How IT is Transforming the Security Business

While technical skill sets and competencies dominate the discussions surrounding "convergence," it is the differences in the channels of product delivery between the IT and Security industries that will have the biggest impact on the transformation of our industry. Specifically, IT convergence will force security integrators/dealers to increase their (1) scale, (2) specialization and (3) efficiency.

• Scale- IT distributors and integrators are routinely 10x the size of their security counterparts; this provides them with significant economic advantages
• Specialization- Because of global competition, IT providers have become domain specialists offering very high value niche services
• Efficiency- IT providers have learned to operate on extremely low (single digit) margins on product sales

In each of these areas, security integrators must respond or they will be at severe and unsustainable competitive advantage. I have seen this pattern play out in other market segments over my 20 plus years in the IT industry. I am seeing the same pattern repeat in my current business as a value-added distributor for IP video solutions.

 

If we review the history of digital data storage, two vertical markets have undergone periods of “convergence” similar to what we are witnessing today in our industry. The first was in the publishing (prepress) business and the second in film editing. In both of these businesses, there were plenty of old-school professionals who doubted how rapidly their industries would migrate to a purely digital format. Indeed, one can draw a parallel to those in the typewriter business skeptical that word processing would ever gain much traction. Analyzing these industries today, it is apparent that there has been a complete transformation, not only in the technology, but also within the companies that produce the products and the channels that deliver them. Having said that, there are also numerous examples of organizations that had the foresight to implement strategies designed to cope with rapid change, many of which exist and thrive today. In the prepress industry, Heidelberg is often cited as a case study in how to remain competitive when markets are in transition. In summary, Heidelberg has maintained its 150-year dominance through strategic acquisitions and forging alliances with companies having newer and complementary technologies.

 

IT Distribution Channel Structure and Function

 

The reseller and distribution channels in the IT industry both underwent major consolidations almost 20 years ago. Thousands of small computer dealers disappeared and a few national dealer/integrators emerged dominant. Similarly, on the wholesale distribution level, many regional distributors were acquired or went out of business and a few major players emerged with a global presence. Today’s major wholesale distributors of IT products share certain characteristics:

 

1. Function mainly as a bank and a warehouse.

2. Expect vendors to generate sales through pull-through and marketing activities.

3. Require vendors to fund all of their marketing initiatives.

4. Charge vendors significant pay-to-play fees and have soft dollar profit centers.

5. Require vendors to handle the majority of tech support.

6. Operate profitably on low single-digit gross profit margins

 

IT products dealers and integrators also share some common characteristics that differentiate them from traditional security dealers and integrators:

 

1. Operate on low gross profit margins on product sales.

2. Carry little inventory and source almost all products through distribution.

3. Focus on services for most of their earnings.

 

The channel model for IT products has evolved to its current state because of competitive market pressures that allow only organizations with scale and efficiency to survive. Today, the top two distributors of IT products each generate sales of more than $25 billion annually. So a 4% gross margin still represents a significant number as a percentage of total revenue. One question is therefore, “How will security products distributors compete in this environment?”

 

It is important to consider the relationship between dealers and distributors and understand how these relationships are perceived. In the security industry, being direct with a manufacturer gives credibility and prestige to an integrator. It is a badge of honor. In IT, being direct carries no meaningful designation, however, there is a significant distinction between being direct and being certified. Even Gold Cisco reseller’s have their orders fulfilled through distribution. Some of the largest IT product resellers are multi-billion dollar organizations that purchase almost exclusively through distribution because it makes economic sense. Their ERP systems are tied to their distributors so they are able to leverage inventory, logistics, and consolidate orders and back office functions. They have cost-plus basis contracts with their distributors and the distributor mark-up is sometimes as low a 2%. So in practice, there is no advantage to buying direct from a manufacturer, while buying through distribution can offer these resellers attractive incentives.

