RFID: The Investment Opportunity

By Admin

The establishment of open, global standards for RFID will reduce equipment costs, spur adoption and create enormous investment opportunities.

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Nov. 25, 2002 - In 2000, at the peak of the Internet boom, venture capitalists pumped a mind-boggling $102 billion into startups in the United States. Venture capitalists were raising money so fast they literally couldn’t find enough companies to invest in. They were pouring money into Linux companies that admitted they might never make a profit and into startups like Pixelon, which spent $16 million on a Las Vegas launch party. John Doerr, the legendary venture capitalist who backed Amazon.com and Netscape, called the Internet the greatest source of legal wealth creation the world had ever seen.

Times, of course, have changed. In the third quarter of this year, U.S. venture capitalists invested only $4.5 billion into 647 startups -- $25 billion less than they invested in the third quarter of 2000. At a VC conference in San Francisco earlier this year, speaker after speaker lamented that there was no Next Big Thing on the horizon.

This is somewhat astounding, since it’s clear that RFID technology has the potential to solve so many business problems – from supply chain theft to out of stocks. RFID has long been held back by the lack of standards, but progress is now being made on a number of fronts. Which standard becomes dominant is not as important as making sure there is a standard (or several standards for broad industry segments).

That raises some important questions: If all vendors have to make products to a set standard, how will small, venture-backed companies make money? Won’t a few very large, hyper-efficient producers dominate the market? And if that is inevitable, won’t innovation be stifled?

It may be counter-intuitive, but standards create opportunity and spur innovation and competition. There are two complementary reasons for this. First, standards dramatically expand the total size of the market, and second, they prevent any one company or small group of companies from dominating to the detriment of others.

Look at the PC industry. Microsoft used its proprietary technology – the Windows operating system – and the market clout it gave the company to systematically drive competitors out of the market for word processing, spreadsheet and other business productivity software. As a result, even as PC prices fall, end users have to pay high prices for Microsoft Office.

Contrast that with the Internet, which is based on open standards developed originally for the United States military. When the Internet was made available for consumer and commercial use, it unleashed a wave of innovation and opportunity. Cisco Systems may dominate the market for Internet protocol (IP) routers, but no company dominates the Internet. As big as Amazon.com is, there is still plenty of competition among online retailers.

Radio frequency identification is essentially a network technology. It extends the existing interlaced web of public and private computer networks to physical objects. Open standards will prevent large companies from controlling the market and will create opportunities for companies of all sizes – and for the venture capitalists that know which startups to back.

One of the keys to any technological revolution is cost. The PC was a radical change because it was powerful but relatively inexpensive. (Even at $5,000, the IBM PC XT was a lot cheaper than a mainframe or minicomputer.) The Internet, of course, was virtually free. All you had to do was pay the communications costs to get hooked into it. Similarly, cost will be a big issue when it comes to extending computer network to objects. The market won’t explode until prices reach a level where companies can achieve a return on their investment in the equipment.

Just as the industry is making progress on standards, there is progress toward lower prices. The five-cent tag may be one year or several years away. But a 25-cent tag can easily be justified on many products and cases of products if there is an open standard. That threshold will be reached next year, opening up new opportunities. Initially, there will be a lot of companies jumping into the business of making RFID tags and labels. But because silicon foundries are so expensive to build, it is likely that the production of low-cost chips for RFID tags will be dominated by a few companies like Philips Semiconductors, Texas Instruments, STMicroelectronics and up and coming Chinese silicon fabs. And label making will likely be dominated by a few large producers who can afford to invest millions in complex, high-speed reel to reel machines that turn out millions of labels per day.

Does that mean there are no opportunities for "fabless" chipmakers – those companies that design the chips, have them made by semiconductor companies, and then integrate them into their products? Of course not. Just as Extreme Networks, JDS Uniphase and Juniper Networks have all been able to compete with Cisco by focusing on specialized areas of the market for routers and switches, fabless chipmakers will exploit large niches in the RFID market.

