U-PF US$ 41.90 2.13 1.21 19.67 34.63 3,563
Accuray ARAY-US N-R US$ 5.14 (0.51) (0.27) na na 416
Northrop Grumman NOC-US N-R US$ 216.81 10.39 10.68 20.87 20.31 39,124
Boeing BA-US N-R US$ 130.50 7.72 8.51 16.90 15.33 83,130
iRobot IRBT-US N-R US$ 37.00 1.47 1.31 25.17 28.18 1,016
Raytheon RTN-US N-R US$ 135.80 6.75 7.14 20.12 19.02 40,330
9. 3D printing - rethinking manufacturing

3D printing - in a Interest and hype around 3D printing peaked in 2014, leading to
hangover from peak disillusionment among investors as stocks continued to come under pressure
of hype but technology in 2015. The consumer market appears saturated with low-cost completion.
is real
Meanwhile, advances in industrial additive manufacturing continue to
progress with adoption among manufacturers doubling between 2013 and
2015 and moving beyond prototyping toward full production.
Figure 100
3D printing Custom fabrication, Consumers, designers, Spare parts, machine 3D Systems (DDD), Stratasys (SSYS), ExOne
prototyping, spare industrial designers, tooling, mass (EXONE), Proto Labs (PRLB), VoxelJet
parts manufacturers, service manufacturing (VJET), Arcam (Sweden), envisionTEC, EOS
providers, materials (Germany), Renishaw (UK), Organovo
producers (ONVO), Autodesk (ADSK), Staples (SPLS),
Adobe (ADBE), Microsoft (MSFT)
Source: CLSA
In 2014, the interest In 2013 and 2014, 3D printing underwent a surge of interest from popular
around 3D printing media and from investors as the public awakened to the promise of
reached the mainstream astonishing low-cost desktop fabrication reviving the moribund US
manufacturing sector. Enthusiasm for a burgeoning consumer 3D Printing
industry propelling shares of related companies to unsustainable highs. 2013
saw ExOne (XONE) and VoxelJet (VJET) join 3D Systems (DDD) and Stratasys
(SSYS) as public companies. 3D Printing software firm Materialise (MTLS)
launched an ADR in the US.
Hype peaked in 2015 Hype peaked with the 2015 Consumer Electronics Show which dedicated a
separate section to 3D printing and there were near daily news stories about
uses of 3D printing whether for food, hobbyists, aerospace, healthcare and
other uses. HP announced that it would enter the 3D printing market and test
machines in 2015 before launching in 2016.
In 2015, 3D Printing In 2015, 3D printing stocks struggled as leaders Stratasys and 3D Systems
stocks struggled wrestled with operational challenges arising from rapid expansion. Stratasys and
3D Systems are the leaders in a market that was already 30 years old. 3D
Systems is exiting its Cube consumer business. Its our view that with sentiment
around 3D printing is now in the trough of disillusionment as Gartners Hype
Cycle describes it, investors are in a better position to better assess the very
real industrial potential for additive manufacturing technologies.
Robust growth forecasts for the sector

Growth forecasts are Theres a range of growth forecasts - all generally bullish for the commercial
generally bullish for the sector. The Wohlers Report forecasts the worldwide 3D printing industry is now
commercial sector expected to grow from US$3.07bn in revenue in 2013 to exceed US$21bn in
worldwide revenue by 2020. Allied Market Research (AMR) projects the 3D

printing market will grow at a Cagr of 20.6% from US$2.3bn in 2013 to

US$8.6bn in 2020. IDC forecasts a 37% Cagr for 3D printers through 2019.
There are high volume markets and high value markets. Most of the value
comes from high-end machines. There will be a 28% Cagr in the value of the
hardware sold. The materials business will exceed services in 2016 - IDC
forecasts services and materials growing at a 29% Cagr to US$14bn by 2019.
3D printing for medical applications is forecast to be a US$2.13bn market by
2020, according to market research company MarketsandMarkets.com.
A diverse, fragmented landscape

Dozens of privately held 3D printing has attracted widespread attention from the investment
firms are making use community. Along with the three US publicly-traded pure-play 3D printing firms
of the open-source (3D Systems, Stratasys and ExOne), there are also service bureaus including
RepRap technology
VoxelJet and Proto Labs and software pure-play Materialise. Dozens of privately
held firms are making use of the open-source RepRap technology to reduce the
price of 3D printers to make them accessible to average consumers.
The market is fragmented The market remains fragmented with dozens of manufacturers selling 3D
with over 40 3D printer printers and over 200 startups worldwide developing and selling consumer-
manufacturers and over oriented 3D printers. Key industrial providers are 3D Systems, Stratasys,
200 startups
ExOne, Arcam (Sweden), envisionTEC, EOS (Germany) and Renishaw (UK). For
bioprinting, there is Organovo. In the consumer market, players are 3D
Systems, Bits from Bytes, MakerBot (Stratasys), Lulzbot, FormLabs, Sculpteo,
Leapfrog and Solidoodle. HPs inkjet-based technology will be coming to market
in the next few quarters. RepRap is an open-source solution. Most software is
bundled, though Autodesk is leading the charge to become a standard with its
Spark software. Microsoft, Adobe and others have added support for 3D
printing to their software. Hundreds of resellers and distributors globally
typically resell CAD/CAM software. Service bureaus include Proto Labs, Kraft
Wurx, Shapeways, Staples Easyprint and others.
Traditional 2D printing Traditional 2D printing players are looking to expand into this market. HP will
players are looking to release their 3D Printer by the end of 2016. This will incorporate some of the
expand into this market technology they have used in business printers. Canon has also showed some
signs around 3D printing. China is focusing a lot on 3D printing. There is a lot
of activity in alliances and research institutes and technology parks that are
focusing on 3D printing. Retailers and service providers are expanding their
offerings with Staples and other service bureaus introducing prototyping
businesses. Logistics service providers like FedEx or UPS are also looking into
offering 3D printing as a way to provide choices to customers.
Figure 101 Figure 102
The price of entry-level Objects printed with Autodesk Spark 3D printed wrench
3D printers continues to
drop towards the
US$1,000 range
Source: CLSA Source: Creative Tools from Halmdstad (Wikimedia

Commons)

There are a lot of startups competing in the market and a number of key
patents have expired as open source platforms like RepRap have given rise to
new entrants particularly in China. Industry analyst firm IDC sees a shakeout
coming in the industry. There are hundreds of players in the market from
North America, Europe and Asia looking to build share, so margins could be
difficult to sustain for hardware-based vendors.
3D printing is expanding One result of the development of 3D printing is its impact expanding the CAD
the CAD and PLM markets and PLM markets. Autodesks Tinker CAD is a simple, free tool - even though
the learning curve is steep. IDC expects expansion of the mid-market CAD
market, so there will also be libraries and marketplaces for designs. PLM is
much more sophisticated; as designs are increasingly digitized there will be a
lot more embedded product intelligence. Autodesk is one of the premier CAD
software firms offering design tools for 3D printing. They have open sourced
and freely distributed Spark, its 3D printing software platform, and has also
launched its Ember line of 3D Printers which retail for US$7,495. The
companys Project Escher networks multiple printers together into a mesh
that can produce far larger, more complex objects with faster throughput.
The origins of 3D printing in manufacturing

