12 Oct RFID gaining investment momentum
Evidence suggests that radio frequency identification (RFID) is clearly moving forward. Despite implementation challenges and adoption risks, development continues at a brisk pace and an increasing number of end users are evaluating the technology.
From a supply chain perspective, the key driver has been “the mandates,” primarily driven by Wal-Mart and the U.S. Department of Defense (DoD). EPC Global also is playing an important role by advancing industry-specific work groups.
In addition to supply-chain opportunities, there is significant RFID momentum in safety and security, most notably in the pharma and government markets.
Given those factors, investment in the RFID space is gaining traction, particularly from a private transaction perspective, and we expect public opportunities will likely emerge in 2006.
State of RFID
RFID momentum continues to build given the increased number of mandates and expanding pilots. The original Wal-Mart and DoD initiatives have spawned incremental mandate requirements from Target, Albertsons and Best Buy. Those mandates and new requirements from Wal-Mart are expected to bring 200 to 300 additional consumer product good (CPG) companies into the RFID implementation market.
Industry feedback suggests that those players are taking a more aggressive approach to implementation than the original “Top 100.” The reason: It has become obvious that the retailers, particularly Wal-Mart, are serious about progressing forward with RFID and, therefore, are not likely to back down on deployment initiatives.
While the mandate requirements have clearly served as a catalyst for RFID adoption, we expect the progression of standardization and better defined returns on investment from deployment will be required before adoption can accelerate.
With respect to standardization, our discussions with end users have indicated that they want low risk of obsolescence and strong interoperability. Therefore, end users won’t begin significant testing or investment until standardized products are available, which suggests that the emergence of Generation 2 technology (Gen 2) is a critical precursor to mass adoption.
While Gen 2 samples are currently available and several vendors may begin early production runs later this year, we do not expect full Gen 2 production until the first half of 2006. We believe the hurdle of EPC Global interoperability testing, beginning in mid-August, and silicon production difficulties are two areas which will likely moderate the pace of Gen 2 availability. Therefore, we expect significant end-user testing will not begin until mid-2006.
ROI must be proved
The second key driver to mass adoption is proven return on investment, which will require substantial end-user testing to quantify payback.
On paper, RFID appears it will drive significant benefits – AMR has released studies suggesting that the attributes of RFID, compared with other tracking technologies, will enable significant supply-chain advantages, including greater revenue from fewer stock-outs, lower labor costs through increased automation and improving inventory management from better visibility.
Wal-Mart has begun to share RFID-related data with suppliers, which has been received with some enthusiasm as consumer product companies are learning more about the routing, timing and sales patterns of their products. While suppliers suggest that such information is valuable, and offers an early indicator of potential ROI, end users will need to develop concrete ROIs before mass deployment will occur.
We expect definitive testing will likely begin in 2006 and last into 2007, thus we view mid-2007 as the earliest possible point for mass adoption to begin. In our view, we expect 2008 is likely a more realistic target for significant supply chain adoption.
In the safety and security area, several groups see potential benefits that require more in the way of government or industry funding and less of an ROI argument. Those include track and traceability in pharmaceutical (anti-counterfeiting) and other bioscience markets, food safety by the U.S. Department of Agriculture (i.e., tracking of cattle for “mad cow”), secure trade and cross-border travel by U.S. Customs and luggage verification by the air transport industry in conjunction with the Transportation Security Administration.
Each of those areas has pilot projects under way and may see faster near-term deployment than supply chain initiatives. Healthcare-related initiatives seem to have the greatest traction given FDA support – several include Pfizer and Purdue in tracking of narcotics and Promega in providing security for lab samples.
Risks to RFID adoption
While we contend RFID has good momentum, it remains apparent that potential risks to adoption exist. Our previous discussion suggested that once end-users discover an appropriate ROI, adoption would follow. However, the high price tag of RFID creates a risk that end users may be dissuaded from even testing the technology. In several cases, the high current price may make a positive ROI case difficult as many end users seek a sub $0.10 tag; most tags today are $0.25-$0.50.
