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Google's Acquisition of Nest Shows How B2C and Advanced Automation Make for Success in Home Energy Management

Lux Research

BOSTON, MA, January 15, 2014 – This week Google announced a cash purchase of home automation start-up Nest Labs for $3.2 billion; Google Ventures has been a major investor in the company, whose last funding round totaled $80 million. The acquisition represents a re-entry of sorts: Information technology companies' initial foray into HEM last decade proved to be tricky, owing to fragmented utility sector, lack of clear standards, high hardware costs, and lack of clear incentives, leading Google, Microsoft, and Cisco to exit the space in late 2011. Google's acquisition signals that home energy management (HEM) is a hot sector for investment again. In addition to Google, Microsoft has shown the intention of re-entering HEM with the acquisition of id8 Group R2 studios in Q4 2012.

Nest labs has done three things well to overcome the difficulties faced previously by HEM segment:

1) Making an aesthetically appealing device with a simple payback under two years, which is the tipping point for the residential consumer;

2) Combining a B2C distribution strategy with advanced automation capabilities; and

3) Moving beyond energy management into security and smoke detection to offer a more complete user-comfort package. 

Lux Research mapped 25 innovative developers in the HEM space based on their distribution strategy and automation capabilities (see upcoming report "Master of the House: Cutting through the Hype in the Home Energy Management Space"). What is striking is that there are just three companies that have both B2C and advanced automation: Nest Labs, Tado, and There Corporation.

Although the price for the acquisition looks rather high, 4X of the valuation in the last funding round in January 2013Google has three distinct motivations for it: 1) innovation in smartphones and tablets is incremental and arguably with diminishing marginal utility; 2) a smart thermostat and smoke detector are good additions to the line of connected gadgets from Google such as Google Glass; and 3) the acquisition fits with Google's long standing strategy of clean energy and energy efficiency investments.

The Nest acquisition has critical implications for utilities, venture investors, and consumer electronics companies. Utilities are looking for differentiation and customer retention, especially in a market like the U.S., which has 3,200 utilities, so partnering with large analytical powerhouses such as Google can now be very attractive. There have been early signs of such collaborations between Nest Labs and NRG Energy. For investors like Nest backers Kleiner Perkins, the attractive returns underscore the appeal of energy IT or "cleanweb" sector for the 10-year venture fund, no doubt prompting the VC herd to keep sniffing around for me-too deals. Finally, Nest's success will increase the already high interest in "smart homes" from consumer electronics companies such as LG Chemicals and Samsung. Conventional thermostat manufacturers such as Honeywell have been behind the curve on this, and have previously tried to stop Nest through legal means. These laggards should change tactics and seek a second mover advantage by coming up with a better version of the smart thermostat.