A State of Surveillance
By: Ryan DeCaire & David Luder
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Founded in 2004, Avigilon has become a leader in the design, manufacturing, and marketing of high definition, high megapixel network-based video surveillance systems and equipment for the global security market. Headquartered Vancouver, this young Canadian technology player is uniquely positioned as the only company that offers both software and hardware for the global security space. The components of the Avigilon system can be sold together or separately to provide customers with the only customizable end-to-end security equipment and monitoring solution. Since its first full year of sales in 2008, revenues have grown at an impressive CAGR of 100%. These growth figures are dominant in the security space, and a token to both the enormous market potential and Avigilon’s effective company leadership.
With Canadian investors aiming to diversify away from the underperforming natural resource stocks that dominate the Toronto Stock Exchange, ample capital has been flowing into historically untraditional sectors including technology. Within this space, Avigilon’s rapid growth has caught the eyes of investors. Avigilon is poised to become one of the few Canadian technology companies that dominate their market on the global stage. With rapid growth in product sales that are in line with the expanding surveillance and security industry, investors have pushed the stock price up almost 185% over the past year.
The Growing Surveillance Industry
Valued at $12.6 billion globally in 2012 and projected to grow to $23.3 billion by 2016, the global security and surveillance market is expanding rapidly. Major catalysts for growth include the development and spread of new high definition digital (IP) surveillance systems and an increased focus among businesses and consumers surrounding asset protection and theft prevention. The market is also highly fragmented; no player holds more than 6% market share, and the top 15 players represent 43.5% of the market. This fragmentation has allowed Avigilon to quickly capture market share while creating a window of opportunity for further expansion, as the company continues to assert its dominance with its technology and product offerings.
Spy vs. Spy
While Avigilon’s growth has been strong and consistent, the long-term sustainability of its current sales strategy raises some concerns. First, with relatively low barriers to entry and with R&D spending being a key determinant of success, some industry experts believe that deep-pocketed competitors like Axis, Bosch, Milestone or Genetech will eventually be able to match Avigilon’s quality products and have the ability to offer lower prices due to economies of scale. There is also the risk of Avigilon losing existing customers to competitors who would be able to implement their systems on top of the existing Avigilon infrastructure. The industry shift toward an open platform, where new systems would be built on top of legacy systems, could pose a serious threat to Avigilon. Additionally, the majority of Avigilon’s sales are conducted through intermediaries, called integrators, who lack concrete loyalty and are primarily concerned with pushing the best available product, regardless of the manufacturer.
Selling its products through an integrator also eliminates touch points between Avigilon and the customer throughout the ownership cycle, decreasing the opportunity to develop customer loyalty. Avigilon’s current model is a one-time equipment and software sale business. Customers purchase Avigilon products through their integrator of choice, who then takes on product installation and educates the customer. This sales cycle can be long, taking up to 36 months. The risk of larger entrants, competitors building on top of their infrastructure, and the eventual saturation of low replacement rate one-time sales could lead to slowing top-line growth. In order to truly become a stalwart in the security industry, Avigilon must develop a recurring revenue component to augment its existing one-time revenue stream.
The Future of Surveillance
Currently, Avigilon is the only company that offers an end-to-end security system solution. The last part of the value chain that Avigilon does not control is the actual monitoring of the cameras. With the advent of IP security technology, surveillance monitoring has become a lucrative and rapidly growing industry with a small number of early entrants. Given Avigilon’s large network of integrators and its control of the value chain, the company has an opportunity to leverage its existing business and develop a recurring revenue stream by entering the surveillance monitoring market. It is estimated that it would require an investment of roughly $35 to $45 million dollars to develop a monitoring business with $10 million of revenue. Due to Avigilon’s lack of knowledge in this sector, Avigilon should enter the surveillance monitoring business by acquiring an incumbent who could bring the required knowledge of the monitoring space.