The term 3D printing is The term 3D printing is interchangeable with additive manufacturing. The
interchangeable with technology has its origins in stereolithography, which debuted in the late
additive manufacturing
1980s. Rapid prototyping persists today, while rapid tooling didnt catch on in
the industry. Rapid manufacturing is at a nascent stage of adoption. 3D
printing encompasses these three applications.
The ink used can be Originally used to construct prototypes and models, the technology has now
any range of materials advanced to the point of producing increasingly complex final goods. 3D
from plastics to
printing works much in the same way as a traditional printer, except that the
powdered metals
ink used can be any range of materials, from plastics to powdered metals.
Depending on the method, an object can be created, for instance, by
depositing molten plastic layer by layer or by blasting powdered metals with
lasers that melt and bond the material.
Advantages lie in uniqueness and complexity

There are many conversations about the potential for 3D printing among
those with a financial interest in the industry: manufacturers of the
equipment (OEMs), materials and software, as well as distributors. The whole
value chain anticipates when additive manufacturing becomes commonplace
as a tool for production because there will be more systems sold and more
material consumed compared to the one-off use cases of prototyping. In
prototyping, machines will make only a few units versus making tens of
thousands or millions of units for production. Equipment initially designed for
a prototyping machine does not have the same constraints as a production
device in terms of repeatability - ensuring everything comes out exactly the
same. Prototyping machines can lack throughput at higher volumes; accuracy
can be a concern; and certainly material choices are key.
3D Printing/additive manufacturing - from prototypes to production

There is a growing There is a growing array of practical uses for 3D printing. This year GE
array of practical expects to print 19 different pieces on their aircraft engines, targeting
uses for 3D printing
100,000 parts by 2020. The automotive industry is ripe for adoption: the
average car has 1,800 parts assembled on a production line, with 30,000
total parts. In the future, cars could be made up of only 100 parts. Privately
held Local Motors is at the forefront of printing ABS (Acrylonitrile-Butadiene-
Styrene plastic) and Carbon Fiber automobiles. Healthcare is using 3D

printing for surgical models, implants, and prosthetics. There have been
titanium printed rib replacements, as well as 3D printed ears, noses and other
body parts. Prosthetics can cost US$40-100,000 so they are expensive.
Theres a project sponsored by Rochester Institute of Technology printing
prosthetics for US$50. Students at Washington University have 3D printed a
robotic arm for about US$200. Traditional robotic limbs can cost between
US$50,000 to US$70,000 and they need to be replaced as children grow.
Moving beyond the hype

Companies are eagerly 3D printing drives the evolution in prototyping and manufacturing, but the
exploring commercial promise of a revolution for the consumer remains far off. Industrial 3D
uses for 3D printing
printing is increasingly mainstream for prototyping, though uses for
manufacturing remain limited. Companies are eagerly exploring commercial
uses for 3D printing. Several well-known automakers are using 3D printers
for around 100,000 prototype parts per year, according to SmarTech analyst
Scott Dunham. Boeing uses printers to make 200-part numbers for 10
different types of aircraft. By 2020, GE the company expects 100,000 engine
parts to be made using 3D printing processes. PWC estimates that two thirds
of manufacturers are already using 3D printing. Of these, 29% are exploring
how 3D printing can be best integrated into production processes. 25% are
using 3D printing for prototyping.
3D printing offers a 3D printing has the potential to transform the way we manufacture things.
more efficient, less The technology offers a more efficient, less costly means of producing custom
costly means of
items by using significantly less raw material and avoiding the expensive
producing custom items
retooling required by mass production lines. In other words, rather than mass
producing for customers, it brings custom production to the masses. 3D
printing has the potential to be highly disruptive to the manufacturing
industry by enabling mass customization and just-in-time manufacturing.
Breakthroughs have advanced the relevance of 3D Printing

There have been a number of key breakthroughs on 3D Printing technology
since 2010 that have changed the market dynamics, according to former
CEO of 3D Systems Avi Reichental. Its now possible to print objects in full
color with over 250 different materials and composites. Full color means
over a million different color combinations in a single print. The
combination of new materials and colors opens up huge possibilities.
Medical devices like hearing aids and braces, implants as well as
customized surgical tools can be created in bespoke fashion. Metal printing
has now been adopted in the aerospace and automotive industries, with the
ability to print with more than 20 different alloys. GE and SpaceX are 3D
printing parts for jet and rocket engines.
The speed and throughput of 3D Printing has also increased to the point
where continuing improvements will make production printing more viable.
The tools and technologies have also evolved to make it easier for end-users.
CAD (Computer-Aided Design) and 3D modeling tools are getting easier to
use, while the emergence of cloud-based marketplaces for models and
images helps democratize the technology.
In each class, there are There is a lot of diversity in the classes of materials that can be processed;
only a few available however, in each class, there are only a few available materials. In the
materials for 3D printing
thermoplastic class, there is commercially available polycarbonate, nylon,
acrylonitrile butadiene styrene (ABS), and a few specialty materials like PEEK
or ULTEM, trademarked names for mechanically sound, temperature-resistant
materials used on aircraft.

Figure 103 Figure 104
Objet Eden 250 3D printer PRUSA 3D Printer
Source: Vigh Eld, John Abella (Wikipedia)
Industries that lead There is a wide variety of materials for use in 3D printing, including
adoption are aerospace, thermoplastics, thermoplastic elastomers, ferrous alloys, non-ferrous alloys,
dental, hearing aids sand, ceramic, paper, glass, electrical inks and even biological materials.
and motor sports
Available materials are limited for each class and there is no standardized way
to categorize or evaluate them, no standardized codex exists for defining their
characteristics. By contrast, traditional injection molding enjoys greater variety
of materials. With injection molding, not only is there more selection of
thermoplastic families, but within each one of those families, there may be 50
or 100 different choices from 10 different vendors. Not so with 3D printing.
Industries that lead manufacturing adoption are aerospace, dental, hearing aids
and motor sports. Aerospace seeks to drive out as much weight as possible and
that typically means either advanced materials or sophisticated designs that
maintain strength and have much less weight. There are challenges for
additive-manufactured parts on an aircraft (eg, regulations for safety).
Companies like Boeing are manufacturing only non-critical components. Motor
sports (eg, Formula 1, motorcycles, race cars, boats) love additive
manufacturing because of their low volume and high complexity.
Dental is a high-profile The dental industry is a high-profile poster child for success. There are
poster child for success smaller components, which are good for additive manufacturing because they
are typically time dependent and cost is size dependent. Its not feature
dependent like traditional manufacturing. Align Technologies InvisAlign
braces for teeth straightening are printed and work for a week or two at a
time. This is facilitated by additive manufacturing. The hearing-aid industry
has been using additive manufacturing for 12 to 15 years; over 90% of all
ear-hearing-aid shells are produced through additive manufacturing.
Bioprinting offers a lot of promise

Researchers have There is no potential application more exciting than in the emerging subfield
developed ways to of 3D bioprinting. Medical researchers and startups are already developing
fabricate genes using methods of printing human organs using genetically identical tissue from
new types of chips
patients. Organovo (ONVO) is developing techniques to print human tissue for
skin grafts and surgery.