From a development standpoint, we see delays in Gen 2 equipment as a potential risk. Recall, that we indicated that Gen 2 technology would be a catalyst for adoption; however, the technology is complex and not yet in production. In addition, the complex nature of the technology may create implementation challenges that are greater than expected, thus leading to a longer test phase. Compounding the complexity issue is the apparent personnel shortage and lack of available implementation skill sets.
The looming risk of intellectual property (IP) confrontation may also create delays. Roughly 20 players in the industry claim to have relevant IP for Gen 2 products, with Intermec being the player appearing to have the most IP pertaining to Gen 2. Given the complex nature of IP, and its necessity to Gen 2 products, we see a great need for industry negotiation, which can often degenerate into litigation (Intermec Technologies and Symbol Technologies Inc. have recently agreed to settle their RFID intellectual property dispute). We see risk that Gen 2 adoption could be slowed if IP confrontations escalate.
We are encouraged to see the formation of a consortium of key RFID players including Avery Dennison, Zebra, Symbol, ThingMagic, Alien, Tyco, AWID and Moore Wallace to develop “a structured approach for holders of essential RFID patents.”
The consortium plans to evaluate IP, determine relevancy and establish a royalty rate. We view the formation of the consortium as positive for the industry as it consolidates a significant amount of IP in one clearing organization. The consortium has indicated that it expects to have roughly 20 members. We are uncertain if Intermec will join; we nonetheless see a simplified IP process – allowing interested parties to negotiate two IP licenses (consortium and Intermec) instead of negotiating over 20 separate licenses. In our view, such simplification is good for RFID adoption. Note that Zebra and SAMSys have already negotiated such a license with Intermec as part of the Rapid Start Licensing program. That allows them access to Intermec’s entire IP patent portfolio, not just those relevant to Gen 2.
Investment in RFID is also gaining traction from both a financial and strategic perspective. Private equity investments (financial) include a total of $208 million in Alien, $43 million in TAGSYS and $50 million in Impinj. Such financial investments are seen with increased frequency.
The industry has also experienced several strategic investments including Symbol’s $230 million acquisition of Matrics in September of 2004, YFY Paper Manufacturing’s (Taiwan) $10 million investment in AWID this past November, and VeriSign’s $15M acquisition of R4 Global Systems in May of 2005. Most public investment opportunity is limited to small segments of existing public companies (Unova, Symbol, Zebra, Texas Instruments) or microcap companies (ID Systems, Sirit, SAMSys).
Given the substantial investments in private companies, we expect many of the RFID startups will have a strong opportunity to participate in the RFID market. Those private players have leveraged this capital to develop strong technology solutions (i.e., fluidic self assembly-Alien or self-adaptive silicon-Impinj) or an expertise in a niche market (i.e., Pharma-TAGSYS). However, as the RFID market opportunity becomes more clearly defined in the next 1-2 years, we expect the incumbents will seek to fill “business” gaps and, thus we anticipate increased industry consolidation.
During early 2005, we saw important Gen 2 development take place. As we move into the second half of the year, we expect increased Gen 2 product introductions, interoperability testing by EPC Global and production ramps. In addition, Wal-Mart is increasing its mandate to encompass ten distribution centers and 500 stores, up from the original three and 150 stores. The next 200 Wal-Mart suppliers must also be RFID compliant by January 2006; Albertsons, Target and Best Buy have implemented similar mandates for late 2005 and into 2006.
The increased mandates and desire to seek an acceptable ROI are generating increased demand for testing in 2006, while the testing and production are expected to provide good tag and reader quantities by 1H06.
Therefore, we expect the RFID industry will experience strong growth in 2006 – and as early as 2007 and into 2008, we expect to see growth accelerate as the technology improves and as end users discover adequate returns on the technology.
We expect the overall RFID market to reach $5B by the end of 2007, which represents a 50 percent average annual growth rate from 2004. Given the substantial technology complexity and the need for the reengineering of business processes, we expect the services component will be the largest growth component, reaching 55% of the total market by 2007, up from 25 percent in 2004.
See previous WTN coverage on RFID:
• The key to finding RFID’s ROI
• Upgrading your business with RFID