Monitoring the Opportunity
The advent of IP security not only made Avigilon’s IP security equipment both a viable and unique business but also created the remote surveillance-monitoring segment. As high-quality surveillance footage can now be transmitted digitally over the internet, observers can monitor cameras that are physically located anywhere in the world from a central monitoring station. Players have entered this space by purchasing cameras through distributors, consulting to customers who require surveillance services, installing cameras and video management software, and then monitoring these cameras. Given Avigilon’s recent expansion into international markets, the global capabilities of digital surveillance and IP camera monitoring will further allow the company to penetrate international markets in the form of a new service offering allowing increased monetization of customers.
The monitoring business, while in its infancy, is a highly lucrative segment of the security market that is growing rapidly with gross margins in the range of 60 to 70%. In general, monitoring centre surveillance can shave approximately 50% off the cost of physical guards and often provides higher quality monitoring in comparison to human observers. This alternative model offers a powerful value proposition to end-users.
Those who operate as pure play monitoring service businesses tend to incur annual capital expenditures that equate to 8.5 times recurring monthly revenue. Hardware providers like Avigilon provide equipment to the pure play monitoring businesses, therefore it can be assumed that Avigilon would incur lower capital costs than potential competitors as it has control earlier in the value chain. Through vertical integration, Avigilon could reasonably incur capital expenditures of only 6.5 to 7.5 times recurring monthly revenue and, therefore, would enjoy more attractive cash flows than existing players as a result.
A key success factor of this business is scale; one operator can monitor approximately 200 cameras or more at any given time. A monitoring service business becomes more efficient if it can minimize false alarms, which must be investigated by an operator. Reducing the amount of time that operators spend investigating false alarms increases margins through greater capacity utilization. Avigilon’s most recent acquisition of Video IQ plays directly into this dynamic. Video IQ is a leader in the development of video analytics, allowing monitoring service providers to focus on true events and avoid false alarms. With the technology and talent of Video IQ in hand, Avigilon’s technological base is currently primed to create a competitive advantage that will allow it to be successful in the monitoring space.
Selling Service
With an entrance into the monitoring space, there is an additional opportunity to further involve the customer with Avigilon product sales. By adopting an equipment leasing model, Avigilon could offer an all-encompassing payment system including both the initial product purchase and the ensuing monitoring services.
In this proposed financing model, Avigilon would produce the cameras and equipment required for an end user’s site. The user would then make a monthly payment to Avigilon directly or through Avigilon’s integrator channel partner. Every 24 months, Avigilon would renegotiate the equipment agreement with the customer, retrieve the existing equipment and replace it with newly developed equipment. Avigilon would then resell the used equipment in the active used camera and equipment market. By the time the equipment is sold to this market, Avigilon will have already recovered the full value of the product plus a healthy profit above the manufacturing cost. This indicates that all proceeds will represent incremental profit.
Reducing the capital expenditure required to install an Avigilon camera system will be attractive to new monitoring customers in both the SME market and among enterprise clients. In addition, the surveillance and monitoring model has traditionally been a recurring monthly revenue business whereby the customer makes a monthly payment for the monitoring provider’s services. By offering customers of their monitoring service business the opportunity to make monthly payments for both the cameras and service, Avigilon would enter the market with a straightforward and comprehendible payment system.
Analyzing the economics of the business model, Avigilon could earn an implied interest rate of 12% per annum on the lease of the equipment while maintaining the present value cost to the customer. This is based on a customer’s average spending on equipment of $14,000, providing Avigilon with a greater net present value of cash flows over a ten year period than it could earn under its current one-time sales model. Although this method of sales would be a drastic shift from Avigilon’s current program, it would ultimately be a win for the customer with lower capital expenditures, a win for Avigilon with improved present value of cash flow, and a win for the new monitoring business as this new fee structure will attract customers that formerly would have feared the excessive cost of installing a surveillance system.
Keep Watching
Embroiled in the heat of the rapidly expanding security and surveillance industry, Avigilon must be prepared to adapt in order to maintain relevance and the long-term sustainability of its customer base. Acquiring a company to enter into the surveillance monitoring space would create the desired recurring revenue stream that Avigilon needs to complement its existing one-time sales model, especially as competition continues to improve its capabilities and threatens a lower total cost of ownership to the end user. Under the proposed model, Avigilon will grasp the remaining segment of the value chain and solidify itself as Canada’s most influential tech giant.
