Industry Consolidation is on the Horizon

As an outsider to the video surveillance industry, one gets struck by its fragmentation. At ISC West 2013, there were more than 1,000 different booths where companies exhibited some type of video surveillance product. The top 10 surveillance vendors in the United States only control about 40 percent of the market, with the leader currently holding an 8 percent market share.

When comparing this situation to other product-oriented industries, it is clear that the current situation is something of an exception. It begs the question: Will there be fewer or more camera exhibitors at ISC West in 2016? Building on relevant theory and evidence from other industries, this industry is likely to become more consolidated in the coming years.

 

The Rule of Three: From Soft Drinks to CCTV

Back in the 1970s, consultants at the Boston Consulting Group (BCG) drew on economic theories to develop “the rule of three” — a statement which posits that in any industry, there will only be three profitable actors, while the rest will either struggle and gradually exit the market or become niche players with very small market share.

The underlying rationale is largely related to economies of scale — i.e. the fact that larger firms can reap cost benefits from larger volumes. This holds true not only for manufacturing, but also distribution, purchasing, logistics, R&D and branding.

The soft drink industry provides a perfect illustration of this pattern, as it is dominated by three large players, Coca Cola, Pepsi Co., and Schweppes. Those three companies are able to put up the money required for advertising, while at the same time, they are able to squeeze suppliers and maintain a strong bargaining position with stores selling their products. They also have the clout to purchase the smaller competitors’ brands.

But can we really use economics from the 1970s and compare soft drinks to technology-intensive products like security cameras? While there is some truth to the argument related to economies of scale, it obviously does not paint the full picture. A distinguishing feature of video surveillance is that the industry is undergoing rapid technological change, which is perhaps the main reason why it remains so fragmented today — and at the same time the main reason why it is likely to consolidate in the coming years.

 

The Technology Shift: Analog to IP

The ongoing change from analog to IP-based surveillance systems can be regarded as a technological discontinuity. Industries normally go through a period of turbulence when the established technology changes. At the initial advent of a new technology, very little happens — a couple of firms make improvements that the old technology could not deliver and begin selling into some fringe market segments who appreciate the new performance attributes.

As the new technology becomes more competitive, it-s market grows. This in turn sparks a wave of entry into the industry. At this point in the technology cycle, firms which dominated the old technology coexist with all the entrants who have been attracted to the “gold rush” promising great fortunes for everyone. But like the Klondike gold rush of the late 1800s, as more join the search for gold, the less there is to go around.

This pattern can be recognized in several historical examples of industries undergoing technological change. By the late 1960s, mechanical calculators were increasingly displaced by electronic ones. In the United States, only 11 firms entered this industry between 1962 and 1970, with 10 surviving. As prices declined and the technology was further improved, entry increased and 21 firms joined the industry in 1970-1972.

The smartphone industry took the same journey, starting with IBM’s Simon in the early 90s, followed by a few innovative competitors including Palm, Nokia and RIM’s BlackBerry, to the game-changing iPhone that hit the market in 2007. Today, we are back to three main platform competitors: Apple, Android and RIM (with Microsoft launching new products in hopes to overtake RIM’s 5 percent share).

With IP video now firmly established, the video surveillance industry has reached a similar phase as in the above examples. CCTV and IP video coexist at present, while the high growth of IP video over the last years has attracted a lot of new entrants. This is confirmed by the fact that the top 10 players controlled 50 percent of the video surveillance market four years ago, while this figure has today declined to about 40 percent.

 

Factors Leading to Consolidation

Why then would the industry start to consolidate at this point? Here are several factors that might contribute to less fragmentation in the coming years:

1. Established firms exit the market: By the early 1970s, most manufacturers of mechanical calculators left the market as the industry was increasingly dominated by entrant firms such as Sharp and Casio. Not only had the competencies of these firms been rendered obsolete — as they knew precise mechanics and not electronics — their vertically integrated business models became inapplicable with the shift to electronic calculators. These firms manufactured their own components and maintained a vast service network, factors which together contributed to high barriers to entering the industry. As calculators became electronics-based and more capable, they were also increasingly sold via other channels and to different groups of end-users, putting incumbents in an awkward position.

