Drones: High-flying tech

A strategic handshake last month between the maker of the world's most successful drone - the Phantom - and one of the leading turnkey drone services providers offered investors a peak at the industry's future. The equipment expertise of China's DJI will combine with the operational knowhow of US-based group Measure in an attempt to capitalize on the industry's inevitable evolution from novelty gadget to practical business platform.

"Businesses increasingly recognize that having a knowledgeable and experienced operator at the controls is key to using UAV [unmanned aerial vehicle] technology most effectively," says Jan Gasparic, DJI's strategic partnerships and business development lead.

The agreement with Measure is one of several that suggest DJI - which is said to control 70% of the global hobbyist market - is repositioning itself to accommodate industrial demand for UAVs. The company has also entered into a partnership with US commercial software leader Skycatch, whereby a professional-use line of Phantoms will benefit from new data capture and mapping systems focused on improving workflow outcomes. It underlines the fact that as equipment becomes more sophisticated, specialized piloting and data processing capacity are increasingly integral to the drone equation.

The Shenzhen-based company is carrying out this pivot with an uncommonly well diversified presence across hardware, software and various international end-markets. This eagerness to be flexible as the industry deals with its growing pains has seen DJI emerge as the clearest exemplification of investor interest in drones.

It has raised at least $100 million since 2006, including a $75 million haul - at a valuation of $8 billion - during last year's record-setting spate of drone funding. DJI's closest rival, Ehang, has raised only about half as much, while Skycatch has received $40 million across three rounds.

After the peak

DJI's strategic stirrings therefore offer significant insights into how the industry's initial impact of dazzling the public with new technologies has given way to a more reflective planning and applications phase. This in turn suggests that the parabolic increase in VC funding that has characterized the drone space in recent years will now stabilize into a growing but more cautious, results-minded flow of investment dollars.

"Two years ago, VC firms invested heavily into hardware and a lot of people bought the technology, but now they're saying it's not enough - they need end-to-end solutions," says Hendrik Bodecker, CFO and founder at Drone Industry Insights (Droneii). "Hardware and software companies are reacting to this demand. That will be a very important point next year."

Private investment in drone companies has increased about 200% year-on-year since 2006, according to Droneii, with 2015 bringing a record $500 million into the industry. This was propelled by advances in the artificial intelligence technologies needed to design marketable products and the success of China's major players in exploiting proximity to domestic production lines, as well as a curious global market.

Personal consumer-use drones are estimated to account for about 70-80% of the $5.6 billion global drone market. This figure is expected to swell to at least $12 billion by 2021, with Asia making up 25% of that. The enlarged market will not remain a consumer dominated environment, however, with only about $190 million of the $500 million raised in 2015 having been channeled into hardware for recreational UAVs.

Investment in software will likely continue to outpace hardware due to its larger perceived long-term potential. In Asia Pacific, this will translate into a market shaped by the type and cost of services provided by drones to the most prominent industries.

"Regions that have strong, profitable industrial and agricultural bases will benefit the most," says Manoj Sahi, a Tokyo-based research analyst for Tractica, a technology market intelligence firm. "The drone manufacturing hubs, mostly in China, may suffer when the drones produced there do not improve their quality, efficiency and functionality to cater to the growing needs of service providers. This would in turn motivate the service providers to seek new manufacturers."

This scenario could be exacerbated by overcrowding in the Chinese drone ecosystem, which has seen substantial uptick in investment. China's drone companies attracted RMB1,714 million ($257 million) in 2015 across 24 deals compared to RMB206 million for four deals the prior year. This compares to a more moderate and seemingly sustainable escalation in the US, where domestic drone companies transacted 11 deals worth RMB920 million in 2015 after charting 10 deals worth RMB 426 million in 2014.

"Investment has already peaked in terms of the number of deals, and there might be a turning now to more mature companies like DJI and Ehang, with fewer investments and larger check sizes," says Jianwei Li, a partner at China-focused ZhenFund. "For start-ups that play in the consumer drone space, it's getting harder unless you have very differentiated product. If you're a DJI copycat, it will be tough because DJI's going to lower the price on its products."

