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Future Themes Science2021

Progress in factory automation is poised to drive significant opportunities for industries and to have broad impacts on the economy and society as a whole. These fascinating and rapidly evolving innovations raise key questions for the future. What needs to happen to enhance human/robot collaboration in factories? What role will software play in future factories? Will robots reduce or increase human-employment opportunities? How will business models evolve? And what broader economic and social implications could this create?

In this paper, we answer these questions by profiling three key areas involving the future of factory automation:

• Collaborative robotics: We explore the current opportunities, limitations, and potential solutions of human/robot collaboration on the factory floor.

• Industrial-software revolution: We highlight the impacts of smarter software, such as greater flexibility and predictive maintenance. In addition, we explore the potential for changing business models and consolidation within the sector.

• Economic and social implications: We discuss the labor market and social implications of higher levels of automation, including thoughts on robot taxes and reskilling.

Finally, we share the investment implications these compelling innovations present.

Collaborative RoboticsCollaborative robotics has humans and robots working side-by-side on the factory floor. There is huge untapped potential for automation on factory floors, in our view, as manufacturing has thus far only embraced robotics at a low level. If we use robot density as a proxy for automation adoption, there are currently just 110 robots per 10,000 factory workers on average.1 Notably, there is a relatively high concentration of robotics in one manufacturing industry: automobiles. One-third of the three million robots installed globally are in auto manufacturing; as technology advances, more industries may be able to move in this direction.

The shift to factory automation is often framed in terms of increasing productivity while also addressing rising labor costs and aging populations. In addition to these factors, automation penetration is also fueled by other long-term trends such as a greater focus on quality, safety, and product individualization.

The significant opportunity collaborative robotics presents stretches far beyond hardware and the traditional mainstay consumer industries (such as autos and, to a lesser extent, electronics). The pandemic has acted as a catalyst for other industry changes that were already expected but have been moved forward, creating opportunities in areas such as logistics, consumer, and pharma.

However, despite this promising outlook, there are several potential impediments to higher adoption. FIGURE 1 shows the factors that could stymie automation

1 Source: International Federation of Robotics. Data as of September 2020.

Robots Won’t Take Our Jobs (and Other Reasons to be Excited About Factory Automation)The factory floor of the future is likely to include robots and humans working together.

Key Points

We believe:   The promise and limitations of

collaborative robotics—humans and robots working side-by-side— may help define a range of future automation opportunities.

  Advances in software can give industrial robots the ability to see, feel, move around, and predict their maintenance needs, boosting manufacturing flexibility.

  Greater automation is likely to create more jobs, not fewer. But the impact on wages could be uneven. In emerging markets, routine labor could become less valuable.

Insight from sub-adviser, Wellington Management

David Reid, CFA Equity Research Analyst

Angel Pan, CFAResearch Associate

Special thanks to:Dr. Henrik Christensen,University of California San Diego

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Future Themes Science

adoption in the short term, including limitations in sensing and vision, mobility, security, standards, connectivity, and user interface.

Here, we discuss three of the biggest perceived headwinds and where they stand today.

• Sensing and vision: This is the largest potential impediment to greater adoption. Robots are traditionally tethered to a fixed space and limited both in movement and ability to interact by their sensing and vision. More advanced solutions are on the way, including developments in tactile sensing and manipulation (such as soft-touch gripper technologies and artificial “skin”).

• User interface: The complex interface between digital and analog raises other significant challenges. Industrial robots often take several days for a skilled engineer to fully program and set up, while collaborative robots can increasingly be programmed within a few hours by a novice. Improvements in user interface to optimize this relationship is a huge area for growth.

• Mobility: Historically, most automation components have been fixed in place. But they are increasingly able to move around. Examples of exciting new developments in this space include dynamic stacking in a warehouse, where both the shelves and the robots are able to move around and optimally interact.

Automation penetration on global factory floors has tremendous room to grow. Many of the largest impediments to higher adoption are on the cusp of solutions.

Sensing & vision

Factorsimpeding

automation adoption

Userinterface

Connectivity

Standards

Security

Mobility

FIGURE 1Impediments to Higher Adoption – Real or Perceived?

Source: Wellington Management. For illustrative purposes only.

Autos and Robots: Room to GrowThe auto industry is still a significant area of potential robotics growth, according to Dr. Henrik Christensen, a roboticist and professor at the University of California San Diego. Dr. Christensen notes: “Even automotive, which is thought of as the most robot-penetrated manufacturing process, only has roughly 10% of the manufacturing done by robots. The smaller, more flexible parts of the process are manual—leaving a lot of room for growth.”

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Future Themes Science

We believe improvements in the above areas are poised to drive opportunities far beyond the traditional use cases such as the automotive industry.

