In its latest move to expand into the cloud, General Electric (NYSE:GE) has decided to partner with Microsoft (NASDAQ:MSFT) to bring its industrial IoT platform, Predix, to MSFT's Azure cloud offering. Predix already runs on AWS and Oracle's cloud platform, and the partnership with Microsoft will help GE establish itself as the dominant player in Industrial IoT. The deal should benefit General Electric in a number of ways, and we believe that GE has positioned itself for long-term growth as more and more customers shift to digital platforms and internet-connected machines.
GE's move into the cloud has been met with skeptics, and many analysts have wondered why the firm would attempt to compete in the increasingly cutthroat cloud industry where established players such as Amazon have carved out strong competitive advantages. Amazon has expanded its own IoT platform in recent years, and while competition is intense, GE does not intend to compete directly with cloud providers. GE's strategy is about building scale, creating first mover advantages, and establishing itself as the dominant player in Industrial IoT. GE does not care so much how its customers reach Predix (i.e. through which cloud platform), but that as many customers use Predix as possible. The purpose is to build network effects: as more customers use Predix it will attract more developers who can design more applications and services, which in turn will attract more customers. Through network effects, we believe GE will be able to carve out a moat in industrial IoT that rivals late to the party who operate at lower scale will have trouble surmounting.
The partnership with MSFT will drive new customers to Predix and help GE build meaningful scale. Azure is the number two player in cloud behind AWS with 9% share, and it is growing rapidly: In the fourth quarter of 2015 Azure revenues increased 124%, the fastest growth rate in the industry. Predix enables industrial machines to connect to the Internet, and as GE grows customers and collects more data the company should be able to sell more software and services that allow clients to analyze data and optimize performance. These services earn higher margins compared to industrial equipment. CFO Jeff Bornstein expects revenue from software applications to grow at a 25% CAGR, from $5 billion (4% of company revenues) in 2015 to $15B (10% of revenues) by 2020, which should help the company expand margins and generate more stable revenue streams (services are less exposed to cyclicality than equipment). In addition, GE can use the data from customers to create hardware products that better suit the needs of customers, which would raise switch costs. Creating differentiated products unique to the platforms of customers would make it costly and time consuming for clients to switch to other suppliers, as they would likely have to alter their production models.
General Electric is at the forefront of a new industrial revolution. Spending on industrial IoT is expected to grow at a 20% CAGR over the next five years, and will encompass a range of industries from mining and manufacturing to agriculture and energy. The partnership with Azure is a big step for GE, and it should help the firm build the critical mass of volumes needed to accelerate network effects and make GE the go-to player in Industrial IoT. We see potential for greater pricing power, higher margins, and more stable revenues as GE expands its Predix platform, which should lead to long-term value creation for shareholders.
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