communications. Given this additional cost, why would firms opt to go public?
698 Management Communications
10. German firms are traditionally financed by banks, which have representatives on
the companiesā™ boards. How would communication challenges differ for these
firms relative to U.S. firms, which rely more on public financing?
1. Douglas J. Skinner, āEarnings disclosures and stockholder lawsuits,ā Journal of Accounting
and Economics (Nov. 1997): 249ā“283, finds that firms with bad earnings news tend to predisclose
this information, perhaps to reduce the cost of litigation that inevitably follows bad news quarters.
2. Kevin J. Murphy and Jerold L. Zimmerman, āFinancial Performance Surrounding CEO
Turnover,ā Journal of Accounting and Economics 16 (January/April/July 1993): 273ā“315, find a
strong relation between CEO turnover and earnings-based performance.
3. For example, George Foster, āRambo IX: Briloff and the Capital Market,ā Journal of Ac-
counting, Auditing & Finance 2, No. 4 (Fall 1987): 409ā“429, finds firms that are criticized for
their accounting by Abraham J. Briloff on average suffer a 5 percent decline in their stock price.
4. See Sarah Tasker, āVoluntary Disclosure as a Response to Low Accounting Quality: Evi-
dence from Quarterly Conference Call Usage,ā Review of Accounting Studies, forthcoming.
5. See Richard Frankel, Marilyn Johnson, and Douglas Skinner, āAn Empirical Examination
of Conference Calls as a Voluntary Disclosure Medium,ā working paper, University of Michigan,
6. Recent research on voluntary disclosure includes Mark Lang and Russell Lundholm,
āCross-Sectional Determinants of Analystsā™ Ratings of Corporate Disclosures,ā Journal of Ac-
counting Research 31 (Autumn 1993): 246ā“271; Lang and Lundholm, āCorporate Disclosure Pol-
icy and Analysts,ā The Accounting Review 71 (October 1996): 467ā“492; M. Welker, āDisclosure
Policy, Information Asymmetry and Liquidity in Equity Markets,ā Contemporary Accounting
Research (Spring 1995); Christine Botosan, āThe Impact of Annual Report Disclosure Level on
Investor Base and the Cost of Capital,ā The Accounting Review (July 1997): 323ā“350; and Paul
Healy, Amy Hutton, and Krishna Palepu, āStock Performance and Intermediation Changes Sur-
rounding Sustained Increases in Disclosure,ā Contemporary Accounting Research, forthcoming.
This research finds that firms are more likely to provide high levels of disclosure if they have
strong earnings performance, issue securities, have more analyst following, and have less disper-
sion in analyst forecasts. In addition, firms with high levels of disclosure policies tend to have a
lower cost of capital and bid-ask spread. Finally, firms that increase disclosure have accompany-
ing increases in stock returns, institutional ownership, analyst following, and stock liquidity.
7. Findings by Paul Healy and Krishna Palepu in āEarnings Information Conveyed by Divi-
dend Initiations and Omissions,ā Journal of Financial Economics 21 (1988): 149ā“175, indicate
that investors interpret announcements of dividend initiations and omissions as managersā™ fore-
casts of future earnings performance.
8. See Larry Dann, Ronald Masulis, and David Mayers, āRepurchase Tender Offers and Earn-
ings Information,ā Journal of Accounting & Economics (Sept. 1991): 217ā“252, and Michael Hert-
zel and Prem Jain, āEarnings and Risk Changes Around Stock Repurchases,ā Journal of
Accounting & Economics (Sept. 1991): 253ā“276.
9. See Mary Barth and Ron Kasznik, āShare Repurchase Decisions and Market Reaction: Ac-
counting, Information Asymmetry, and Investment Opportunities,ā working paper, Stanford Uni-
Sensormatic Electronics Corporationā”1995
On July 7, 1995, Sensormatic said earnings would be substantially
below expectations and below last yearā™s fourth quarter. Also troublesome was an
Business Analysis and
August 31 announcement that the release of 1995 results would be delayed, pend- Valuation Applications
ing an extended audit by Ernst & Young that is to be completed by mid-September.
[Sensormatic] says it doesnā™t believe there will be any āmajor write-offs.ā [How-
ever], Wall Street short-sellers, who thrive on signs of accounting shenanigans,
have targeted the company. [They argued that] Sensormaticā™s revenue accounting,
while permissible under generally accepted accounting principles, was āoverly
aggressive.ā While that put pressure on the stock, it was the July 7 announcement
that caused the stock to fall to $23 from a high of $36 two days earlier.1
Business Week, 9/18/95
BUSINESS HISTORY AND OPERATIONS Management Communications
Ronald Assaf, CEO of Sensormatic, founded Sensormatic in 1965 after a burglary in his
grocery store in Akron, Ohio. His idea was a security device that would deter shoplifting.
