Is Cognitive Computing the Next Disruptive Technology?

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For every tech investor, the questions that always revolve around his/her mind are “What will be the next disruptive innovation?”, and “which technology is going to shake the world?” I guess International Business Machines (NYSE: IBM) tries it’s best to answer these questions every year. Over the last several years, IBM has been forecasting the technologies and innovations for the future. But this year IBM has something amazing on its plate: 'The Five in Five List'.

Cognitive computing will be a larger part of the future as an emerging field in which computers can operate more like a human brain. The computers will go beyond performing static operations and will begin using the five senses, just like a human brain. IBM's research initiative, such as the IBM Watson, is an early example in the field of cognitive computing that has charmed the world after its launch in January 2011. The Watson project includes a bunch of natural languages, artificial intelligence, and machine learning technologies. On the one side where computer vendors are trying to profit from existing trends such as Cloud computing and big data, IBM is one of those few companies that has gone a step further to create a unique business model for itself that is very difficult to replicate.

Healthcare Application

IBM is exploring various opportunities in different industries that can help it monetize the Watson solutions. Until now, IBM has focused mainly on using Watson in the healthcare segment, where it is helping doctors make important decisions with potential life saving implications, while reducing medical costs. IBM already has an agreement with Nuance Communications (NASDAQ: NUAN) that began in 2011. Under this agreement, both companies will invest in five-year research to analyze and commercialize Watson advanced solutions in the healthcare industry.

Nuance is known for its impressive speech and imaging solutions, and it has a strong foothold in the healthcare sector. It has various voice recognition solutions in healthcare, and this experience would benefit IBM to expand its base in this industry. Currently, Watson is used by Healthcare giants WellPoint and the Sloan-Kettering Cancer Center as a diagnostic aid. IBM is also targeting to use Watson in the field of cancer research, diagnosis, and treatment. The first commercial tool under this agreement is expected to be launched in 2013. Along with this, Pharmaceuticals, Oil & Gas, Financial services, and Telecommunications are the next industries that IBM is focusing on to deploy Watson's capabilities.

The Path Ahead

Presently, IBM's Watson has a trivial share of just 0.3% in total revenue and contributes only ~$0.06 into the EPS. This gives IBM a big scope to boost this revenue stream in new markets. The next interesting move by the company is to develop its Watson technology for smartphones, which would be a superior version to Apple's (NASDAQ: AAPL) Siri. It will be a voice-activated Watson, which could generate a volume of information within seconds. IBM is trying to position Watson as a better replacement to Siri, which has not achieved the desired success for Apple with many unhappy users. Siri is only limited to handling common questions, and therefore Apple is continuously looking out for ways to enhance its productivity. Apple can make an update for Siri in 2013, making it all the more useful for a large number of queries. This loophole in Siri is an add-on advantage for IBM to enter this rapidly expanding market of mobile phones apps. It upgraded 'Watson 2.0,' which would be more suitable for complex inputs as well as energy efficient for Tablets and smartphones. IBM needs to put together the distribution as well as the pricing strategy for the app to grab good market share. I believe with technology like Watson, IBM can completely take hold of the voice-based apps market in the smartphone industry.

The Financial Aspect

Currently the Watson solution makes a minimal contribution to the company's total revenue. However, the future prospects are extremely bright for the company. According to Credit Agricole Securities, Watson technology is expected to generate ~$2.65 billion in total revenue in 2015. Moreover, the contribution margin for Watson solutions is ~70%, which is higher than IBM's other segments. Therefore, this technology has the capability to drive the company's earnings over time. Let's have a look at the below mentioned table.

<table> <tbody> <tr> <td> <p><strong>Particulars</strong></p> </td> <td> <p><strong>2013</strong></p> </td> <td> <p><strong>2014</strong></p> </td> <td> <p><strong>2015</strong></p> </td> <td> <p><strong>2016</strong></p> </td> <td> <p><strong>2017</strong></p> </td> <td> <p><strong>2018</strong></p> </td> </tr> <tr> <td> <p>Watson as % of total revenues</p> </td> <td> <p>0.5%</p> </td> <td> <p>1.1%</p> </td> <td> <p>2.1%</p> </td> <td> <p>4.1%</p> </td> <td> <p>8.6%</p> </td> <td> <p>12.4%</p> </td> </tr> <tr> <td> <p>Watson related EPS Contribution</p> </td> <td> <p>0.13</p> </td> <td> <p>0.26</p> </td> <td> <p>0.52</p> </td> <td> <p>1.06</p> </td> <td> <p>2.28</p> </td> <td> <p>3.43</p> </td> </tr> </tbody> </table>

Source: Credit Agricole Securities USA

Moving forward, I feel the only challenge for IBM is that Watson is an expensive technology for enterprises. The company needs a successful execution policy to create compelling value out of this technology, along with a competitive differentiation for itself. It will need to launch packages with attractive prices for Watson and its technology. But despite this, I see there are two strong reasons why Watson will lay a solid and profitable foundation for IBM. Firstly, I don’t see any competition as off now from the big IT giants such as Google, Oracle, and Microsoft. Secondly, if Watson generates great value for a company, the other companies would need the same solution to be competitive. Watson technology is a breakthrough in the field of IT, and IBM has the leverage to capitalize on this big opportunity.

ShwetaDubey has no position in any stocks mentioned. The Motley Fool recommends Apple and Nuance Communications. The Motley Fool owns shares of Apple and International Business Machines Corp.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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