Why Would Google Pay $3.2 Billion for Nest?

(This blog is co-authored by Howard Chong)

Google’s acquisition of Nest Labs Inc. is puzzling. It’s nice that Nest is about reinventing previously “unloved things” like thermostats and smoke detectors. But is it really worth $3.2 billion? To put it into context, assuming a 20% profit margin (Nest’s profits are opaque and will remain so as a subsidiary to Google), selling a $250 Nest thermostat to all 132 million U.S. households comes out to $33 billion in revenue and $6.6 billion in profits. So, you break even only if you sell to about 50% of all homes in the United States. This seems unlikely. Of course there is also scope for increased market share internationally, but this will take time. Plus, unlike the iPhone, after someone buys a Nest, they aren’t going to upgrade every 18 months.

nest-thermostat-featured

Google is a smart company. So what is their angle? How will Google monetize Nest? We think the answer is data. Remember, Google is a media company. They sell ads. For most of its revenue, Google doesn’t sell the “thing”, it sells to sellers a way to find buyers. Nest data will help it do this. The $250 you pay for a Nest thermostat is only a small part of a much larger stream you spend on electricity, natural gas, and all the appliances in your home that use this energy.

Nest data give Google a strategic advantage in these other markets, immediately creating opportunities for selling targeted advertising for companies that operate in this space. In some ways, targeting will be straightforward. If 19 Pine St. has its air conditioner on three times as often as 21 Pine St., Google can suggest a local air conditioning repair specialist or salesperson. A new central air conditioner can cost thousands of dollars, so it is reasonable to think that local retailers would be willing-to-pay substantial amounts for these connections. And it is not just air conditioners.  Google can sell targeted advertising for furnaces, roof and wall insulation, energy-efficient windows, and other parts of the building shell.

In fact, Nest data can allow Google to perform a complete audit of the energy used in your home for cooling and heating. This is not as good as an in-home energy audit, but it also is much less expensive. After all, it is not cheap to send a technician to your home, have them set up instruments and spend the afternoon blowing air around your house. In-home energy audits cost both money and homeowner time.  Nobody wants to wait around all day for a technician to crawl around their attic.  In contrast, an audit performed with Nest data does not require anyone to ever step foot in your home. A Nest audit is necessarily more limited than an in-home audit, but with smart data analytics and high-quality weather data it can still provide important information.

And at the end of the audit, Google can provide a set of tailored recommendations aimed at improving the thermal comfort in your home. No need to stop at generic suggestions – these recommendations could come with real quotes from local service providers. We think it is this sales lead generation potential (AKA advertising) that Google hopes to monetize. In addition to energy audits, the same data can be used to monitor changes in behavior after retrofits, and/or to verify savings guaranteed by product retailers.

In many cases, energy utilities will be the one driving these sales. Utilities would like to be better able to target their energy-efficiency programs, and to verify savings after energy-efficient investments have been made. This is a large enough market, and the incentives strong enough, that one could imagine utilities like PG&E and NYSEG paying hefty licensing fees to access Nest data. If the data are valuable enough, these utilities might even be willing to subsidize the Nest thermostat itself, in order to include more households in their data analytics.

These services would beat the status quo technology, not because it is better, but because it is good enough, fast, and convenient. This is the classic Silicon Valley entrepreneurial story: find something that was expensive to do before, disrupt, offer a higher quality of service for a 10th of the price. And make it much more convenient. This is transaction cost economics. What the service Google/Nest can sell is convenience and a smarter way to interact with everything having to do with your home energy use.

About Lucas Davis

Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.
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10 Responses to Why Would Google Pay $3.2 Billion for Nest?

  1. Azmat Malik says:

    There are certainly rational good-business reasons.
    If all Google was going to do is sell data for ads and services etc that would be, sort of, OK.

    I might also look at a sinister angle: they will know when-where you are at home … and a hacker will know when to break in.
    They will know which part of the house you spend more time, when you are watching TV, when you are in the toilet, etc. [Remember the Truman show, or for the older folks, The Prisoner series; big brother knows all. AND we are bothered by the NSA snooping; Google is ALREADY snooping.]
    Google might subsidize the nest; IF certain people could initially be the representative [will it play in Peoria] of a demographic they could get a lot of predictive data.