While analog incumbents in the CCTV industry have so far been better off than these calculator companies, it is still clear that the shift to IP has upset and altered established practices in the industry. The required technological competencies have arguably also changed, as IT skills are becoming increasingly important. It remains to be seen whether analog incumbents will be able to stay competitive, but it would be surprising if all of them are still left in the same shape four years from now.

2. Competition forces entrants to leave the market: Accounts of technological change usually paint a picture of conservative incumbents being displaced by innovative entrants. Such descriptions are largely incomplete and they rarely attend to the fact that entrant firms are often also wiped out of the market.

A lot of firms entered the electronic calculator industry in 1970-72, trying to grab a share of this rapidly growing market. Soon after, however, most left the industry as they struggled to deal with increasing competition. Going back to the Klondike analogy, the promise of gold creates a swarming pattern around the new technology, but as so many search for the same gold, few get rich since the industry becomes highly competitive.

A growing market is by no means a guarantee of growing profits. When looking at the hundreds of companies now offering IP-based cameras today, one must ask whether they all are able to compete in the long term. Some of them are arguably too vertically integrated, others will have inferior products with no ability to differentiate, and others lack sufficient technological competencies. It remains to be seen which ones possess both technological skills and the right business model — those will be the survivors.

3. Economies of scale increase in importance: Increased competition is far from the only factor driving the industry towards consolidation. Going back to “the rule of three” and the arguments related to economies of scale, these seem largely applicable in the video surveillance industry.

A larger player can obtain lower costs throughout its entire value chain, thereby having the luxury of either making a larger profit or lowering prices to levels where smaller firms take losses. In terms of brand recognition and market coverage, the odds also favor the larger players. Furthermore, a large company can invest more money in R&D than smaller actors — in some cases, they can even reinvest significantly more money than the small company makes in revenue per year.

However, having more engineers does not always mean a company will win – the fact that Nokia had 30,000 engineers did not prevent them from collapsing in the shift to smartphones.

4. The impact of new standards: The emergence of new standards can alter the competitive landscape swiftly. The early television industry presents an interesting example of this pattern. In the 1930s, a couple of firms were experimenting with new technology, and as it evolved and became increasingly attractive, more companies entered the industry and the amount of firms peaked at 85 in 1952. In 1951, disputes about technical standards were settled by the Supreme Court and, two years later, a nationwide standard was adopted. Radio Corporation of America and a couple of other large firms had supported this standard and, needless to say, they benefited extensively from these events. From the early 1950s on, the number of firms decreased rapidly and the industry became increasingly consolidated over the next 30 years.

The emergence of the HDTV standard for IP cameras in 2008-2009 created a similar, temporary shakeout. As many IP camera manufacturers joined in a megapixel race, they struggled to compete once standards-based HD format and compression technology (H.264) emerged as the standard of image quality. When the megapixel race subsided, these companies whose unique selling point was “more pixels” struggled because it was no longer interesting. Similar changes in standards may in the future contribute further to a shakeout.

 

Conclusion: Increased Consolidation is Coming

Based on historical examples, economic theory, and the current state of the surveillance market, the industry will become more consolidated in the future. Currently, analog and IP coexist, though one technology is clearly gaining momentum. Analog firms will need to reinvent themselves to stay competitive, and some are likely to exit the industry altogether.

Furthermore, the increase in firms offering IP cameras can be regarded as temporary. As competition intensifies, some firms will be forced out of the marketplace when economies of scale become more important. Changes in standards and new technologies can be regarded as wild cards in this game as such shifts are difficult to predict, yet may have a large impact on the competitive dynamics of the industry.

Those who attend ISC West in 2016 will see whether I am right or not.

 

A public speaker and academic researcher, Christian Sandström wrote his doctoral disseration on how new technology affectes established industies. Among other things he studied the shift to digital photography and its implications for incumbent firms.

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