Security in Review

One of the most encouraging findings from Memoori’s 3rd annual report “The Physical Security Business in 2011” is that this industry has outperformed most peers and, despite a troubled economic climate, has increased revenues and profitability while merger and acquisitions have surged by more than double in the last two years to $9.847 billion. This business looks like a very safe port in a storm.

The total value of world production at factory gate prices was $19.17 billion, and it has grown by a compound annual growth rate (CAGR) of 4.25 percent over the last two years. Of this, video surveillance products at $9.1 billion taking a share of 47 percent has been the fastest growing sector, followed by access control at $4.41 billion, which took a 23 percent share, while sales of intruder alarms fell to $5.65 billion and now have a 30 percent share. The developed markets of North America and Europe are losing market share to Asia, and particularly China, which will be the largest single market by the end of this decade.

In the diagram, it shows the relationship between the performance of the market size, value of acquisitions and company earnings before interest, taxes depreciation and amortization (EBITDA) valuation on acquisition over the period 2007 to 2011. It shows that the market for physical security products did not decline until 2009, while acquisition activity and valuations declined in 2008. In 2009, both acquisition and valuation started a rapid two year rise while the market has grown by CAGR 4.25 percent.

The anticipated aftershock from the 2008 financial meltdown now looks inevitable irrespective of whether the right corrective actions are taken now. This will dampen future demand but there is optimism that as it can now deliver more attractive opportunities for clients to improve security and profit from it, demand will edge forward at a CAGR of 3.7 percent over the next five-year period, while forecasts show a much more modest growth in mergers and acquisitions, well down in single figures.

Delving into the report’s details, one factor stands out and that is that growth has been driven, not so much by the need for security which is a given, but by industry’s capability to produce a constant stream of new products that meet the customers’ need to drive more ROI out of investment. Across almost all verticals, security managers have found the budget to invest in systems that are, through delivering increased productivity at lower prices, moving ever closer to becoming a profit center.

It is the application of new technologies that has enabled this to happen. The report identifies five emerging technologies that have created new business opportunities. They are wireless communications, IP networking technology, video surveillance as a service (VSaaS), managed video, analytics software and security management software, including Physical Security Information Management (PSIM) and Physical Identity and Access Management (PIAM).

Not surprisingly, they all have one thing in common and that is they improve productivity and provide safer and more efficient security systems, and in some cases for less cost. However, all of these technologies embrace a wide divergence of skills and expertise, and clearly it will require large research and development--and development budgets--to take them forward. It is unlikely that any one company in the security industry will master them all.

So far, the leaders in introducing these new products are small- to middle-sized companies focused on one segment of the market, with the majority having been around for fewer than 10 years. The traditional market leader’s shares have stagnated, and the average share is less than 10 percent. Financing these developments will not in the short term improve their competitive positioning but they have the cash to buy this expertise through acquiring companies steeped in it; at this time, they seem reluctant to take the initiative.

This is one of the baffling things thrown up by the report: that despite a surge in acquisition activity, which has doubled in the last two years, most of the traditional market leaders have not participated other than watching this from the sidelines. It is not easy to fathom out why, because like all multinational companies they have up to 2008-09 had an active policy of growth through acquisition, and they all have strong cash reserves.

By 2010, the security industry got itself back to profitable growth, and the industry had proved itself to be an attractive, robust business; as the report shows, although company valuations have gone up, they are still below 2008 levels.

Interestingly, some $1.178 billion, accounting for 12 percent of total investment in acquisitions in the last 12 months, was made by companies from the defense and IT-related industries. In addition, venture capital and private equity groups acquired six companies, investing some $3.60 billion: including Bain Capital’s purchase of Securitas for $3.26 billion. This follows on from an active campaign in 2010 of companies external to the business seeking to become a part of it. Both defense and IT-related companies see opportunities in the industry to leverage through their technological expertise, and, together with their strong finances, they will play a significant role in strengthening and growing this business.

The longstanding multinational suppliers such as Bosch, Honeywell, Johnson Controls, Schneider, Siemens and UTC Technologies are both product manufacturers and system suppliers and cover almost all aspects of physical security. When you take account of this and review market share on the basis of product sales, which this report does, then it shows that average market share figures are little more than 3 percent, with the highest around 12 percent.

If you then start to look at market share in some of the segments, the fast-growing IP video networking camera market not inconsequential at $1.3 billion, is led by supplier Axis Communications, which share around 35 percent with no other supplier in reach.

You might wonder if some of the major traditional suppliers are spreading themselves thin on the physical security front and need to refocus on either the product or systems business or combine these to focus on particular product areas for specific vertical markets. They have all performed well financially in the last three troubled years and have been successful in growing their systems business. One of the major reasons for this is they have fed off their heritage estate business and at the same time have integrated activities from other parts of their organization<\m> as fire detection and extinguishing, evacuation control, mass notification and energy management<\m> holistic solutions for their clients. This has been a successful strategy but it appears to have taken their eye off the product business.

Last month, Tyco International announced that it will split into three separate companies, with two based on security and safety. This will likely open up the opportunity for at least one mega-merger in 2012, and our betting is that the traditional major players in our industry will not sit it out this time around. However, they will have to make sure that if they are going to stay in both the product and systems camps they will commit sufficient resources to spend on the enabling technologies and or acquire companies that have this expertise.

Jim McHale is the founder of Memoori, a consultancy company based in London.

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