Industrial Software RevolutionFor most vendors, the current motivation for selling software is to sell more hardware. After all, hardware is likely to remain important for some time as many factory owners are conservative and risk-averse, so legacy hardware vastly dominates. However, we believe software is going to play a much larger role in the future.

Greater flexibilityIn our view, software innovation will increasingly accelerate and enhance factory automation. Currently, a key problem with automated product lines is inflexibility. Robots are great at producing the same product over and over again. But as the product cycle shortens and product variety expands, we think flexible manufacturing is going to be a requirement, not a “nice to have.” Smart software is critical to enabling a flexible production line.

Predictive maintenance Predictive maintenance represents another exciting advancement opportunity created by smarter software. In our view, this innovation—in which artificial intelligence (AI) and big data enable software to predict when a machine might fail—is going to become more mainstream. Downtime is the biggest concern of any factory owner and predictive maintenance can help prevent unexpected downtimes. This is potentially one of the highest return-on-investment software investments for factory owners in the near term. After all, even the best machine a factory can buy needs maintenance and has occasional failures. Predictive maintenance is likely to drive trends of reduced downtime and fewer spare parts for factories and lower after-sales revenue for hardware providers.

A changing revenue modelIn our view, software cash flows are going to become more and more attractive over time. As Dr. Christensen says: “Right now, hardware is a commodity, and the margins are razor-thin. Many companies are going away from hardware, as the highest growth potential is in the software.” We think the significant increase in both the role and impact of software in factory automation is likely to cause a shift in the revenue model. We believe it will transition from the current perpetual licensing model to a subscription model that links ongoing payments to continued investment in capabilities. This change is still in its very early days but could be quite significant for the industry, as it has been for others.

Consolidation across the stackAs we move toward this future, we expect to see more hardware vendors using acquisitions to improve their software capabilities. We think smart-software startup companies in analytics, AI, augmented reality, and virtual reality are the most attractive potential targets. Because the use of the software is closely tied to hardware, the industry has a chance to develop solutions internally rather than face full-strength external competition.

Where could we see disruption?We are very early in this transition. The monetization opportunity is still ahead, in our view, but it won’t be easy. We think the success or failure of “factory as a service”—and its potential for disruption—will be defined by the reliability and capability of the product, a deep understanding of the future cost base, and the market’s competitive intensity.

In our view, the critical equipment providers will first and foremost remain product companies, though the hardware supply chain will need to improve. In addition, we

Additive Manufacturing3D printing has created a new class of “additive” manufacturing. This technology is highly amenable to automation. In fact, advances in automation directly spurred innovation in physical manufacturing processes such as 3D printing. Additive manufacturing permits a step-change in the complexity and efficiency possible through new design rules. It enables the efficient creation of previously impossible complex geometries, offers the ability to design new functionality into components, requires limited tooling, works with a range of substrates, and simplifies manufacturing and supply chains.

Notably, it has unit costs that are less sensitive to quantity than traditional manufacturing. This enables manufacturers to create a new class of batch product, blurring the line between product development and manufacturing. This flexibility creates economies of scope as the unit costs of creating different incremental goods is reduced, compared to traditional mass production, where unit-cost efficiency is normally delivered by producing identical incremental goods.

“We think the significant increase in both the role and impact of software in factory automation is likely to cause a shift in the revenue model.”

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believe less-differentiated original equipment manufacturers will likely get coerced by system integrators and thus face pricing pressure.

For now, we do not think that automation will have a meaningful impact on how the value is distributed. In our view, critical components remain as critical as before. However, manufacturers are being very mindful of the transition to a more software-focused future and are pushing for open-source solutions. Dr. Christensen views this is a key area: “The customer side wants a unified, open platform across hardware providers. And I believe we will get such a platform, but we’re still a few years away. The provider won’t make money on the platform but instead on the services it enables.”

Importantly, in that future, the retention of data is a must for capturing value. Therefore, if manufacturers retain data, the value-capture opportunities for software companies come down and scalability is lower. Notably, because the automation ecosystem is much more complex vs. that of consumers, we think investors should avoid viewing the software revolution as a direct parallel to the consumer internet revolution.

Economic and Social ImplicationsIndustry 4.0—the development and proliferation of smart manufacturing systems—may have substantial impacts on the wider economy and society. The development of truly autonomous, adaptable cyber-physical systems goes far beyond the digitization and optimization of existing processes that we currently see. Key technologies such as AI, big data, the Internet of Things (IoT), and quantum computing enable significant steps forward in this area.

Impacts on business modelsAs mentioned previously, the competitive advantages may shift to software IP as this innovation grows. In addition, new network effects may start to arise from smart manufacturing ecosystems. Product/service systems may likely grow in importance as manufacturing becomes less about delivery of an individual product and more about delivering a manufacturing service to other firms in the ecosystem.