    And actually Google has built scale-volume and is riding that wave; I don’t know how ‘smart’ it is. Another possibility is that they just didn’t want Apple to get in ahead of them.

    • Marco Pritoni says:

      Hi Azmat,
      in most of the residential application there is only one thermostat that records:
      -occupancy (not very reliable in a big house)
      -temperature
      -runtime of the furnace/AC.
      With that information you can’t really:
      “know which part of the house you spend more time, when you are watching TV, when you are in the toilet, etc. ”
      The nest does not record smart meter data (if the house has one). That is managed by Utilities.
      best
      -Marco

  2. Howard Chong says:

    Thanks for the interesting comments. Lucas and I shied away from the data privacy elements to focus on data value.

    You raise two important other points: 1) Privacy and 2) Apple
    1) Privacy is a very real concern. I’d only mention that most people who use Gmail are implicitly letting Google know everything they discuss with their parents and girlfriends — with the goal of selling stuff that you talk about. People have an option to run their own email (or use a competitor), but people actually VALUE this convenience.

    On the energy data realm, regulators are dealing with privacy. A good review is in the following report titles: A Regulator’s Privacy Guide to Third-Party Data Access for Energy Efficiency. A good read for people in this space.

    www1.eere.energy.gov/seeaction/pdfs/cib_regulator_privacy_guide.pdf

    2) Apple
    Yes, I heard from rumors that it’s mostly Google pre-empting Apple. Yes, this defense is probably a big part of the purchase, but Google wouldn’t buy it if it didn’t think Nest was valuable — way more valuable than Nest’s product sales and growth projections would suggest. (Since it is a private transaction, we don’t get to see the particulars of their Income Statement.) Regardless of who buys, the question of valuation is still key. This could easily have been called, Why would Apple pay $2B for Nest, and why did Google pay $3.2B? It’s the data.

    Thanks again for the read and the comments.

  3. Sam Borgeson says:

    No questions that the data is likely the primary attraction, but don’t get caught thinking of Nest as a thermostat or efficiency company. They have already figured out (probably never believed) that you can’t sell very many products based on energy savings alone. They are the 800 pound gorilla in the smart home market, with 100s of potentially lucrative product categories and 1000s of potentially useful applications. So far Nest has built just two of them – a thermostat and a smoke detector.
    Now consider the market for better home security systems – no more false alarms, video integration, remote administration, and snazzy door locks that open with a chirp like your car does. Oh yeah, and a nice $20 a month fee for monitoring – or rather some (still lucrative) alternative to this hated industry practice.
    Consider the desirability of integration into the Nest home network from the perspective of appliance manufacturers. They are in deep water with advanced sensing, networks, and data capture and storage – they will never keep pace with innovation or anticipate the security concerns. Why not just license the hard stuff from a trusted household name?
    Now consider that the team that developed the Nest is comprised of top Apple product designers and engineers who were central to the delivery of the iPod and iPhone. Google has dozens of products hoping to be similarly disruptive and, of course, the Android phone OS and Motorola phone hardware.
    The value of Nest to Google is way beyond access to efficiency programs and services, but we can hope that all the other lucrative angles are used to support aggressive efficiency as well. It is a very rare thing to have a company that is interested in efficiency (they surely are), knows how to deliver innovative and exciting products, and knows that efficiency alone is a very poor sales pitch. It is possible to imagine some point in the future when they could be the biggest player in home efficiency and not even consider that their primary purpose.

    • Howard Chong says:

      Thank you Sam for, again, many insightful comments.

      We don’t think of Nest as a thermostat or efficiency company. It’s a technology AND data and now a media company. It was always a technology company, and may very well build a platform for Home Automation. The blogs I’ve seen EXCLUSIVELY tout “The Internet of Things” to the detriment of data value. Our blog post hopefully puts that data and media potential more front and center. Nest/Google’s roadmap may be very different and none of this would come to fruition.

