Amazon Prime Air has gotten a lot of attention, but it may not be the business to watch in the drone market. Image source: Amazon.
Drones have made a surprisingly swift entrance into everyday life in the U.S., with the FAA recently allowing drones to fly under rules usually reserved for model aircraft and a fairly broad number of commercial applications. With companies like Amazon (AMZN 1.49%) wanting to make a push toward delivering packages using drones, there's a lot of media hype around the little flying machines.
But most drones flying today aren't delivering packages: They're hobbyist drones you can buy almost anywhere. In a short time, that might change, but Amazon won't be the company to watch when it does.
AeroVironment is talking about commercial drones, but its biggest business is still drones for the military. Image source: AeroVironment.
Drones are coming
We've known for years that drones were going to be popular. What was and is less known is how or when they would be allowed to fill the skies. The FAA is in charge of creating regulations for drones and has been pretty aggressive in building such a framework. There are rules for hobbyists -- for example, they must fly under 400 feet, within line of sight, and not near airports -- and commercial rules are coming out as well.
Companies like AeroVironment (AVAV -0.20%) and Boeing's (BA 0.39%) Insitu division are leading the way in the commercial drone market, having received licenses from the FAA to fly missions already. Some of these drones are being put to work exploring oil fields or monitoring crops.
However, that's just scratching the surface of drones' potential. What they need to gain wider adoption is a business model that makes their usage safe, reliable, and profitable.
But maybe not with packages to your door
The Amazon drone-delivery business model gets a lot of talk, but it's still a long way from being something we'll see on a large scale. An Amazon distribution center would have to be within 10 to 20 miles of your home, and for now, drones demand about a 20-foot-by-20-foot landing area, excluding millions of Americans from drone delivery right off the bat.
But that doesn't mean drones won't find a place in another type of delivery space in the near future. A company called Matternet is already using drones to send medical samples from the location where they're taken to an off-site laboratory. The company isn't operating in the U.S. yet, but has been operating internationally since 2011.
The idea is simple enough. A clinic or hospital may not have the right laboratory equipment, so a drone could get results from a central lab more quickly, and for less overall cost, than either driving the samples to the lab or installing more lab equipment in more locations.
A model for the future
This could pave the way for a business model that uses drones to invest in capital more efficiently and to reduce wasted time and expense in moving high-value goods. A company could build expensive capital equipment or inventory in one central location and have drones fly goods to satellite locations to serve their needs.
Maybe this concept could be used in the 3D printing industry, making it possible for product designers to design and test parts and get them made from a specialized 3D printing company. This would save on the capital cost of owning a 3D printer and on the time spent picking up parts printed by a contractor. Or auto repair shops could order parts from a centralized warehouse and get them as jobs come in rather than holding inventory or sending someone to a parts store multiple times a day. And maybe drones make sense in the food services industry, where transporting fruits, vegetables, and fish is time-sensitive.
As with high-value medical tests, these businesses could benefit from having a central location for equipment or inventory that could be tapped into in a matter of minutes.
Getting on board with drones
With the FAA already outlining hobbyist drone rules and allowing some commercial flights, it's setting the stage for full commercial drone regulations in mid-2016, when the drone boom could begin in earnest. But investors should keep in mind that these aren't toys, and companies will have to have a viable business model to justify deployment. Right now, delivering things like high-value medical samples to a network of clinics with established landing and take-off zones makes a lot more logistical sense than quick delivery of a Kindle from Amazon to your backyard (if you have one).
The challenge for investors is that there are precious few ways to invest in drones today. Boeing's drone business is still primarily focused on military applications, and commercial drones are just a fraction of the company. AeroVironment is the company I've bet on in this space, but it's still developing a commercial strategy to compete with innovative start-ups.
It's easy to see that drones could be commonplace across the country in a matter of years if FAA rules are favorable and drone technology continues to improve. What's unclear is how investors can capitalize on that trend. Maybe we should be looking more at business-model innovation rather than who makes the coolest drones. That may be where the real value is created long-term.
