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The Industrial App Store

Just 9 years ago, Apple (NASDAQ:AAPL) took the world by storm when they introduced the App Store for the iPhone. Today, similar developments are happening in industrial automation.

Late last year, Fanuc (OTCPK:FANUY, OTCPK:FANUF), one of the biggest players in industrial robots announced its open platform FIELD (Fanuc Intelligent Edge Link and Drive) system. In line with the global IoT movement, the FIELD system basically lays out the groundwork for an integrated, robotic, automated, and overall futuristic factory. Software developers can build applications that gather and analyze data obtained from the robots to improve operational efficiency, decrease equipment downtime, improve product quality, etc.

Now, Fanuc isn’t alone in this endeavor – Rockwell Automation (NYSE:ROK) is in to help with automation, Cisco (NASDAQ:CSCO) is helping with digitization, and Preferred Networks (Private) is helping with AI technology.

Fanuc’s announcement was not just a statement of intention. Rather, the company has already developed a working prototype of the FIELD system and demonstrated it by connecting 250 robots together at an event back in November last year. According to Nikkei (Japanese source), a software development kit is set to be released by the end of April.

For those interested in learning more about the FIELD system, you can find more information here, here, and here.

Shifting Strategies

Fanuc’s big move into the internet-of-everything realm is admirable. The demonstration of the FIELD system got plenty of media attention in Japan. However, the FIELD system isn’t the only thing I want to cover here. What seemed to slip through the media’s cracks was the surprise factor of Fanuc being the company to develop an open platform system.

Let me explain.

Why is it a surprise that Fanuc announced an open platform system?

For most Westerners, Japan is probably a mysterious place. To give you a frame of reference, Fanuc is a box of mystery, even for the Japanese – so much so that Toyo Keizai (news site) called them the “Yellow Kingdom of Mystery” (Fanuc’s company color is yellow). Everything about this company is secluded.

Fanuc HQ is located about an hour and a half away from Tokyo in a small town called Oshino-mura (appx. 9,000 people). Uniforms, machines, buildings, cars… just about everything is yellow:

Source: Nikkei BP

Anybody want to take a guess where the Fanuc employees are?

Fanuc’s reputation for mysteriousness comes from its history of operating behind closed doors – minimal press releases, interviews, etc. At one point in 2011, the company even shut its Japanese website down for 6 months, which is unheard of for companies traded on the first section of the Tokyo stock exchange.

More recently, the historical lone wolf has slowly opened up to partnerships and customization of products. And then the FIELD system, a coordinated effort with Rockwell Automation, Cisco, and Preferred Networks, was announced by Fanuc.

This is why it’s a big surprise that Fanuc, a company that was allergic to the public (and customization requests) just a few years ago, is going full force on developing an open platform system.

Fanuc’s “closed-door” approach has performed well. While this is a simple metric, Fanuc has the highest gross margins among the big 4 robotics and automation companies:

Source: Data Compiled from Financial Times

How has Fanuc achieved such a high gross margin percentage?

According to a 2015 Nikkei BP column (Japanese source), Fanuc’s R&D department has 3 guidelines: “Weniger Teile (fewer parts), Reliability Up, and Cost Down”. Customized machines usually mean customized parts, and customized parts means more factory space. More factory space means larger overhead. And so, Fanuc tries to figure out how to build machines with existing parts and technology first before jumping into brand new R&D projects.

In the same column, author Hiromi Sato mentions that Fanuc is known for affordable machines. Given Fanuc’s industry-leading gross margins, this is a bit surprising. However, it starts to make sense when we think about Fanuc’s R&D guidelines. Fanuc’s products are comparatively more standardized (fewer parts), which also means the business is more scalable. Companies like Kawasaki Heavy Industries (OTCPK:KWHIY, OTCPK:KWHIF) and Yaskawa Electric (OTC:YASKF, OTCPK:YASKY) are generally more open to customizing machines at Toyota’s (NYSE:TM) request. This tells us that Fanuc’s high gross margins are not necessarily a result of some magical technology advantage, but rather a result of strategic cost control through standardization (or some combination of technological advantage and cost control).

Interestingly, Fanuc has historically maintained strong relationships with American car makers (like General Motors (NYSE:GM) and Tesla (NASDAQ:TSLA)) vs. Japanese car makers. This, at least in part, is due to customization requirements by companies like Toyota (TM). Fanuc has a reputation for turning down orders that are “too customized” for the sake of standardization.

Implications Of A Strategic Shift

The development of the FIELD system hasn’t exactly been a walk in the park. The system was originally planned for release in 2016. We are in April of 2017 now and the development kit has not been released yet. It’s too early to tell how the FIELD system will impact Fanuc’s financials, but there are a few talking points to consider when it comes to strategy.

The world’s 4 largest robotics companies have more or less played along with one another. Yaskawa has a stronghold in Asia, while Kuka (OTCPK:KUKAF, OTCPK:KUKAY) and ABB (NYSE:ABB) maintains a stronghold in Europe and Fanuc in the US. In an endless pursuit for efficiency, it was only a matter of time before a robotic-factory management platform was introduced. Like SAP (NYSE:SAP) enabling large companies to run a unified, integrated operation, the FIELD system is intended to run a unified, integrated, robotic factory operation.

The FIELD system will invariably visualize strengths and weaknesses in machines. This is because the whole system is designed to report operational data. The FIELD system development is in line with Fanuc’s drive for “Zero Down Time“. This tells me that the industrial robot scene is ripe for consolidation as companies with large talent pools will be better equipped to survive in an environment where machines are expected to operate at 100%, all the time.

It’s too early to figure out whether the FIELD system will be the de facto standard for smart factory operations software. Given Fanuc’s history of quietly, quickly, and resourcefully perfecting technologies, it wouldn’t be a surprise if the FIELD system dominates the market in 10 years. If that happens, Fanuc’s technological moat will double as the company’s robots will be deeply integrated with the FIELD system. Investors ought to pay attention to whatever traction the FIELD system gains as this will likely determine how sticky Fanuc’s future revenues become (even for its robots).

If you enjoyed this article and would like to read more on Japanese ADRs, please click the orange “Follow” button at the top of this article. If you would like to read about Japanese securities in general, please visit my website at KenkyoInvesting.com.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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