Dr. Christensen believes there’s a huge amount of opportunity in the business model impacts of predictive maintenance, noting, “The industry may be transformed in this space once we get an open platform. There’s lots of money in sending supplies at the right time rather than on a consistent schedule.”

Are robots taking our jobs?These innovations create quite compelling opportunities. They have the potential to boost GDP growth, increase productivity and wages, and subdue inflation. But will they destroy labor markets?

In our view, empirical evidence for “neo-Luddism”—or the opposition to new technologies—remains poor when it comes to job losses. The intensity of robotics usage has not historically been correlated with manufacturing employment. In fact, historical evidence suggests the scale of the demand boost permitted by better efficiency often outweighs the negative impact (for employment) of unit-labor efficiencies for new technologies. Whether we look at the long histories of steel, textiles, or automotive production, increasing automation led to huge amounts of new hiring compared to when they were artisan industries. Historically, technology often creates more jobs. Empirical evidence on wages, however, is more mixed. While more efficient production has historically increased average wages across the economy, the benefits can be unequally distributed. This can lead to losses concentrated in certain sections of society and a different experience between the mean and the median “average” worker.

The intensity of robotics usage has not historically been correlated with manufacturing employment. Technology often creates more jobs.

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These potential downsides of factory automation will need to be tackled. The need to transition skills, prevent rising inequality, and adapt to public concerns will be crucial policy issues impacting the growth of factory automation. Policy responses may likely include both regulatory and fiscal considerations. Critically, though factory automation could provide a solution for the demographic challenges of many developed markets, it is a potential threat to emerging-market economic-convergence models as inexpensive, routine labor could become less valuable. For example, more sophisticated garment-making robots are making headway in a previously human-dominated manufacturing industry such as clothing—some developing countries will need to look for ways to prepare for this new economy.

Automation will be like electrificationAutomation will likely be a global phenomenon reminiscent of electrification. Though not every country is innovating better ways to generate electricity, all nations are putting electricity to work in their economies. In our view, robots will be the same. If robots allow for some of the large economic changes we anticipate, every country may need a strategy in order to maintain economic sovereignty and competitiveness. As noted above, we believe this is especially true for export-reliant developing nations. Getting robotics “right” may be key to thriving going forward.

Will there be robot taxes?As the economy evolves, many investors wonder if there will be taxes on robots as there are taxes on workers’ wages. Historically, most efforts to tax robots have failed to make progress, hindered by issues such as: What is a robot? Who pays the tax? What are the negative effects on innovation? If governments believe robots will have negative effects on employment, tax revenue will need to be made up. If robot taxes are as difficult to implement as they appear, this could potentially lead to higher marginal income taxes, higher corporate taxes, or changes to depreciation for tax purposes.

Bottom Line: Investment ImplicationsThere are numerous companies in the industrial robot space—both public and private—working to make industrial robots more collaborative and able to sense the environment. We’re following firms focused on 3D monitoring to increase legacy robots’ collaboration, makers of robotic skins that make them more aware of their environment, designers of safety-eye technology, and companies working to improve user interfaces. These are just the beginning of a growing opportunity set.

In our view, beyond the auto industry, sectors such as logistics, consumer, and pharmaceuticals are all poised to benefit from factory automation. There are also other previously labor-intensive use cases, such as drones making large-scale agriculture more efficient in China and southeast Asia and robots enhancing the hospitality industry. Once the software improves, we also expect e-commerce and logistics to see greater automation penetration in areas such as bin-picking and packing. Even a conservative industry such as construction is now seeing companies, most notably in Japan, using robotic exoskeletons to prevent fatigue, boost productivity, and prevent injuries from overexertion.

We believe any industry with a structured manufacturing environment can benefit. The textile and 3D-printing examples noted above are examples of robots’ sensing/dexterity skill sets increasing so much that these innovations can handle more complex products.

The scope for automation is far larger than past industrial revolutions. Innovations such as AI, IoT, and big data simply replace more of what humans can do.

Future Themes Science

Important Risks: Investing involves risk, including the possible loss of principal. Focusing on one or more sectors may lead to increased volatility and risk of loss if adverse developments occur.

The views expressed herein are those of Wellington Management, are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. They should not be construed as research or investment advice nor should they be considered an offer or solicitation to buy or

sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.

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The scope for automation is far larger than past industrial revolutions. Innovations such as AI, IoT, and big data simply replace more of what humans can do. We believe the value this creates may ultimately flow to consumer surplus; cheaper, faster, better-quality products; and more “bespoke” consumption. We may also see factory automation drive a positive supply shock that leads to higher GDP, increased productivity, higher wages, and more subdued inflation. But most people still fear automation at some level. Factory automation may have significant impacts on the economy and society more broadly and likely spur regulation and policy changes. We believe its robust potential to drive global growth will outweigh any potential threats. However, this is less true for early-stage developing economies, which may likely see a greater need to adapt.