With the help of two scientists, Assaf developed a semiconductor device encased in a
plastic tag that could be attached to clothing. The tag, which must be removed with a
special tool, operates in conjunction with a transmitter of microwave signals near the
store exit. When the thief tries to leave the store, the microwave signal sets off an alarm.
Incorporated in 1968, Sensormatic grew steadily. For 39 consecutive quarters prior to
July 1995 Sensormatic reported revenue and earnings growth of 20 percent or more. In
1995 Sensormatic reported sales of $860 million and net income of $73 million. Sensor-
maticā™s tags guarded everything from stereos at Macyā™s department stores to shampoo at
CVS drugstores and lumber at the Home Depot. Hospitals used Sensormaticā™s equipment
to prevent babies from being snatched from nurseries.
Doctoral Candidate James Jinho Chang and Professor Krishna G. Palepu prepared this case as the basis for class
discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Professor
Amy Patricia Hutton provided helpful comments. Copyright Ā© 1997 by the President and Fellows of Harvard
College. Harvard Business School case 9-197-041.
1. Excerpts from āThis anti-theft company is feeling insecure,ā Business Week, September 18, 1995.
700 Management Communications
With diversiļ¬cation through acquisition, Sensormatic became an integrated supplier
of electronic security systems to retail, commercial, industrial, and governmental mar-
Sensormatic Electronics Corporation
kets. Sensormatic manufactured and marketed electronic article surveillance (EAS),
closed circuit television (CCTV) systems, and Access Control systems. In ļ¬scal 1995,
revenues from EAS accounted for 57 percent of Sensormaticā™s total revenues and reve-
nues from CCTV and Access Control accounted for 34 percent of total revenues. Sensor-
maticā™s products were marketed by a worldwide sales and service organization
complemented by a broad network of business partners, independent distributors, and
dealers. Sensormatic was appointed as an electronic security supplier for the 1996
Electronic Security Industry 2
There were two theft-prevention methods: to monitor articles and to monitor people. The
electronic security industry, based on EAS, monitored articles, and CCTV/Access Con-
trol systems monitored people. EAS, CCTV, and Access Control systems were used by
retailers to deter shoplifting and internal theft. Inventory shrinkage was often the second
largest variable operating expense of retailers, after payroll costs, and normally ranged
from 1 to 5 percent of sales.
EAS systems consisted of two components: detectable security circuits embedded in
tags, which were attached to the articles to be protected; and electronic detection equip-
ment, referred to as sensors, usually located in the exit path. By 1995 the EAS market
reported about $1 billion sales and was estimated to grow at 20 percent annually. The
ultimate market size of EAS was estimated to be $2.5 billion. The fast industry growth
was due to several factors: improved technology capabilities of loss prevention devices,
lower costs of electronic security systems, the rising cost of security staff labor, and an
increased need for open display of product. Major players in the EAS industry included
Sensormatic, Checkpoint Systems, and 3M in the U.S. as well as Esselte Meto and
Nedap B.V. in Europe. In 1995 Sensormatic was the worldā™s largest provider of elec-
tronic anti-theft technology.
EAS products were ļ¬rst used by retailers to protect soft goods (e.g., apparel mer-
chandise). Due to subsequent technological advances, applications for hard goods mer-
chandise, which was generally packaged, also became economical and effective. Hard
goods retailers such as drugstores, supermarkets, home improvements centers, and video
stores increasingly became users of EAS products.
Sensormatic and Checkpoint competed primarily in the hard goods market, which ac-
counted for 40 percent of Sensormaticā™s total revenues. Even though Sensormatic and
Checkpoint had expanded the installation of EAS substantially, EAS penetration into
hard goods stores was still low in 1995. The drugstore penetration by EAS was only 41
2. Some of the material in this section is drawn from a report on checkpoint systems by Barry J. Peter, Deutsche
Morgan Grenfell Inc., October 24, 1996.
17-17 Part 3 Business Analysis and Valuation Applications
percent of the 38,150 drugstores in the U.S. Penetration in the supermarket industry (ļ¬ve
times the size of the drugstore market) was just beginning. Only 4 percent of a total of
Sensormatic Electronics Corporation
125,000 stores in the U.S. supermarket industry used EAS in 1995. Currently Sensor-
matic and Checkpoint split the EAS market in the supermarket industry evenly.