      To put it more starkly, how much of the $3.2B is associated with the data? If Google/Nest spun off the data analytics/media rights to the thermostat data (with consumer opt-in and privacy notices, of course), I would guess the data/targeting rights to be on the $100M-$1B range in value. If I could buy those rights, I’d piece out licenses. potential buyers would be the DOE (who I think should be making an offer right now to buy a Nest data snapshot for $10M for research purposes), Honeywell/Lennox for marketing purposes, and PG&E and NYSEG for a $1M license to do efficiency EM&V.

      When a 30 second ad for the Superbowl costs $4Million to sell more Pepsi, the value of being able to connect Nest Users to Energy service providers (conventional, not just efficiency based) to sell $4000 furnaces, $300 targetted audits, or $10,000 retrofits is big business.

      Importantly, this is the thing Nest has a lead on. On alarms (which I agree is big), companies like AlertMe and offerings from Comcast make that space crowded. See http://techcrunch.com/2014/01/14/these-fledglings-could-fall-now-that-google-has-its-nest/ and http://www.comcast.com/home-security.html .

      I also agree and am relieved that one of Nest’s strengths has been to depricate energy savings to the 2nd or 3rd tier of their value proposition. It’s encouraging to see they have the pulse of the customer which has demonstrated that they generally care more about other issues, as you and your colleagues at LBNL astutely find in http://middleincome.lbl.gov/

      Again, thanks for the read and the comments.

  4. Robert Borlick says:

    I find this analysis of Google’s motives very disconcerting. Firstly, because I think Lucas is correct. Secondly, because I distrust Google and find reprehensible its freewheeling use of our personal information.

    Energy consumption data read by smart meters is the property of the individual customer. Google has no legal right to have this information but will probably get around this by putting in the fine print some language that by default transfers those rights to itself. And who reads the fine print in multipage documents? Almost nobody.

    Maybe its time for state legislatures to pass laws prohibiting Google from accessing these data without the explicit approval of the customer, who must sign a simple half-page statement of agreement.

    • Marco Pritoni says:

      Hello Robert,
      as I wrote before the Nest is not reading your smart meter.
      It is reading temperatures, occupancy (in front of the thermostat) and runtime of the HVAC.
      I also have privacy concerns, but we need to be aware of what we worry about.
      best

  5. Howard Chong says:

    I want to acknowledge that this blog post wouldn’t have been possible without outside discussions.

    Notably, I want to thank Thermostat Guru Alan Meier (http://akmeier.lbl.gov/) who gave some historical perspective and Entrepreneur Shawn Chiao (http://fablelabs.com/) who helped parse some of the tech gossip. All opinions and errors are, of course, attributable to just Lucas and I, not these outsiders.

  6. Deborah says:

    Does a Nest learning thermostat generate more energy savings than a 7-day programmable thermostat that is programmed to heat and cool at optimum setpoints?

  7. Howard Chong says:

    Thanks Deborah for the question. I would answer (and believe Nest would answer) that Nest *might* do a little better, but not much. The reason is that they have the auto-away feature, so they can turn the system off if you are away. Though, some reports (see the Yang article on Nest) find this feature to be unpredictable and, hence, frustrating.

    But, if you know you will be away only from 9am-5pm and want the temperature to be 66F and then have a setback of 54F, the Nest vs a standard programmable will be no different.

    I believe most of Nest’s claims of savings are versus the average household that does not program their thermostat and, hence, do not have a good setback (less HVAC at night).

    Nest discusses it somewhat in their whitepaper, which is a very good read: http://downloads.nest.com/efficiency_simulation_white_paper.pdf

    This is also part of the remarkable thing about Nest. It’s feature set for controlling the HVAC is not that different from a $30-$60 programmable Lux thermostat. But, the design has made it more appealing and people have been willing to pay $250 for it. Something similiar happened with the Ipod. Other MP3 players already existed, but the Apple team’s breakthrough was making the user experience easy; and hence Apple became the #1 music retailer.

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