As Software and Hardware Advance Together, the Next Innovation Wave Rises

The strengthening marriage of hardware with software plays into Silicon Valley’s strengths
Clockwise from top left: Courtesy Apple; Getty Images; Courtesy SpaceX; Courtesy Tesla; Courtesy Nest; Alamy

Craig Venter, the scientist who first decoded human DNA, is a speed junkie who owns dozens of sports cars and motorcycles. His favorite ride: a red Tesla Motors Model S sedan. Venter says the appeal isn’t just that the Model S is a smooth, quiet drive, but that it’s also something of a gadget. Its wireless connection lets him stream Internet radio stations and unlock the doors with his smartphone. When the car suffers from glitches, like the time its 17-inch touchscreen panel died, nobody had to come to his La Jolla (Calif.) home to repair it. “While I slept that night, a software engineer logged on to the car, found the problem, and fixed it,” Venter says. “I mean, it changes everything about transportation. It’s a computer on wheels.”

The Model S is just one example of the growing range of software-infused machines that could be a huge boon for the U.S. economy. From smoke detectors to jet engines, machines are more efficient than ever, and they’re becoming more powerful thanks to code. This merger of hardware and software plays into America’s strengths, giving clever companies the chance to redefine all manner of consumer objects and industrial hardware in the same way Apple rethought the phone and Tesla the car.

The insight is simple but easy to miss, even in Silicon Valley. For the past several years, many companies have bought into the idea, effectively summarized by venture capitalist Marc Andreessen, that “software is eating the world.” Andreessen, the co-founder and general partner of VC firm Andreessen Horowitz, posited in 2011 that more industries would come to revolve around the services and data their software provides. What that theory doesn’t account for is the value of hardware, says Tyler Cowen, an economist at George Mason University, who predicts a different kind of revolution. “I would have called this ‘software and the physical have finally teamed up,’ ” he says. (Bloomberg LP, which owns Bloomberg Businessweek, is an investor in Andreessen Horowitz.)

In 2003, Tesla had the luxury of creating a car from scratch during a boom era of consumer tech. The company wrote its own code and made its software and massive touchscreen the stars of the vehicle. Instead of fiddling with knobs, Tesla drivers use finger swipes. Via the wireless network, Tesla can add features to its cars—quicker charging, better handling—the way Apple issues downloadable upgrades for the iPad. This is part of the reason Tesla gets valued like a tech company instead of an automaker: In 2014 its share price has soared from $120 to $284, putting its market cap at $34 billion, a little above Twitter’s.

For about 50 years, top minds have worked to advance the state of software. They built the Web, word processors and databases, and the operating systems that run our financial systems and communications networks. Only recently has software evolved to the point where the most sophisticated code can safely be injected into machines. Imagine trying to run a car on Windows 10 years ago the way Teslas and Google’s self-driving cars now cruise the freeways.

The rising quality of software has combined with the availability of cheap, powerful processors and sensors and more reliable electronics, to produce what Tony Fadell, the man credited with developing the iPod, calls a supercycle of innovation. It used to be that the government or a large company would fund a breakthrough in hardware, and the rest of the tech industry would spend years developing software to make use of it. Now, Fadell says, both sides of the equation are progressing at once. “All of a sudden, there is a wholesale change,” he says. “Whether it’s Tesla, or SpaceX taking Ethernet cables and running them inside of rocket ships, you are talking about combining the old-world science of manufacturing with low-cost, consumer-grade technology. You put these things together, and they morph into something we have never seen.”

Fadell’s company, Nest Labs, took thermostats and smoke detectors and outfitted them with software, sensors, and wireless communications. Google acquired it for $3.2 billion in cash, seeing a chance to rethink home gadgets. A handful of startups are blending software and hardware in DNA sequencers and body scanners and building coordinated armies of tiny satellites that can act as reprogrammable eyes in the sky.

General Electric’s top priority is making jet engines, trains, and turbines that use software and sensors to measure and tune their performance. “The vision has clearly been that where the next major technological change comes from is this matching of software and hardware,” says Marco Annunziata, GE’s chief economist. “Some people say this will only drive incremental advances. To me, it’s clear that we are opening up a new dimension.”

There are, of course, highflying software companies such as Facebook that haven’t needed to diversify. (The social network now owns virtual-reality headset maker Oculus but hasn’t done much with it yet.) Some of tech’s software stories, however, haven’t lived up to early promise. Zynga, Groupon, Foursquare—all celebrated by Andreessen—have had mixed results. Many of the highest-profile cloud-computing companies simply package yesterday’s software with a new interface and are struggling to turn a profit.

The more radical model for change is the iPhone. Its pairing of hardware and software transformed the cell phone into a pocket computer and swung the balance of power in communication technology back from Asia and Europe to the U.S. Google reinforced America’s position with its Android software, phones, and tablets. Apple became the world’s most valuable company on the back of this turn, and Google’s software dominance is the envy of the industry.

The U.S. has a chance to win bigger with the rise of smarter, software-driven machines. Silicon Valley remains a hub for the most sophisticated software and creative uses for processing power. Tesla’s cars and GE’s jet engines have begun to fit this model. Now the factories that produce them are being computerized. A startup called Sight Machine taps into cameras and sensors on factory floors and uses software to analyze data and spot flaws; it’s also been hired to monitor fast-food assembly lines, says Chief Executive Officer Jon Sobel. “When you think about combining the innovation that’s available with the physical world, it implies some major changes to how we do things,” he says.

America isn’t guaranteed victory. Nest recalled smart smoke detectors after a software glitch. Economists such as Cowen and Annunziata also point out that this era might not be great for everyone; an automated car factory cranking out self-driving vehicles stands to put plenty of people out of work. Cowen predicts a massive labor shift from taxis and factories toward housekeeping and child care.

Annunziata’s take is more optimistic—that new smart equipment can help drive the global economy for years to come. “There is no limit to human beings’ hunger and desire for new things and services,” he says. “This will create wealth.”

    Before it's here, it's on the Bloomberg Terminal.