3D Bioprinting Solutions is a Skolkovo, Russia-based company headed by

Vladimir Mironov that announced in March 2015 that it printed a thyroid gland for
an animal (mouse) using the companys patented bioprinting process.
Researchers at Princeton University have developed a proof of concept for a 3D-
printed bionic ear. The scientists seeded a culturing cartilage with human cells in
the shape of a human ear, and then embedded an inductive coil made of polymer
with silver nanoparticles to allow signal processing from cochlea-shaped
electrodes. Joseph Jacobson, head of the MIT Media Lab's Molecular Machines
research group, is bio-fabricating genes using CMOS chips with integrated
sending electrodes on silicon. Although implementation of printed organs remains
some years off, replacement parts for humans - as there already are for
machines - may someday be readily available at the touch of a button.
Key issues around Key issues around 3D printing include intellectual property (IP) rights. The
3D printing include question is who owns the designs to objects if they can be scanned and
intellectual property converted into a 3D file? Current law does not protect the digital rendering of
rights
a physical object, only the associated brands and trademarks. Without
established IP laws, we expect continuing skirmishes to arise over ownership
and rights for 3D schematics. 3D printing marketplaces like Shapeways or
Makerbots Thingverse include digital renderings of copyrighted characters,
but under the Digital Millennium Copyright Act, marketplaces have a safe
harbor provision as long as they have a posted policy that says they will
remove infringing material if the copyright holder requests it.
Print me up a car
Local Motors Strati One of the most impressive demonstrations of the technology is 3D printing a
is an electric vehicle car. Local Motors designs kit cars that are crowd-sourced designs, and the
with just 25 parts components can be machined for easy assembly by customers who are also
hobbyists. Local Motors Strati is an electric vehicle with just 25 parts. In the
future, customers may be able to walk into a mall, choose the configuration
and style and have it complexly printed within a few hours. While this may
seem very far off, the technology is on a trajectory that could realize this
vision within a few years.
Figure 105
The Strati electric car has Assembling the Strati

25 discrete parts versus
1,700 for the average
automobile
Source: CLSA

Falling prices stimulate growing consumer market

3D printing devices and The consumer market for 3D printing continues to attract dozens of startups
services are rapidly as prices fall as key patents held by Stratasys and others expire. Designers
developing a consumer
market have been using use printers like the MakerBot to start consumer-oriented
businesses selling shoes and jewelry (often on sites like Etsy) and we are
seeing 3D printing devices and services developing a consumer market. The
MakerBot Replicator Mini is priced at US$1,375, less than half the price of the
full-size Replicator at US$2,899. There is also a plethora of startups offering
sub-US$500 devices including Solidoodle 2 Pro, XYZ Printing Da Vinci 1.0 and
PrintrBot Simple Maker Edition Kit.
Future breakthroughs
There are a number of exciting developments that could prove disruptive to a
number of different industries. A new generation of 3D printers that print
edible products promises to enable personalized nutrition, for instance
creating a personalized nutrition bar with the precise amount of proteins,
carbs, vitamins and supplements needed in that moment. Over time this
could give rise to personalized pharmaceuticals compounded and created
specifically for the end user.
Fashion is another area Fashion is another area where 3D Printing is gaining ground, particularly in
where 3D Printing is shoes and garments. Nike and other shoe makers will be able to create shoes
gaining ground
customized to size, posture, stance, and your arch. Accessories will be
customizable and immediately printable. Theres a lot of interest in printing
accessories and clothing, for example Manufacture NY is a new initiative in
Brooklyns DUMBO neighborhood collocating designers and 3D fabricators for
all manner of apparel and accessories. Technology is advancing to enable
printing of mixed-material devices that may include rubber, structure and
wiring so that we may be able to print electronics, cars and even houses.
The combination of 3D Printing (additive manufacturing) with traditional

subtractive manufacturing promises to increase production speeds by orders of
magnitude. We will increasingly see 3D printing combined with CNC machining,
additive layering, and injection molding into factory in a box systems.
As we highlighted in Section 1 of this report, 3D printing stocks have

experienced a cycle of hype followed by disappointment. Although there are
limited investment opportunities at present, the technology itself promised far
greater impact among users of the technology.
Figure 106
3D-printing related stocks

close (US$m)
3D Systems DDD-US N-R US$ 12.56 0.27 0.33 46.52 38.24 1,407
Stratasys SSYS-US N-R US$ 21.45 0.19 0.33 112.89 65.74 1,118
ExOne XONE-US N-R US$ 10.10 (1.79) (0.90) na na 162
Voxeljet VJET-US N-R US$ 4.73 (2.81) (1.17) na na 88
Materialise MTLS-US N-R US$ 7.19 (0.07) (0.05) na na 340
Autodesk ADSK-US N-R US$ 55.71 0.84 (0.82) 66.32 na 12,516

10. The Internet of Things hits the mainstream

A world connected - the Hype around the Internet of Things reached fever pitch in the mainstream
Internet of Everything media in 2015, as technology and industrial raced to articulate their out IoT
strategies. Our 2014 report Deep Field: Discovering the Internet of Things
focused on growing relevance and opportunities across consumers and
businesses in a full spectrum of industries. Interest in wearable computing
and smart home also reached fever pitch in 2015 with a flood of new market
entrants resulting in a highly fragmented market. In 2016 we are seeing
industrial proof of concept projects chart paths to sustainable ROI, but some
businesses are taking a wait-and-see approach. While we do not expect a
major inflection point in IoT spending, the success of small projects paves the
way for greater investments down the road.
Figure 107
Connected Myriad implications Consumers, Companies with high IBM (IBM), Cisco (CSCO), GE (GE), PTC
Everything (IoT, for both industrial businesses, reliance on manual (PTC), National Instruments (NI),Google
eHealth, Sharing and consumer manufacturers, processes (GOOG), Intel (INTC), AMD (AMD),
economy) logistics, military, Siemens (SI), Oracle (ORCL), Salesforce
public safety, wireless (CRM), Amazon (AMZN), Teradata (TDC),
sensor network SAP (SAP), Splunk (SPLK), Broadcom
providers, analytic (BCOM), Qualcomm (QCOM); Apple (AAPL),
software vendors Samsung (5930), Sony (6758), Nike (NKE),
Intel (INTC), Microsoft (MSFT), GoPro
(GPRO), FitBit (FIT) , wireless network,
sensor and analytic software vendors
Source: CLSA
The term, Internet of Things, broadly encompasses a class of devices that