 

A traditional security integrator with $5 million in annual sales is considered to be substantial by security industry standards. In the IT world, an integrator with the same revenues is often regarded as quite small. This distinction is important to make for reasons other than scale. If we consider an IT integrator that focuses on the K-12 market, a school district might represent as much as $1 million in annual business. So the additional resources that the IT integrator will employ to capture the physical security business from the account are not significantly incrementally. They are also accustomed to operating at much lower margins then their counterpart in traditional security. That same school district might represent only $100,000 of potential business for the traditional security integrator. But providing additional services beyond security is unlikely for this reseller. So it is very difficult for the security integrator to operate on the same lean margin structure as their IT competitor.

 

So how can integrators prepare for these major shifts in the way business is conducted in our industry? It should be no secret that today most network camera sales are being made through the IT distribution channel. If we accept the premise that network cameras will replace analog cameras, whether sooner or later, then it is critical for security professionals to have a clear understanding of the IT channel model. With this knowledge, the dealer or integrator should then examine the way their business is structured and determine how to increase efficiencies. For instance, if an integrator’s daily routine includes dispatching employees to pick up equipment from their local distributor, that’s a strong indication that operational procedures need to be re-evaluated.

How the Security Integrator Must Change

 

The following are some of considerations for security integrators adapting to today’s changing environment:

 

1. Transition from integrator to a true VAR (Value Added Reseller). By definition, an integrator is a service-provider that takes various off-the-shelf hardware and software components and assembles them in a system where they operate together in unison. A VAR takes this a step further by adding additional value to the sum of the components. VARs deliver systems for specialized environments or applications.

2. Hardware products will become increasingly commoditized and margins will shrink. Integrators should identify vertical markets where they can differentiate themselves by providing a high level of understanding, expertise, and software tools for specialized applications. They will need to understand the complexities of specific types of businesses and their challenges in order to develop and deploy systems tailored to those specific operations. Whether the value added is in knowledge or in the product delivered, it is the added value that represents the profit opportunity.

3. There is value in the data. If an integrator focuses on big box retail, for example, they will not only need to deploy systems designed for loss prevention but also be able to use the data generated by these systems to provide information useful and valuable to their customers beyond the scope of loss prevention. Customer behavior analysis as an obvious example. This will also provide access to budgets outside of Loss Prevention.

4. Expand geographic footprint to increase scale. Rather than providing general solutions to all types of customers in a limited geographic area, specialized capabilities can be taken to a broader geographic market. As a generalist it is difficult to take an undifferentiated offering into new markets where there are established competitors with similar offerings. As a specialist, the field of competition will be much more narrow.

5. Buy, sell, or merge. As the market consolidates, size will become increasingly important. Security integrators should identify other resellers that offer products and services complementary to their own, or those selling similar products and services to a different geographic market. This will increase purchasing power and lower operating expenses through consolidated operations and administration.

6. Improve financial management. An integrator’s financial manager must be much more than a bookkeeper maintaining ledgers and generating reports. They must be cost accountants that know how to create efficiencies and streamline operations in order to positively impact bottom line results. They must be able to think laterally and have a clear understanding of the complete supply chain and how it can be leveraged.

7. Purchasing as a senior management function. The employee responsible for purchasing can have more influence on profitability than any employee. Every dollar saved on cost falls directly to the bottom line. The purchaser must have the capability to evaluate and select suppliers based not only on product costs but on vendor support and services which reduce margin leakage from such things as inefficient RMA returns, order discrepancies, late deliveries, etc. As margins shrink on hardware sales, this function will become increasingly important.

8. Reevaluate supply channels. The supply channels which an integrator has used historically may not be best suited for current product needs. Existing supply channels should be evaluated, not only on price offered, but also on value-add knowledge and services in important areas such as pre- and post-sales support. Suppliers having an in-depth understanding of their products can save the integrator money and time by providing accurate information on product suitability for specific applications while offering guidance on practical solutions to complex challenges.

 

It may be a rocky road ahead for many security dealers and integrators, but change also represents opportunity. The discussion as to whether IT or security integrators will emerge dominant is not a productive one nor does it address the reality of the market place. The successful organization, whether coming from an IT or traditional security background, will be the one that can leverage current technologies to meet specific customer requirements and deliver them along with a portfolio of professional services that are more attractive than the competition. As video and access control migrate to the network, security integrators must start to think of themselves, and act as, highly specialized VARs.

 

Bill Douglas is a Founding Partner at United Digital Technologies.