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Retail shrinkage makes merchandise security a growth business. Advancing technology might make the antitheft industry even better -- but dot-com it's not.

Retail shrinkage makes merchandise security a growth business. Advancing technology might make the antitheft industry even better -- but dot-com it's not.

By Jeffrey Kutler
November 2000
Institutional Investor Magazine

Shoplifting isn't what it used to be. Anyone who has walked out of a Wal-Mart or Carrefour store without paying for that watch, wallet or welcome mat has probably been captured on video and, thanks to tagging technology, embarrassed by sirens sounding near the exit. Most of these antitheft systems come from two companies: Sensormatic Electronics Corp. of Boca Raton, Florida, and Checkpoint Systems of Thorofare, New Jersey.

The competition is lively because there seems to be no shortage of criminal intent. Sensormatic has the edge in market share; its $1.1 billion of annual revenues is almost half again Checkpoint's $750 million. But Sensormatic president and chief executive officer Per-Olof Loof says that the companies have barely scratched the surface. He points out that only 27 percent of retail doors are secured and that entire sectors, notably the grocery industry, are not protected at all.

This is not solely a salesmanship battle. Loof says it is increasingly about mastering technologies that combat not only customer theft but
also insider crimes. And through more-advanced techniques -- such as tags that can be tracked with radio
signals -- manufacturing and inventory controls can be improved and integrated with stores' antitheft and point-of-sale systems.

The technology and complexity of this changing field explain why Loof, a 50-year-old native of Sweden, was attracted to Sensormatic in August 1999. He is a veteran of Digital Equipment Corp., AT&T Corp. and former AT&T subsidiary NCR Corp., where he headed the financial industry group. In the 1998 fiscal year, which ended June 30, Sensormatic had lost $33 million on $987 million in sales. Loof revamped management, reduced costs and in fiscal 2000 got profits up to $72 million. The first quarter of fiscal 2001 saw a 62 percent boost in income, to $12 million. At 12 cents per share, that beat consensus estimates by a penny -- good news amid the worst of October's technology stock decline. During that period Sensormatic's stock gained more than $2, hitting $17.37, and its price-earnings multiple climbed from 18 to 20. It now has a market cap of $1.3 billion.

Loof recently discussed his company's view of technology, and how it differs from purer high-tech plays, with Institutional Investor Assistant Managing Editor Jeffrey Kutler.

Institutional Investor: What was it like to move to Sensormatic with your big-company technology background?

Loof: There is a lot more technology in Sensormatic than people give it credit for. Interestingly enough, it's a combination of physics and technology. You can see it in our Puerto Rico plant. In manufacturing we do everything from carpentry to circuit boards.

How do you define your core business?

Article surveillance is what we are mostly known for: If you try to steal something from a retail store, the alarm goes off. Second, we are in video surveillance and recording, which includes digitizing and analyzing the data and transmitting it over the Internet. And we are in access control, protecting people and assets, keeping track of where they should and shouldn't be. Looking to the future, we are going into the RFID [radio frequency identification] business, tracking products and people as they move through various locations and processes.

The technology is interesting, but aren't you first and foremost in the physical economy?

Nicholas Negroponte [director of the Massachusetts Institute of Technology Media Lab and author of Being Digital] has written about the evolution of the world from atoms to bits. We are focused on atoms as they work their way through the manufacturing chain to distribution centers to retail stores and, ultimately, to consumers. We apply technology to that, with an increasing emphasis on tracking mechanisms. Shrinkage is a staggering problem -- in the U.S. and Europe alone, $52 billion a year. That equals 1.72 percent of retail sales and is evenly divided between external shrinkage, or shoplifting, and internal theft, which is by employees. We had been looking at the external side almost exclusively. That had been the company's reason for being since 1966. As we get more into internal theft, it requires more of a systems approach. The tagging, point-of-sale, video surveillance and access control systems all have to work together.

Where does radio frequency identification fit in?

We know how to do tags and labels, and we understand how products move through the chain. Bringing those two together, RFID technology actually goes on the product, so it can be tracked as it moves through the chain. You not only can manage the process better, but you can also ensure that the product is not diverted. This also gets at counterfeiting, which is a huge issue for big-brand companies. This can tell you if something is authentically a Black & Decker Corp. product, for example.

How far do you take your technology beyond tracking and authentication of goods -- to people, for example?

We already do employee ID systems. You might ask, should we also be concerned with protecting electrons -- in other words, data security? Today almost all of our revenue comes from things that we do in the retail store. But there is a lot of theft in warehouses and in the manufacturing area. Besides that, the next extension for us is product tracking. Electrons are certainly part of the protection systems today. We send digitized information up and down the Net. But that's a different thing from becoming, say, a Web security company. For now we'll let others worry about that.

How are you affected by the supply and cost of silicon chips?

Our RFID chip may cost $1, and it will come down, but not to a penny. But the first application of what we call SmartEAS, the combination of RFID with our traditional electronic article surveillance, should have interesting economics. We are doing a trial of self-checkouts for video rentals with the Movie Gallery chain. A machine reads the tag for inventory tracking and registers the video to the renter who inserts his or her card. If it's not paid for, an alarm will go off. When the product is returned, it is scanned back into inventory, and the alarm is reactivated.

Technology costs tend to come down, but how are you managing on the physical manufacturing side?

We were very pleased with the results of my first year. Revenue was up 12 percent. Profits rose 123 percent, and expenses fell 2 percent. We had a net reduction of 200 in head count, to 5,500. The closing of manufacturing activities in San Diego, which we are moving to Puerto Rico, will cut another 100. But as we grow, I anticipate we'll begin to see some increases again.

Is there still a clear-cut advantage to manufacturing offshore?

The move from San Diego is meant to better leverage our existing facility in Puerto Rico. We look for the best, most cost-efficient places to do business, which is why we opened a facility in China this year. [Others are in Brazil and Ireland.] We do manufacture in the U.S. to support source tagging, which is when manufacturers place security labels on their products at their factory. Producing these on rolls at the rate of 100 labels per second -- our labels were source-tagged on 1.65 billion products last year -- is incredibly complicated. The error tolerances are minuscule. So we keep this close to home in Boca Raton.

Are you trying to be perceived as more of a technology company?

Yes, and I think that's catching on to some degree. If you look at our customer list -- ASDA Group, Habitat, Home Depot, Kmart Corp., Wal-Mart Stores -- it's like a who's who in retailing internationally. But we also worked with a hand-geometry access control system to protect the U.S. Olympic basketball team in Sydney. We secure the U.S. Olympic training sites in Colorado Springs, Colorado; Chula Vista, California; and Lake Placid, New York. We will do all the electronic security for the 2002 winter games in Salt Lake City. And we protected this year's Expo 2000 technology fair in Hannover, Germany.

Given the stock market volatility, can't the tech label also have a downside?

To us, it's important to be perceived not as a tagging company but as one that goes beyond the traditional world of security. Most of my management team comes out of the computer industry. Then again, we are not a dot-com. We have real products that people pay real money for. We are very serious about securing a much wider area of business than in the past. Our stock price and P/E are up, but I think they should be higher.