can monitor their environment, report their status, receive instructions and
even take action based on the information they receive, according to a
definition by The McKinsey Global Institute.
2015 was the year that the Internet of Things as a term went mainstream.
Our September 2014 report Deep Field: Discovering the Internet of Things
focused on the growing relevance and opportunities across consumers and
businesses in a full spectrum of industries. At the 2016 Consumer Electronics
Show over 900 companies out of 3,800 at the show said they had Internet of
Things products.
The promise of IoT results The promise of IoT results from the confluence of powerful technology
from the confluence of innovations (eg, sensor networks, ubiquitous connectivity, cloud computing,
powerful technology Big Data, Internet Protocol version 6 [IPv6] and other communications
innovations
protocols, declining chip and compute costs). Miniaturization and declining
cost of sensors make it increasingly easy for devices and physical assets to be
instrumented; declining cost of connectivity makes it easier to transmit data
so it can be collected, analyzed and acted upon based on context and
business need - in many cases automatically.
New services are The scope of whats referred to as the Internet of Things is extraordinarily
democratizing access broad, touching nearly every segment of the economy. Much of the early
for individuals focus has centered on industrial uses (eg, GEs Industrial Internet), public
infrastructure (IBMs Smarter Cities) and energy (smart-grid initiatives). New
services are democratizing access for individuals as well. The automotive and
transportation industries are actively adopting connected applications. There
is a growing range of products in self-tracking and healthcare (fitness bands
and other wearables) and home automation.
We know its big, but Market interest around the Internet of Things is building, but the landscape is
its still early still taking shape and remains difficult to delineate precisely. Initial
multitrillion-dollar forecasts have focused on economic value-add. Various

sources forecast dedicated technology spend on IoT to range between

US$300-500m by 2020. Investment is focused around consumer technologies
(home automation and health & fitness) and convergence
industrial/operational and information technologies.
IoT may have entered We had anticipated that hype would outpace reality in 2015, and whats
what Gartner refers happened so far in 2016 suggests that IoT may have entered what Gartner
to as the trough of refers to as the trough of disillusionment - the disenchantment with the hard
disillusionment
realities of implementing new technologies following a peak of inflated
expectations.
2015 was the year that On the consumer side, weve see some air come out of the proverbial bubble.
hype around wearable 2015 was the year that hype around wearable computing reached peaked,
computing reached and a flood of new market entrants has resulted in a highly fragmented
peak hype
market. FitBits (FIT) IPO in July 2015 was initially greeted with a lot of investor
enthusiasm but growing concerns over competition and commoditization caused
the shares to trade down. As of April 27, 2016, the shares are trading at
US$18.10, a 65% decline from annual high of US$47.60. We expect Quantified
Self, medical monitoring and vertical applications to give rise to a plethora of
specialized wearable devices over time, but business value will be created
from applications and data rather than devices themselves.
Googles Nest business The home automation sector did see Alarm.com IPO in June 2015 shares
unit has seen some gaining 36% as of 27 April 2016. However, Googles Nest business unit has
unfavorable public seen some unfavorable public commentary. After Google announced it would
commentary
discontinue any support for its Revolv automation hub in March 2016, the
former CEO of Dropcam spoke out publicly criticizing management of the Nest
product line. Apparently Dropcam accounted for over half of the US$340m in
annual revenues where the unit was losing over US$100m per year.
Samsungs SmartThings unit also faced negative blowback in the summer of
2015 when a faulty software update created problems for users.
Figure 108
The consumer IoT is the Consumer IoT application categories and sample devices
most visible in the
market today
Source: IDC, March 2015
On the commercial/industrial side, theres been a lot of steady progress with

proof of concept projects. IBM pledged to invest US$3bn into IoT technologies
and solutions. Cisco and GE have oriented their market messaging and
product strategy around IoT and connected products. Salesforce, Amazon and
Microsoft have launched IoT technology platforms. Intel reports IoT-related
revenues, and carriers like ATT, Verizon, Telefonica and others are investing in
IoT businesss units.

Forecasts anticipate robust growth

IDC estimates IoT market IDC estimates that worldwide Internet of Things (IoT) market spend will grow
spend will grow from from US$591.7bn in 2014 to US$1.3tn in 2019, a Cagr of 17%. The installed
US$591.7bn in 2014 to
base of IoT endpoints is expected to grow from 9.7 billion in 2014 to over
US$1.3tn in 2019
25.6 billion in 2019, reaching 30 billion in 2020. Devices/hardware,
connectivity, and ongoing services are estimated to account for approximately
60% of worldwide IoT market spend in 2019. The Asia/Pacific region leads the
market with roughly 38% of spending in 2019, followed by North America
with 28% and Europe with 22%.
ABI Research forecasts that IoT-related value-added services will grow 1t a

16% Cagr from US$50bn in 2012 to US$120bn in 2018. BI Intelligence
forecasts IoT software and services will grow at a 44% Cagr to reach
US$600bn by 2019, with number of IoT connected growing at a 35% Cagr
through 2019. A survey by Vodaphone found that 27% of respondents have a
Machine to Machine (M2M) project in place, up from 22% in 2014 with a
further 37% reporting projects ready to go live within two years.
Figure 109
IoT market expected Internet of Things market forecast to grow at a 17% Cagr
to grow to US$1.3tn
Source: IDC
Gartner forecasts Internet of Things endpoint spending will reach US$1.5tn in

consumer, US$566bn in cross-industry business, and US$911bn in vertical
business. Gartner forecasts 6.4 billion connected things in use in 2016,
growing a 30% YoY to reach 20.8 billion by 2020. 5.5 million new things will
get connected every day in 2016. Gartner also estimates that through 2018,
75% of IoT projects will take up to twice as long as planned. GrandView
Research estimates the IoT market at US$606bn in 2015 growing at a 15%

Ericsson and Cisco Cagr to US$1.9tn by 2022. There are also forecasts that look at the number
forecast 50bn connected of connections. Ericsson, the telecommunications company, has forecast 50bn
devices by 2020
connected devices by 2020 including M2M and other devices. Cisco estimates
that every second 80 things are newly connected to the internet, and this is
expected to reach 250 per second by 2020, reaching 50 billion connected
things and five billion connected people. Gartner estimates there will be 21
billion IoT devices connected by 2020.
Manufacturing is where the biggest IoT opportunity resides

Process and discrete According to IDC, process manufacturing (US$162bn) and discrete
manufacturing are the manufacturing (US$163bn) are the largest market opportunities. There are
largest IoT market
110m cars on the road with massive opportunity for sensors. By 2025 there
opportunities
could be 80bn sensors connected globally. Agriculture is a multi billionsensor
market. There are massive opportunities for factories - some of which have
50,000 sensors. The home is a big opportunity as are human beings. Over
4,800 devices are connected to networks every minute. By 2025 IDC
estimates there will be 152,200 devices connected every minute.
There is an enormous amount of data being created as well. IDCs Digital