ZhenFund invested in a differentiated consumer drone start-up earlier this year, participating in a Series A round for Beijing-based Zero Zero Robotics, a company on the cusp of launching a camera drone for indoor and outdoor use. The device has no exposed propellers and is operable out of the box, representing an extreme commitment to ease of use that the likes of DJI have so far ignored.

The Hover Camera is expected to be priced under $600, reflecting consciousness of a potential price war between the top hardware producers. Its arrival also suggests that as patent lawsuits between the industry's top manufacturers begin to signal an increasingly competitive environment, functional uniqueness will be new entrants' primary investment case.

"We're really just at the dawn of personal robotics and intelligent devices, and I'm a full believer that we'll see more exciting companies emerging with interesting consumer electronics products that will be more interactive, engaging and impressive," says Mengqiu Wang, CEO and co-founder of Zero Zero. "Next year, we're going to see a whole new generation of drones that fit this profile of being smarter than anything we've seen before."

The enterprise angle

Start-ups looking to find niches in the consumer space, however, may be at a disadvantage to industrial-use players when seeking VC support. While early movers at the recreational end of the market have cemented the main investment avenues, professional-use drone companies are tipped to benefit from a more open field of as-yet unexploited business models.

"The consumer segment is pretty settled in terms of the competitive landscape. You have the top player and the second and third players - all getting better," says Roger Wu, a partner at Maison Capital, which was an early investor in DJI. "But for the professional-use segment, we may see leaders emerging from the different verticals."

Industrial drones are bigger, stronger, more complex affairs than their consumer-oriented equivalents, typically costing 10 times more on average, or about $10,000-20,000 per unit. Investments in this space have so far focused on companies that explore technical solutions to support the drones' heavy duty workload and specialized operator skills providers. A pilot that can effectively fly a real estate shoot may not be the right person for an agriculture assignment.

Indeed, the main reason industrial drones investment appears likely to overtake the consumer segment is the service provider component. Many major industrial players that purchased drones with a view to operating them independently have struggled to get the return on investment they expected. This phenomenon has led to the emergence of a class of operators offering piloting and data processing services.

"The next wave of investment is going to be in companies that integrate drone-sensor platforms with back-end systems to drive customer outcomes in significant sectors like infrastructure and energy," says Mark Stevens, CEO at Measure Australia, an independent drone services company. "That's where the market is going, but it might be the second half of next year before serious investors start waking up to that."

Real estate has emerged in many jurisdictions as the strongest industrial area due to its relatively straightforward operational aspects and high volumes. In a country such as Australia, where more than 100,000 land parcels are sold each year, a 5% uptake by a drone services company would still represent a significant project pipeline of 5,000 flights a year. Agriculture, meanwhile, is perhaps the fastest growing industrial space, with a wide territorial scope necessitating different types of drones.

Opportunities will also depend significantly on geography. For example, the prevalence of offshore wind power installations in Europe has begun to dictate the shape of surveying drone services. In Asia Pacific, Australia is expected to be an early adopter of drone technology since it could contribute to more efficient operation of the country's widespread family farms.

One of the biggest obstacles to uptake in the industrial drone space is market awareness. While Asia Pacific is the fastest growing region for the industry globally, it continues to demonstrate signs of immaturity that will require investors to recognize which marketing voids are due to a lack of potential and which are due to a lack of familiarity with the technology.

"A drone is more like a wow element than a meaningful every day-use machine," Tractica's Sahi explains. "VC investors can benefit by focusing on local issues that can be resolved with drone applications and provide financial benefits at a moderate price. Bringing successful and proven drone applications from other regions may not prove beneficial unless there is a real demand for them in Asia Pacific."

VC ambivalence?

Given these challenges, some VCs continue to show faith in the advantages of the existing consumer drone market, where rising disposable incomes rather than volatile industrial factors seem to underpin a more stable demand outlook. "It's still very early for VC in terms of investing in a pure software company or a key component of the commercial drone space," says Kuantai Yeh, a partner at Qiming Venture Partners. "We always want to invest when the market is emerging, but not too early."

