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.

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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.