Universe project has broken out types of data: classically created
(transactions), IoT relevant data (sensor data) and IoT actionable data. 44
Zettabytes in 2020 becomes 180 ZettaBytes. IoT actionable data will grow in
2025 at a rate eight times that and be as big as the digital universe in 2020.
Estimates of aggregate impact are even larger

Massive opportunity Different approaches have estimated IoTs value potential in the trillions of
defined by new dollars. GE forecasts that the Industrial Internet will add US$15tn to the
business models
world economy over the next 20 years. McKinsey Global Institute estimates
that the Internet of Things has the ability to create potential annual economic
impact of between US$2.7-6.2tn annually by 2025. Most current solutions
target cost savings and efficiency gains. New revenue-generating and
Everything-as-a-Service apps will create the greatest lasting value in our
view. Platform economics will power the long-term winners.
Cisco believes there is Cisco prominently publicized its view that there is US$14.4tn of value at
US$14.4tn of value stake globally over the next decade, driven by connecting people to people,
at stake
people to machines and machines to people. Value at stake represents
potential profits that can be created from improved asset utilization,
employee productivity, supply chain and logistics efficiencies, improved
customer experiences and innovation.
The pace of Internet-of-Things M&A is accelerating

Over US$7.5bn in total M&A of Internet of Things continues as a torrid pace, with Ciscos acquisition
disclosed IoT transaction of Jasper Technologies for US$1.4bn in February 2016 the most significant
value from Jan 12
deal of late. PTC has spent over US$500m on several IoT assets including
to Sep 14
Coldlight, Axeda and ThingWorx. According to M&A advisory firm Hampleton
Partners, there was over US$39.9bn in total disclosed IoT transaction value
over the past three years, Transaction volumes increased by 110% YoY in
the period between November 2014-2015, with a median disclosed revenue
multiple of 3.5x; multiples ranged from 0.5x revenue through to 51.6x.
According to Hampleton Partners analysts, the initial wave of M&A focused
on lower levels of the tech stack as players sought to establish ownership of
the basic building blocks for IoT solutions. Business, consumer and
government demand is driving adoption and currently M&A activity is most
active around monitoring.

Capital is readily accessible for startups

IoT companies raised By one estimate, 10% of VC investments are IoT related. There are a growing
over US$1.5bn across number of IoT-dedicated efforts from Intel Capital, Frost Capital, McRock,
153 deals in 2014
Motus and many other firms. According to CB Insights, IoT companies raised
over US$2.0bn across 221 deals in 2014, with US$1.5bn 141 for the first nine
months of 2015. Crowdfunding is also playing a key role, with IndieGoGo and
Kickstarter helping startups test the market for their ideas.
Asia leads adoption of IoT solution

The US and China will According to IDCs the US and China will account for around 65% of the
account for around market opportunity together. Every region is moving ahead for different
65% of the IoT market
reasons. In the US adoption is focusing on Digital Transformation. In China,
theres a surge of investment focusing on bringing a middle class online.
Japan is interested in creating a connected society around manufacturing. In
Europe adoption is driven by the auto industry and Industry 4.0 initiatives.
Internet of Things is accelerating innovation

In the view of IDC, the IoT is the most advanced and most important of
innovation accelerators what the analyst firm refers to as the 3rd Platform -
a set of technologies encompassing cloud, big data, social and mobile. The
cloud is necessary for scale - variable workloads from different devices that
need to scale. IoT needs to have analytics engines that enable real-time
decision making.
Spending will target applications, services and analytics

Software and services are We see parallels to the enterprise-resource-planning (ERP) market in the late
the big opportunities 1980s and early 1990s as benefits of declining compute and storage costs are
amplified by near-ubiquitous connectivity. For the near term, IoT relies on
customized software and services. Over time, we see growth of SaaS
businesses and connected products.
While fragmented, Software lies at the heart of IoT solutions, with value accruing to applications,
software platforms will the analytics stack and platforms. Concerns over heterogeneous standards
knit the IoT together
are overdone in our view. As IoT-specific standards emerge, interoperability is
key to success, facilitated by evolving software platforms and cheaper
compute cost.
Native innovations Unique requirements of IoT applications are driving innovations in hardware,
plumbing the future components, wireless networks and networking architecture. IoT-native
devices will benefit from cheap open-source components, improving power
management and lean communication protocols. Next-generation
architectures will power IoT-designed wireless networks and fog computing.
Intelligence at the core of IoT value

Intersection of The idea that machines can be instrumented with sensors and connected to
information technology the internet to transmit data and updates to business has been around for
and operational
technology is the key many years. The intersection of information technology and operational
technology is the key and there is no dominant vendor at this point. An
intelligent system increases the value of business decisions. The value of IoT
solution is proportionate to the speed and number of times IoT data is
analyzed. Value and speed are the two vectors to measure potential value
creation. The City of Melbourne has a highly sensor-enabled tram system that
gives citizens apps to see whats going on. The trams are free and the
business district never has problems with parking.

Cost reduction, incremental revenues and customer satisfaction are the main
areas for value creation from data and predictive or preventive maintenance.
Replenishment automation is both a revenue enhancer and customer
satisfaction driver.
Creating a high value IoT system of intelligence

IoT ecosystem is The IoT ecosystem is enormously complex. For devices the main focus is
enormously complex energy consumption and density. Theres a lot of discussion of who will build
the network. Theres an aggregation point called the IoT gateway (this is key
for ownership and mindshare). There needs to be an open-data platform as
the input funnel for solutions. IoT platforms need to manage at an enterprise
level. Most IoT contracts are in the US$5-10m range. There are not a lot of
big paydays right away for most vendors.
Figure 110
Benefits accrue broadly from IoT adoption

Category Applications Benefits
Smart cities Street lights that dim when roads are empty, traffic sensors that optimize Energy savings, lower congestion,
lights to traffic flow, monitoring bridges and other public infrastructure to cost savings from proactive
monitor maintenance maintenance
Healthcare Remote monitoring of patients, personal health monitoring, diagnostic and Better quality care, more frequent
surgical procedures assisted by ingestible computing devices access to professionals, better health
Automotive Accident alerts (GM OnStar), automated traffic-flow optimization, proactive Regulatory requirement
maintenance alerts
Supply chain and logistics Fleet optimization, supply-chain tracking and product tracking Cost savings, improved logistics
Intelligent buildings Automated monitoring and adjustments of HVAC based on human activity Energy cost savings
Retail/commerce Wireless payments, indoor "geo-fencing" applications, enhanced omni- Higher sales, improved customer
channel experience satisfaction and loyalty
Construction, mining and Sensors to monitor location, usage of vehicles, anticipate preventive Better efficiency, lower repair costs,
transportation maintenance less downtime
Emergency services Faster, better coordinated disaster response Improved safety, response time
Source: CLSA
A market at the early stages of exponential growth