EAS sales are comprised of one-time sales and recurring revenues. Installation of an
EAS sensor in the exit path (one-time sale) was charged at $40,000 per store with a 50
percent gross margin. Recurring revenues included disposable tags used by hard goods
retailers. Each supermarket was expected to use 175,000 antitheft tags annually. Each
antitheft tag was sold at $0.035 with gross margin approximately 70 percent. The recur-
ring revenues from tags could grow from 25 to 50 percent of total revenues within the
next three years.3
Checkpoint Systems, Sensormaticā™s main domestic competitor, was a popular sup-
plier to the drugstore industry for many years (71 percent market share in 1995) because
it was a ļ¬rst mover and a low cost provider. With revenues of approximately $204 mil-
lion in 1995, Checkpoint had less resources than Sensormatic did. However, Check-
pointā™s competitive position was supported by its manufacturing know-how and, to a
lesser degree, its technology and patents. Checkpoint believed that its manufacturing ef-
ļ¬ciencies gave it a signiļ¬cant cost advantage over its competitors. Checkpoint expected
that volume increases would result in a further decrease of product cost. Checkpointā™s
strategy was to continue to increase its sales penetration in existing markets and to de-
velop a signiļ¬cant presence in new geographic markets.
Checkpointā™s current technology advantage was its reliable scan-deactivation of hid-
den tags. This technology deactivates hidden tags as salespeople check out customersā™
shopping items. Sensormatic was offering a different technology, a pass-around system
that did not have the deactivation process. Under the pass-around system, merchandise
is passed around a pair of sensors located at the checkout lane and only the customers
go through the sensors. Problems of the pass-around system were tag pollution (tags
which were not deactivated might cause false alarms at other stores) and higher capital
costs (one pair of sensors per checkout lane rather than one per store). However, Check-
pointā™s scan-deactivation technology was not likely to be a sustainable advantage be-
cause Sensormatic was expected to develop the same technology in the near future.
The new trend in the EAS industry was source tagging, where disposable tags were
packaged into consumer products at the point of manufacturing. The application of tags
in an automated factory rather than at retailersā™ stores reduced labor costs. Source tag-
ging increased tagging compliance and its feature of being hidden inside the package
improved effectiveness. The ultimate market size for source tagging was believed to be
in the neighborhood of 20ā“30 billion tags annually.
Most companies producing EAS expanded not only domestically but also inter-
nationally. EAS sales in Europe and Latin America had increased substantially. Industry
experts forecasted that there was a great growth opportunity for EAS sales in the Asia/
3. Excerpts from Deutsche Morgan Grenfell Analyst Report.
702 Management Communications
CCTV products were used to protect against inventory shrinkage in retail businesses,
and for the protection and monitoring of personnel and assets in ofļ¬ce and manufactur-
Sensormatic Electronics Corporation
ing complexes. CCTV systems could be used alone or in combination with EAS and Ac-
cess Control. The electronic door lock Access Control systems allowed employees with
clearance to have free access and movement around the plant and ofļ¬ces without the
need for constant checks or locked doors.
CCTV and Access Control markets were estimated to have $2ā“$3 billion combined an-
nual sales. These businesses were also beneļ¬ting from the increasing costs of labor inten-
sive methods (such as hiring security guards). The companies in CCTV and Access
Control systems competed on the basis of product performance, multiple technologies,
service, and price. CCTV and Access Control systems markets were highly fragmented
with numerous providers, including Philips, Panasonic, CardKey, and Westinghouse
Electronic Corporation, and there were few signiļ¬cant entry barriers. Firms with greater
ļ¬nancial and other resources could enter into direct competition with existing companies.
GROWTH STRATEGY. Sensormaticā™s key element for growth was to expand its prod-
uct line and geographic market presence through acquisitions. Acquisitions were in-
tended to strengthen Sensormaticā™s core business by increasing its ability to distribute its
products and achieving synergy in the combined companies. In ļ¬scal 1993, Sensormatic
acquired Automated Loss Prevention Systems (ALPS), a large European distributor of
EAS, and Security Tag Systems, Inc. (Security Tag), a U.S. manufacturer and distributor
of loss prevention products. In 1995 Sensormatic acquired Knogoā™s overseas operations
through a stock exchange.
The acquisitions of ALPS, Security Tag, and Knogo resulted in goodwill of approxi-