New software for traditional hardware manufacturers

June 15, 2017

Establish an unassailable position and achieve network effects.

With the transition to Industry 4.0 with its connected machines and sensors that continuously collect data and transmit it to central servers over WiFi, even machinery and equipment manufacturers need to upgrade their products to digital. Other industries that used to be

McKinsey & Company's Mark Patel

strictly analog have already made the switch. Today, the average car, for example, has more lines of software code than an Apple Macbook.

By 2012, smartphone makers already employed twice as many software developers as hardware developers. And a good two-thirds of all machinery and equipment manufacturers now also offer their customers software solutions.

So how do companies successfully tread the path from analog products to digitally ready products? How do they equip their machines with the right software? They need to bring in new skills and talent, as well as new organizational structures and processes. They need to focus on what creates value. 

Companies that previously specialized in the mechanics of their machinery will find it extremely difficult to suddenly develop a convincing strategy for installing software from a standing start.

What do customers want? How much are they prepared to pay? What are our competitors doing?

Unfortunately they lack the experience to answer these questions.

The following principles can help develop a software strategy that really delivers value:

Develop a detailed plan for the transformation that fits the company strategy

Software requires more frequent updates and ongoing support than traditional mechanical products—which is why the company needs its own software strategy. This strategy must outline the software-specific capabilities that will differentiate the machines from rival products in the future, what type of software is needed, and the deadlines for achieving this. First, however, market research needs to identify which problems or inefficiencies customers encounter that could be solved by software.

Intel, for example, developed a range of digital assistants for its high-performance chips used in advanced analytics. In its market research, Intel discovered that customers often feel they are on their own when they run into problems—hence the development of these help programs. The strategic plan for software development is based strictly on the company’s overall strategy and its quantitative targets for the most important products. And if brand image is a crucial component of the strategy, this must be supported with particularly advanced and powerful software. Automaker Mercedes plowed extensive resources into establishing digital capabilities—from entertainment and navigation systems to autonomous driving. 

Top management must be involved in the development of the strategy

Without the chief executives, nothing will work. Without the impetus that only the top management can provide, transformation efforts will generally focus only on smaller projects, and never fully realize the potential that a full-scale rollout throughout the organization can deliver. And only top management can take the strategic decisions necessary in the event of target conflicts. For example, does the company primarily want to develop software to boost sales of hardware products, or does it want to achieve additional revenues through software sales? 

Focus on the company’s strengths rather than trying to emulate the strategy of a start-up

For most traditional manufacturers, it makes little sense to go into direct competition with start-ups when they lack their pace, agility, and specialist skills. Instead, they should concentrate on products where their strengths can help—their customer base, brand appeal, and industry knowledge. Aggressive new market entrants can even be combated by forming alliances with competitors to help develop better software. Audi, BMW and Daimler, for example, work together as partners in the mapping service Here, which they acquired from Nokia. Here delivers the accurate, automotive grade maps needed for autonomous driving—and since it also supplies other automakers, it keeps mapping service providers from outside the industry at a distance. 

Strategic aim: Establish an unassailable position and achieve network effects

An ambitious target, but entirely feasible: Many companies have become indispensable in their particular field because they offer unique products or services. Siemens, for example, succeeded in developing machines and automation software for production lines that are now used by 14 of the world’s 15 biggest automakers, while capturing an 80% global market share in the industry. Companies that offer a strong product can also invite external software developers to develop apps—the more smart applications a product has, the greater its appeal. After launching the iPhone, for example, Apple set up its own App Store, which delivers very strong revenues. 

Develop a pricing strategy

Customers don’t trust free products—and businesses don’t like them because they generate no revenue. Which is why strategists should come up with lucrative pricing strategies: One option is the “freemium” model where the basic software is offered free with the purchased device, but a better version with more features costs extra. Another option is a pay-per-use model either for the software alone or for the overall package. And a third option is a subscription system regardless of use—again, either for the software alone or for the machine and programs. 

Mark Patel is a partner in the San Francisco office of McKinsey & Company.