Activity around the Much of the activity around Internet-of-Things startups, device adoption and
Internet of Things is value-add is expected to accelerate in the 2018-20 period. Currently, there
expected to accelerate
are early adopters in retail, energy (notably lighting and smart grid),
in the 2018-20 period
healthcare and industrial equipment but we expect a broad range of products
to be sold into different markets. In healthcare, there will be an increasing
range of wearable devices, monitors, surgical tools and even ingestible
devices. In physical infrastructure, we will see devices for monitoring all types
of transportation (air, rail, shipping and trucks) as well as sensors on roads,
bridges and in public spaces. In agriculture, there will be soil, temperature
and weather sensors. Factories will increasingly deploy sensors on industrial
machinery and robotics. Some of the key industries likely to see massive
changes and benefits from adoption of connected devices include healthcare,
manufacturing, insurance, banking, retail, computing services, government,
transportation, utilities and others.
Retailers are the most Retailers are the most advanced industry in terms of adoption. The retail
advanced industry in industry is smaller (around US$70bn according to IDC) and thats leading the
terms of IoT adoption
way for IoT customers. Burberry currently tracks 80% of all transactions and
everything in the supply chain. One of the biggest challenges is getting
people to opt in for retail. In manufacturing theres a far more spread out
view of IoT deployments. Harley Davidson makes a new motorcycle every 86
seconds. Healthcare is a laggard, but adoption is still at the learning phase,
because its risk averse, highly regulated and security conscious.

Business model shift - From buying and selling to renting

Internet-of-Things Perhaps the most subtle yet significant benefit in a world of connected
technologies enable a things. While the trend of attaching maintenance and monitoring services is
new class of applications
not new, whats increasingly possible is the business model transition from
buying and selling products to renting assets. Internet-of-Things technologies
enable a new class of applications that deliver goods and services on demand
to customers (mostly consumers) via the smartphone.
Figure 111
The rise of on-demand Technologies enable asset-sharing, rental and context-based services
mobile services is an
outgrowth of connectivity
and location services
Source: Steven Schlafman, RRE Ventures
New business models According to a Deloitte survey, most current IoT applications target cost
and innovation will savings, visibility, efficiency gains and risk reduction with only 15% focused
provide the catalyst
on innovation and new business models. We believe an inflection point will
follow from new services that harness incremental value from data and
analytics. Importantly, the Internet of Things allows buying-and-selling
businesses to transform to rental businesses, while enabling cities, homes
and cars to become platforms at the center of further innovation.
Uber is a prime example. Its smartphone app allows customers to order a car
service while being able to see where cars are in real time on a map. The ride
is paid for on the riders account through Uber, so no money changes hands,
and both the driver and rider are rated (leveraging social technologies). In
many respects, this is a simple location-aware ecommerce app; what could
make this truly an IoT experience is if the car were self-driving.
Cars To Go is an IoT Daimler makes Cars To Go, an IoT app that allows a customer to get a car
app that allows a based on a local app. Launched in several German cities and San Francisco
customer to get a car
initially, the app allows customers to rent from a fleet of cars by the minute
based on a local app
or the hour. The cars can be parked in reserved street spaces and users can

monitor the electric charge or gas tank levels, mileage and other
diagnostics. This is a way for an automaker to become an operator of a
rental fleet. This cuts out fleet providers, distributors, insurance companies
and other intermediaries.
The value is not from Continental automotive subsystems are developed so that devices in autos
connections and are an IoT package that enables connected vehicles. Cummins makes
instrumentation, its the
industrial diesel engines for tricks and combines, IBM enables them to
value of the data
collect information and potentially rent it to customers. Pratt & Whitneys jet
engines have 16% more fuel economy from thousands of sensors, with 1TB
of data per flight analyzed to help improve reliability and reduce fuel cost.
The company runs this as a service, with airlines renting engines. Whirlpool
has connected devices for home appliances. The value is not from
connections and instrumentation, it is the value of the data and the
experience it creates for customers. The entire delivery model changes in a
connected products environment.
Figure 112
IoT technologies span IoT technology elements

the full stack plus
cloud services and
vertical expertise
Source: IDC, 2015
PwC estimates that Crowd Companies founder Jeremiah Owyang estimated that sharing economy
five sharing-economy companies have received over US$21bn in funding over the last 10 years. A
sectors will reach
study by PWC estimates that five main sharing-economy sectors (peer-to-
US$335bn by 2025
peer lending and crowdfunding, online staffing, car sharing, peer-to-peer
accommodations and music and video streaming) accounted for US$15bn in
revenue in 2013, growing to US$335bn by 2025. The traditional rental sector,
including equipment, bed & breakfast (B&B) and hostels, books, cars and
DVDs, accounted for US$240bn in 2013 and are also expected to reach
US$335bn in 2025. There has been quite a bit of pushback though, car-for-
hire service Lyft announced it would pay US$12m to settle a class action suit
along with extending some benefits for drivers. Uber and Airbnb have also
faced lawsuits over employee benefits and customer safety.

The Internet of Things For investors, the Internet of Things poses a bewildering array of potential
poses a bewildering winners and losers with a sprawling universe of companies exposed to
array of potential different layers in the technology stack and different segments in the value
winners and losers
chain. There is a broad range of technologies with applicability and varying
stages of maturity. Theres connectivity, which includes cellular, fixed
broadband, WiFi, protocols like ZigBee, ZWave and other networking
technologies. There are hardware requirements such as at end points theres
need for modules and sensors, gateways or propagator nodes where data is
aggregated and real-time analytics performed. Theres need for security
hardware, server, storage and other hardware including switches, routers and
industry-specialized hardware.
Software includes analytics, for real-time analysis and event-triggers as well

as deeper trend and predictive analytics. Application software can extract
data from physical systems and translate to workflow, or provide industry
specific functions. Platforms can handle the flow of data from device through
the network, enabling collection, integration and analysis of data. Services
may include consulting, IT implementation and installation, managed services
and outsourcing and delivery of security, hardware and software as a service.
For large-cap investors, companies like GE and Cisco have made IoT central
to their messaging and business strategy, so to some extent these companies
provide a proxy for adoption of IoT solutions more broadly. In software, we
favor PTC as a platform play - its ThingWorx offering is arguably the broadest
and deepest in the market, and while it represents just 8% of software
revenues for the firm, wed expect robust growth to continue for the
foreseeable future. Splunk also represents a promising and unique play on
machine data analytics and the company has a dedicated IoT practice in early
stages of evolution headed by a former GE Capital CIO.
Figure 113
Internet of Things related stocks

