Everything You Need to Know About Nest, Google's Big Bet on the Smart Home

Alphabet, Google’s newfangled conglomeration, arrived in August, but we will not see its first financial figures until January, when the company reports two sets of earnings — Google and the “other bets.” Each subsidiary will not break out its own performance, but the earnings reports will offer some view into their costs and output. Before then, Re/code is unpacking one Alphabet company a week*, presenting the facts, figures and, just maybe, the financials behind the silos of the world’s most ambitious company. Up first: Nest.

Of all the Alphabet companies, Tony Fadell’s Nest may be the clearest beneficiary of the new corporate structure. Since selling his connected-device startup to Google nearly two years ago, the former Apple exec has reiterated, again and again, that his company — and its data — operates independently from the search behemoth. Alphabet gives him good cover.

Sales: $450 million (estimated)

Operating Expenses: $500 million

Key Execs: Tony Fadell, CEO; Matt Rogers, VP, Engineering; Ana Corrales, CFO

And of all the bets Alphabet is making, Nest may be the one it needs most to pay off. Google priced it that way: At $3.2 billion, it is one of the company’s largest acquisitions. Nest is now both Alphabet’s emissary in a massive potential market — the smart home — and a test of its stated belief in entrepreneurial founders.

Post-acquisition, Nest has grown sharply, at least in personnel. It has nearly quadrupled from its size of roughly 300 employees. On Monday, the company announced the addition of two new VPs: Jim Alkove, a Windows enterprise exec at Microsoft, to run security; and Nik Sathe, CTO of American Express and a former Googler, to run apps and services.

That expansion has come with some growing pains typical of startups. Nest’s revenue growth is less clear. Those familiar with the company say it’s not yet moving at an impressive clip — hobbled, in part, by the nascence of the industry and intensifying competition from home-security incumbents, startups and mobile giants Samsung and Apple.

What to Know

Today, Nest sells the two devices it sold at acquisition — a thermostat and a smoke detector — along with the Nest Cam, an IP video camera rebranded from the company’s $555 million purchase of Dropcam. A fourth device is under way, according to multiple sources. (A Nest spokeswoman said the company is working on multiple projects.)

That dearth of products has prompted some criticism of an anemic pace. Nest’s response has been to point to its deepening investment in software. At its early stage, the smart home industry lacks a communication standard — a way for the myriad impending Internet-connected things to talk to one another. Nest is positioning itself as the provider of that standard.

Eventually, the company’s earnings from services could outpace hardware sales, Robert Peck, an analyst at SunTrust Robinson Humphrey, wrote in a September report. Nest is laying the groundwork for this business, cutting deals with insurance and energy companies. Peck pegged Nest’s overall revenue at $450 million this year and estimated that it will double by 2017, putting the company’s value then at $3.5 billion. Nest declined to comment on revenue. Multiple sources familiar with the company said that sales from Dropcam, now Nest Cam, are well ahead of those of the other two Nest devices. According to sources close to the company, Google agreed to budget $500 million annually for Nest for two years. It’s not clear how large Nest’s outlays will be for 2016. Again, Nest isn’t commenting.

Who to Watch

Fadell, a brazen and certainly not press-shy exec, draws most of Nest’s attention. He does have noteworthy lieutenants, however. Several came with him from Apple. Matt Rogers, his co-founder and a former iPhone manager, runs much of Nest’s daily operations, and is widely respected.

Greg Hu, another Apple vet, manages Works with Nest, the company’s program to convince developers building connected devices and applications to use Nest’s platform. The company is gunning for each layer of the smart home back end — with protocols for device communication (Weave) and mesh networks (Thread). In August, Nest recruited an exec from the networking world: Ana Corrales, an SVP at Cisco, joined as Nest’s CFO and operations chief.

Yet those close to the company say Fadell still calls the bulk of the shots. And Larry Page, Alphabet’s honcho, is fond of him. So fond, in fact, that he trusted Fadell with Google’s most tormented hardware product, Glass, which Fadell is working on separately from Nest.

Where It Stands

In July, Fadell’s former company booted products from his current one out of their stores. For many in the industry, the move indicated Apple’s connected-home strategy: Only work with companies compatible with its platform, HomeKit.

And it indicates the competitive field Nest is in, where Apple and Samsung, which also owns a connected-device company, are grappling for the devotion of consumers, developers and device makers. Some are wary of partnering with Nest on the software side, given the widely expected assumption that it will deliver a lineup of hardware products.

For thermostats, Apple picked Ecobee, a Toronto startup. It’s much smaller than Nest — it sells just one device and has 120 employees. But analysts said its wireless remote sensors, which let owners track and change settings in multiple rooms, give it an edge over Nest. Ecobee CEO Stuart Lombard claimed that his company doubled its retail footprint in the third quarter, after the Apple selection, to reach some 4,000 outlets.

Nest said its devices are sold in over 7,000 retail locations and have 25,000 professional installers.

Nest is in a competitive field where Apple and Samsung, which also owns a connected-device company, are grappling for the devotion of consumers, developers and device makers.

Still, the smart home is a young market with a high ceiling. NPD Group estimates that October sales revenue for smart thermostats rose 51 percent. Here, Nest competes primarily with Ecobee and Honeywell. IP camera revenue grew 31 percent, according to NPD. Nest is in a good position here, but some upstarts, such as Canary, a New York-based home-automation startup, are gaining traction. “We’re growing faster than Nest,” said its CEO, Adam Sager.

Nailing down sales figures in the connected-device market is difficult. But some signs are pointing that Nest, which went through some early product foibles, may be losing consumer interest. Research firm Argus Insight tracks connected-device sales by gauging consumer sentiment. Lately, it is seeing demand for Nest products “drop significantly,” said Argus founder John Feland. According to its research, the recent Nest Cam launch has stumbled, and Nest’s thermostat trails behind Ecobee and Honeywell in consumer perception.

Smart home items today are still largely novelty purchases, Feland said. Sometimes, he added, they involve unforeseen tradeoffs. Some customers who buy a Nest Cam, for instance, enjoy the viewing stream that’s immediately uploaded to the cloud — until they notice that their Netflix has slowed, dragged by the camera’s strain on the wireless connection. Then they ditch the camera.

That anecdote takes us to next week, when we will dig into Alphabet’s nebulous effort to fix these issues and wrangle control of every step of how we access the Internet.

* So far, Alphabet has confirmed the existence of nine subsidiaries, including Google. It’s very likely that an additional one or two or many may get the official stamp before the earnings report in January. Rest assured, we will tell you about it if it happens.

This article originally appeared on Recode.net.

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