There are many products that will only be worth tracking if the tag costs less than five cents. But there are many other products that will use more expensive RFID tags that contain more than just a simple serial number. Airplane parts, for instance, need to be certified as authentic, and their history has to be tracked. Many medical devices must be used only once. An electronic product code might be useful for tracking these items, but additional features will be needed to meet regulatory and business requirements.

One area getting little attention so far is the design of the tag antenna, which plays an important role in the reliability of any RFID system. Alien Technology bought a company called Wave ID, whose CTO, Curt Carrender, has 14 years’ experience designing antennas. One antenna he designed couples with a coffee can, effectively making the can part of the antenna. Eventually, someone will figure out how to integrate the chip into the can, so the can itself is the antenna. Many products and environments will require unique antennas.

Perhaps the biggest long-term opportunity surrounding the tag involves marrying chips and smart sensors. Texas Instruments and Philips recently came out with RFID tags that monitor tire pressure, something that will be required by law in the U.S. from 2004. Right now, both use a separate chip for sensing pressure and communicating with an RFID reader. It may be possible to create one chip that performs both tasks.

One day, tiny sensors might detect an increase in machine vibrations, thus warning of a breakdown long before it occurs. Other RFID sensors might monitor the temperature of produce in transit, or detect listeriosis in meat or the presence of anthrax in the air. We are years away from seeing such low-cost sensors on the market, but they are a particularly attractive investment opportunity because it will be possible to patent specific techniques for detecting specific pathogens or environmental conditions.

The U.S. military is keenly interested in smarts sensors because it fears enemies in the future might not try to fight with guns, but disable U.S. war ships with pathogens. It is funding research at the University of Alaska at Fairbanks and North Dakota State University and University of Alaska at Fairbanks, which could help spur new industries in those regions (see Low-Cost RFID Sensors: From Battlefield Intelligence To Consumer Protection).

To date, three companies have designed readers to the Auto-ID Center’s specification: Alien, ThingMagic, and AWID. SAMSys Technologies can update the software in its readers to make them compliant with the Auto-ID Center’s spec as soon as a market for the readers emerge. Others will quickly follow if there is a sudden surge in demand for such equipment.

As with tags, the cost of readers is going to be critical. We expect the rapid increase in the number of companies making RFID readers to be followed by rapid consolidation. That’s because the competition will quickly drive the price down to a point where only a handful of large companies are efficient enough to make a profit.

The winners in this broad market for readers may be big companies like Solectron and Flextronics, which have the ability to produce readers in massive volumes. They can also afford to buy up innovative reader technologies and expertise from companies like SAMSys and ThingMagic. In our view, it is unlikely that any small reader company will become the dominant player if the market grows rapidly because the huge capital costs needed to ramp up production will be beyond a small company’s means.

However, there will be a lot of opportunities for companies with expertise in designing and building RFID readers. Large companies may be able to mass-produce three or four types of general-purpose readers for stores and warehouses, but RFID is not a one-size-fits-all technology. A reader designed to work on supermarket shelf won’t easily integrate into a conveyor system, help robots "see" or read the air pressure in car tires. Many small and midsize companies will do well specializing in specific market segments.

Smart shelves represent another big opportunity. There are already consumer packaged goods companies, paper and packaging makers, conventional business equipment companies, and big electronics outfits working on smart shelves with built-in RFID readers. Again, there may be a proliferation of companies jumping into the market to seize the short-term opportunity, but in the end, partnerships between electronics firms and business equipment manufacturers will likely dominate.

But there will be a huge demand for specialized displays. Marketing companies may take advantage of the chips in products to produce point-of-sale displays that talk, move or react to customers in some way. The companies that will succeed will be those that understand RFID’s power, have some basic technical competency and think creatively about new ways of marketing. We’re likely to see a lot of hokey displays as the concept catches on, but eventually there will be a real science to using this new tool to sell.