IBM IBM-US O-PF US$ 151.02 14.92 13.44 10.12 11.24 145,021
PTC PTC-US O-PF US$ 37.75 2.23 1.59 16.93 23.74 4,327
Oracle ORCL-US U-PF US$ 38.84 2.62 2.80 14.82 13.87 161,181
Salesforce.com CRM-US BUY US$ 81.05 0.75 0.95 108.07 85.32 54,938
Teradata TDC-US BUY US$ 27.30 2.06 2.43 13.25 11.23 3,549
Splunk SPLK-US BUY US$ 56.64 0.18 0.31 314.67 182.71 7,526
Samsung 005930-KR BUY won 1,380,000 121,491 152,165 11.36 9.07 188,491
Sony 6758-JP BUY 2941.00 119.40 90.60 24.63 32.46 35,055
GoPro GPRO-US N-R US$ 9.71 0.76 (0.91) 12.78 na 989
Fitbit FIT-US N-R US$ 13.00 1.07 1.17 12.15 11.10 2,018
Qualcomm QCOM-US N-R US$ 52.70 4.66 4.10 11.31 12.87 77,412
Intel INTC-US N-R US$ 32.14 2.33 2.39 13.79 13.44 151,765
GE GE-US N-R US$ 30.45 1.31 1.50 23.24 20.28 279,916
Cisco CSCO-US N-R US$ 28.96 2.21 2.33 13.10 12.42 145,660
FleetMatics FLTX-US N-R US$ 42.76 1.58 1.76 27.06 24.33 1,667
CalAmp CAMP-US N-R US$ 14.42 1.15 1.24 12.54 11.66 529
Numerex NMRX-US N-R US$ 7.45 (0.12) (0.17) na na 145
Digi International DGII-US N-R US$ 11.12 0.26 0.39 42.77 28.33 288
AT&T T-US N-R US$ 40.40 2.71 2.86 14.91 14.14 248,721
Verizon VZ-US N-R US$ 52.99 3.99 3.93 13.28 13.50 216,003

Important disclosures 2020 innovation
Companies mentioned
3D Bioprinting Solutions (N-R)
3D Systems (N-R)
Accenture (ACN US - US$116.47 - OUTPERFORM)
Acxion (N-R)
Adobe Systems (N-R)
Aerovironment (N-R)
Airbnb (N-R)
Alcatel-Lucent (N-R)
Align Technologies (N-R)
Alphabet (GOOGL US - US$721.71 - BUY)
Amazon (AMZN US - US$702.80 - OUTPERFORM)
Ambarella (N-R)
AMD (N-R)
Amex (N-R)
Apple (AAPL US - US$95.22 - BUY)
Applied Micro (N-R)
Arcam (N-R)
ArcSight (N-R)
Aruba Networks (N-R)
AT&T (N-R)
Audi (N-R)
Autodesk (N-R)
AVG (N-R)
Baidu (BIDU US - US$170.05 - BUY)
Barclays (N-R)
Barracuda Networks (N-R)
BBVA (N-R)
BlackDuck Software (N-R)
BlackRock (BLK US - US$354.01 - OUTPERFORM)
Bloomberg (N-R)
BMW (N-R)
Boeing (N-R)
Bosch (N-R)
Box (N-R)
Broadcom (AVGO US - US$146.73 - OUTPERFORM)
Broadcom (N-R)
BYD Electronic (N-R)
CA Technologies (N-R)
Canon (7751 JP - 3,115 - BUY)
CBA (CBA AU - A$77.96 - SELL)
Checkpoint Systems (N-R)
Cisco (N-R)
Cleversafe (N-R)
Cloudera (N-R)
Cognex (CGNX US - US$40.11 - UNDERPERFORM)
Cognitive Scale (N-R)
Cognizant Tech (CTSH US - US$62.94 - BUY)
Coin Desk (N-R)
Coinbase (N-R)
Coldlight (N-R)
Composite Software (N-R)
Credit Suisse (N-R)
CSC (N-R)
Cvent (N-R)

CyberArk (N-R)
Cycorp (N-R)
DataStax (N-R)
Dell (N-R)
Didi-Kuaidi (N-R)
Digital Reasoning (N-R)
DISH Network (N-R)
Dominos Pizza (N-R)
Dropcam (N-R)
Dupont (DD US - US$65.75 - UNDERPERFORM)
EMC (EMC US - US$27.81 - OUTPERFORM)
Emerson (EMR US - US$50.65 - UNDERPERFORM)
EnerNoc (N-R)
EOS (N-R)
Ethereum (N-R)
Eucalyptus (N-R)
ExOne (N-R)
Expedia (N-R)
Experian (N-R)
Fab.com (N-R)
Facebook (FB US - US$117.35 - BUY)
FICO (N-R)
FireEye (N-R)
Fitbit (N-R)
Flipkart (N-R)
Ford Motor (F US - US$13.19 - OUTPERFORM)
Fortinet (N-R)
Fujitsu (6702 JP - 417 - BUY)
Gemalto (N-R)
General Dynamics (N-R)
General Electric (N-R)
General Motors (GM US - US$30.57 - OUTPERFORM)
GitHub (N-R)
Goldman Sachs (GS US - US$154.51 - OUTPERFORM)
GoPro (N-R)
Greenplum (N-R)
Gridpoint (N-R)
Hitachi (6501 JP - 495 - BUY)
Honeywell (N-R)
Hortonworks (N-R)
HP (HPQ US - US$11.66 - UNDERPERFORM)
HTC (2498 TT - NT$67.3 - BUY)
IBM (IBM US - US$147.25 - OUTPERFORM)
Imperva (N-R)
Imprivata (N-R)
Infosys (INFO IB - RS1,190.8 - OUTPERFORM)
Ingram Micro (IM US - US$33.79 - UNDERPERFORM)
Intel (INTC US - US$30.15 - UNDERPERFORM)
Interbrand (N-R)
Intuit (N-R)
Intuitive Surgical (N-R)
Invensys (N-R)
IP Softcom (N-R)
iTron (N-R)
IXYS Corp. (N-R)