At the laboratory level, the immature nature of the drone space lends itself to a number of start-up opportunities. Some of the "silver bullet" technologies that are needed to make various applications economic - or even physically plausible - include various sense-and-avoid solutions and beyond-line-of-sight programing. Another area seen as having potential involves sensors that can do multiple tasks in the air. This capacity is in critical need among service operators since it allows them to economize jobs by collecting more data across fewer flybys.

Investors are advised to seek out competitively positioned companies in these fields that demonstrate an ability to troubleshoot everyday issues related to drone operation. Robust technology networks and relationships in industries that are gearing up for the integration of drones are also desirable.

That said, venture capital interest was muted until the 2015 eruption. Anecdotes from drone players from just a few years ago color the venture community as passive, dismissing UAVs as toys with few industrial uses that couldn't be more efficiently handled by satellites. For Measure Australia, which rebounded from a disastrous lack of VC interest during a 2012 funding drive to welcome Matthew Hunter, managing director of Rivendell Capital, as its new chairman earlier this year, one of the biggest blind spots among financiers remains the practical, results-oriented services segment.

"It's very difficult to find people in the venture capital market who think about the sort of conversations that we're having with clients all the time on the industrialization of drones and integrated data solutions driven by drones," says Measure Australia's Stevens. "The thing that investors need to understand is that it's all about the data - not the drone or the sensor or the pilot."

 

SIDEBAR: Red tape - Rules for drones

The rising popularity of drones has resulted in regulators arguably having a stronger influence on investor behavior than the industry's technological milestones or the marketing success of its top manufacturers.

The investment surge of 2015 in part prompted China's Civil Aviation Administration to clarify its first set of operational rules. Formalized in January, the rules categorize drones into seven classes based on weight and size. Lighter recreational drones are typically exempt from paperwork and clear to fly under the 150-meter mark. For heavier models with industrial applications that may require higher flying, the rules include parameters on operational factors such as line-of-sight control, flight data monitoring and cloud connectivity.

In the US, pilot's license requirements have recently been introduced, but in most jurisdictions rules have focused on height restrictions. This results in further complications even after all operational specifications have been approved due to the various classifications of airspace. Fly zones are delineated by either distance above sea level or distance above the ground, with special dispensations for airport proximity and other security factors.

Although the legitimacy that these regulations bring to drones as a business tool has helped spark the latest surge in investment interest, many VCs are wary of the rules' complexity or uniformed about the developments. "A lot of VCs aren't aware of the regulations because they don't look at the industry," says Jenny Lee, managing partner at GGV Capital. "They simply think the government will not allow drone applications until the industry becomes big enough. That's the reason why some VCs are ahead and some are behind."

Waiting for the industry to become mature enough to support a comprehensive set of regulations across all applications could be a mistake. The early rules have focused on lower-risk use cases with limited human contact such as remote equipment inspection jobs. However, investment potential could ultimately be stronger in areas of high interaction that are yet to be regulated such as urban deliveries. Recent success in developing these use cases has indicated that as governments become more experienced in legislating lower-risk operations, urban flight rules will begin take shape.

Earlier this month, US authorities approved Google's parent company Alphabet to conduct a drone delivery test aimed at answering critical safety questions ahead of a large-scale commercial launch. This coincided with clearance for Amazon's parcel delivery drone testing in the UK. In Asia, Foodpanda has begun testing meal deliveries in Singapore while the Japanese government and Rakuten have executed successful medical deliveries in the city of Chiba, a Tokyo satellite with a population of one million.

These forays highlight two essential aspects of the evolution of the drone space: the transition to commercial applications and the steady accumulation of regulatory concessions.

"The recreational drone phase is over," says Hendrik Bodecker, CFO and founder at Drone Industry Insights. "The industry and users are now waiting for the ‘professional' breakthrough. That still depends on clear regulation for commercial use, airspace integration and technical standards, but when this milestone is reached, the new industrial revolution will be unstoppable."

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• Topics
• Greater China
• North America
• Australasia
• Technology
• Venture
• Early-stage
• ZhenFund
• GGV Capital
• Qiming Venture Partners
• Accel Partners
• China
• Australia
• USA