As RFID becomes more ubiquitous, interactive signage will become a major opportunity. RFID will make it possible to have dynamic pricing. Computers will change the price of goods as they approach the sell-by date or if they have been sitting around too long. Large in-store signs might respond to information on a loyalty card and greet customers personally. Some companies are working on signs that will read a badge that says what language the customer speaks and display information in that language. At the Frontline show in September, Zebra showed off an RFID reader that used voice technology to tell blind people what was on a medicine label. The possibilities here are limitless.

The web of RFID tags and readers that will spread across the supply chain as standards are introduced and the technology is adopted will essentially be a network, not unlike the road network. So far, we’ve discussed opportunities related to equipment that is part of the network. This is analogous to companies that build the roads, make the dividing barriers or provide road signs and lighting.

But after the initially dramatic growth of the network, the companies that make the network are rarely the companies that make the most money from it. That’s because sales peak when the network reaches maturity. The real winners are the companies that use the network to provide value to their customers. Amazon provides consumers with convenience, and FreeMarkets provides businesses with lower sourcing costs through reverse auctions. They can continue to grow when the network matures, as long as they continue to add value.

The companies that do well will be the companies that figure out how to use the RFID network to make or save businesses money or make life better, more convenient or more enjoyable for consumers. Perhaps that seems obvious, but one thing we often hear from end users is: "RFID vendors know RFID, but they know nothing about my business." It’s important not to sell just RFID tags and readers, but to sell "solutions" – an overused marketing word – to the end users’ problems.

There will be a great need for specialization, both horizontally and by vertical industry. Several RFID vendors might understand warehouse management and the special needs surrounding the challenging RF environment in the warehouse. Some will develop broad expertise in in-store retail systems, and still others will focus on logistics. Software vendors like RedPrairie and SAP will benefit because they are adapting their software to enable companies to take advantage of data from RFID tags. RFID vendors would do well to partner with such companies to offer turnkey products.

Every vertical industry has common business practices, and there is an opportunity for RFID vendors that focus on specific problems in specific industries. For retailers and consumer packaged goods companies, one of the big issues is out of stocks. Anyone who can help them solve that problem is going to make a lot of money.

A big headache for consumer electronics makers is tracking the large number of components that go into DVD players, computers and other products. In many cases, electronics have a very short shelf life, so it is critical to get to market quickly, respond to spikes in demand and be able to track goods for warrantee purposes. Yet there are few vendors marketing RFID systems particularly aimed at this industry.

The auto industry represents another major market opportunity. Many carmakers, including Ford and Toyota, are already using RFID to track parts bins. But given the complexity of their operations, it is likely that they are going to need specialized hardware and software for different applications. A company called Athena Integration has already launched a software system designed to track the progress of a car through the production system. So far, it hasn’t gotten much traction, but that may change when RFID equipment prices come down and standards proliferate.

Companies like TrenStar, CHEP International and Envirotainer are developing tracking systems for reusable containers for specific sectors. There may be large niches where individual companies can dominate. As we mentioned, tracking airplane replacement parts has special requirements.

Medical equipment manufacturers and the broader health care industry have special regulatory issues. Office and manufacturing equipment makers want to track the health of their machines remotely so they can improve customer service, add value and boost margins. All of these vertical industries will require not just special RFID hardware and software, but special expertise to design and implement systems.

We’ve only touched on some of the major market opportunities. No doubt, as standards catch on and RFID proliferates, innovative companies will find myriad ways to use the technology to solve business problems and add value. We expect to see a wave of innovation similar to the one unleashed by the Internet, as entrepreneurs realize they can profit from adding value to an RFID network.

During the Internet boom, venture capitalists invested in companies that offered nothing more than an interest in selling something besides books online. Many RFID companies, by contrast, offer venture capitalists not just an opportunity to jump into a growth market, but an opportunity to invest in businesses with real intellectual capital. Not patents for how tags communicate with readers, but expertise in solving real business problems. And in the end, that’s where the money is.