Jasper (N-R)
Jaunt (N-R)
Joulex (N-R)
JPMorgan Chase (JPM US - US$63.51 - BUY)
Kayak (N-R)
Kensho (N-R)
Lenovo (992 HK - HK$4.88 - BUY)
Lexmark (N-R)
LinkedIn (LNKD US - US$125.56 - BUY)
Lockheed Martin (N-R)
Looking Glass (N-R)
Loop AI (N-R)
Lyft (N-R)
Mashery (N-R)
Materialise (N-R)
McAfee (N-R)
Meituan-Dianping (N-R)
Mercedes-Benz (N-R)
Microsoft (MSFT US - US$50.62 - OUTPERFORM)
Mind Meld (N-R)
Mobiletron (N-R)
Mobileye (MBLY US - US$36.84 - BUY)
MongoDB (N-R)
Moog (N-R)
Motorola Solutions (MSI US - US$68.75 - UNDERPERFORM)
National Instruments (N-R)
Nest (N-R)
Netflix (N-R)
New Egg (N-R)
Nice Systems (N-R)
Nike (N-R)
Nissan Motor (7201 JP - 1,050 - BUY)
Northrop Grumman (N-R)
NQ Mobile (N-R)
Numenta (N-R)
Nvidia (N-R)
OpenTable (N-R)
Oracle (ORCL US - US$39.41 - UNDERPERFORM)
Palantir (N-R)
Palo Alto (N-R)
Panasonic (6752 JP - 963 - BUY)
Panaya (N-R)
Pinterest (N-R)
Pivotal Labs (N-R)
Polycon (N-R)
Priceline (N-R)
Proofpoint (N-R)
Proto Labs (N-R)
PwC (N-R)
Qihoo 360 (N-R)
QlikTech (QLIK US - US$30.95 - BUY)
Qualcomm (QCOM US - US$54.52 - BUY)
Qualys (N-R)
Quest Software (N-R)
Quirky (N-R)

Rackspace (RAX US - US$23.53 - SELL)

Rapid7 (N-R)
Raytheon (N-R)
Red Box (N-R)
Renishaw (N-R)
Rio Tinto (RIO AU - A$44.00 - UNDERPERFORM)
Ripple (N-R)
Risk Metrics (N-R)
Rockwell (ROK US - US$111.17 - UNDERPERFORM)
Royal Bank of Scotland (N-R)
RSA (N-R)
Saffron Technology (N-R)
SAIC (N-R)
Salesforce.com (CRM US - US$81.02 - BUY)
Samsung Electronics (005930 KS - 1,286,000 WON - BUY)
Secret (N-R)
SecureWorks (N-R)
Sentient Technologies (N-R)
ServiceMax (N-R)
Shapeways (N-R)
Siemens AG (N-R)
Silverspring Networks (N-R)
Skyworks (N-R)
Snapchat (N-R)
Softlayer (N-R)
Sony (6758 JP - 2,904 - BUY)
Sourcefire (N-R)
SpaceX (N-R)
ST Microele (N-R)
Staples (N-R)
State Street (STT US - US$61.43 - UNDERPERFORM)
Stratasys (N-R)
Symantec (N-R)
Tableau (N-R)
Tata Comm (TCOM IN - RS449.5 - BUY)
Teledyne (N-R)
Teradata (TDC US - US$26.44 - BUY)
Tesla (TSLA US - US$220.28 - UNDERPERFORM)
Texas Instruments (TXN US - US$58.53 - UNDERPERFORM)
Textron (N-R)
Textura (N-R)
Theranos (N-R)
Tiger Direct (N-R)
Time Publishing (N-R)
Toyota Motor (7203 JP - 5,506 - BUY)
Twitter (TWTR US - US$14.43 - UNDERPERFORM)
Uber (N-R)
UBS (N-R)
UPS (N-R)
Varonis (N-R)
Verisk Analytics (N-R)
Vertica (N-R)
Virgin Galactic (N-R)
VMware (VMW US - US$59.76 - OUTPERFORM)
Vocal IQ (N-R)

Volkswagen (N-R)
Voltage (N-R)
Volvo (N-R)
Voxel Jet (N-R)
Vuforia (N-R)
Walmart (N-R)
WebEx (N-R)
Whetlab (N-R)
XenSource (N-R)
Xiami (N-R)
Yahoo! (YHOO US - US$36.50 - OUTPERFORM)
Zenefits (N-R)
Zipcar (N-R)
Zynga (ZNGA US - US$2.56 - UNDERPERFORM)
Covered by CLSA Americas; Covered by CLSA; Covered by CAST
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2020 in Sight

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2020 in sight

Innovation pulls the bits together

The Unicorn Era winds down ............................................................34

Bits flow into currents .....................................................................53

10 themes from digital to physical ...................................................63

Virtual reality ............................ 69 Autonomous vehicles ............... 101

Blockchain ................................ 77 Robotics ................................. 108

Open source ............................. 82 3D printing ............................. 116

Security ................................... 88 Internet of Things .................... 123

Follow our 2020 innovation series

2 ed.maguire@clsa.com 20 June 2016

10 themes frame A new generation of high-growth businesses builds on connectivity, massive

Recommended innovation stocks

20 June 2016 ed.maguire@clsa.com 3

Add the bits together and stir

4 ed.maguire@clsa.com 20 June 2016

Signs of a new industrial revolution emerge

Why is innovation so important?

Bits come together for a Cambrian innovation explosion

20 June 2016 ed.maguire@clsa.com 5

robotics and automation is extraordinarily powerful. Gartner refers to a Nexus of

Grownups dont believe in unicorns

Source: Research.stlouisfed.org, FactSet

Sentiment is growing more cautious, judging by the dropoff in VC funding

6 ed.maguire@clsa.com 20 June 2016

Average return of 90 US According to an analysis by CB Insights, the average return of 90 US VC-

20 June 2016 ed.maguire@clsa.com 7

Innovations shifts from atoms to bits . . . to atoms

Technology adoption Evolution of technology systems

8 ed.maguire@clsa.com 20 June 2016

among businesses and consumers, along with significant productivity gains

The coming Fourth Industrial Revolution as growth catalyst

20 June 2016 ed.maguire@clsa.com 9

Creating value: Platforms, applications, applied analytics

Platform businesses harness innovation from an ecosystem of partners,

Application businesses (more broadly referring the application of various

10 ed.maguire@clsa.com 20 June 2016

Applications can be Applications can be horizontal in nature (customer relationship

20 June 2016 ed.maguire@clsa.com 11

businesses: eBay is an application that makes money from transaction fees;

There are dozens of pure-play publicly traded application companies. Leading

12 ed.maguire@clsa.com 20 June 2016

Leading applied analytics Applied analytics vs S&P 500

Companies that are leaders in applied analytics include Amazon, Google,

20 June 2016 ed.maguire@clsa.com 13

to solve complex optimization problems, and Microsoft (MSFT), which has

High-growth software is High-growth software versus big tech stock performance

14 ed.maguire@clsa.com 20 June 2016

IT security exhibits IT security - strong fundamentals but a crowded market

The 3D printing sector 3D printing stock performance

20 June 2016 ed.maguire@clsa.com 15

Solar cost projected to undercut natural gas by the early 2020s

Source: Ramez Naam

16 ed.maguire@clsa.com 20 June 2016

A brief survey of the rich landscape of innovation

Innovations in the digital sphere

20 June 2016 ed.maguire@clsa.com 17

Innovations in the digital sphere

18 ed.maguire@clsa.com 20 June 2016

Innovations in the physical world

Autonomous vehicles The fundamental nature of transportation is changing as autonomous vehicles

3D printing - in a Interest and hype around 3D printing peaked in 2014, leading to

20 June 2016 ed.maguire@clsa.com 19

Innovations in the physical world