The Shoddy Business of Home Security
there are a few things that sell as well as Security in America burglaries and home invasions are highly publicized crimes that surface regularly in fiction and media turn on the news and it seems like just about every week someone nearby is getting robbed whether it's shoplifters at retail stores burglars who steal valuables or viral footage of opportunistic creeps caught on a doorbell camera while the FBI reports that robberies and burglaries in the United States are down significantly since the 80s and 90s there are two constraints with applying statistics one is that the FBI's data only goes up to 2020 and is at best a lagging indicator the second is that even if the probability has gone down significantly the risk is not at zero by Nature crime happens quickly and spontaneously and those who are targeted are as much a victim of unfortunate circumstances and bad luck as they are of ignorance even the nicest homes get burglarized and the world's best security can't guarantee protection against a determined Thief many companies have popped up over the decades with a variety of solutions to help people better protect their homes offering armed private patrols Panic rooms burglar alarms wired surveillance and more recently DIY wireless cameras that can record to the cloud only need to connect to Wi-Fi and can be mounted anywhere inside or outside in the world of home security there is no company that is more famous than ADT ADT and its iconic blue signs and stickers are plastered over many Lawns and commercial building entrances all around the world ADT was the first to turn home security from a product into a service a company that would come to your house install a custom security system and then remotely watch your home 24 7 365 for a decently affordable monthly subscription whenever your system detects an intruder a signal is sent to adt's Monitoring Center where the staff there can react on your behalf and can send in police and other Emergency Services ADT was unique as a company who not only provided the hardware of home security but also the service of installation customization and having an extra pair of eyes and hands 24 7 in monitoring as a result ADT has always positioned itself as a premium and these days costs anywhere from forty dollars to a hundred dollars a month and as their sales would say that's a small price to pay for protection through the high crime in the low-tech era of the 80s and 90s ADT was seen as a necessary investment for homeowners and amassed millions of customers on paper today ADT seems like a good defensive business it's a mainstream Subscription Service it has established leading brand earns reoccurring Revenue as high cash flow a large customer base and holds the majority market share yet as we dive deeper the fundamentals reveal the opposite and that home security as a whole is a decaying business with no real winners in this episode we'll cover ADT a troubled company who even with the highest market share must still rely on sleazy outdated tactics like multi-year contracts lock-in hidden pricing and aggressive selling in order to cover up a fundamentally flawed business and the sobering reality that no one makes money in Home Security while people in the 80s and 90s thought of security exclusively in the sense of personal safety and the loss of material possessions and thus created the need for companies like ADT threats these days extend far beyond the physical boundaries of one's home digital crime today is rampant and vicious in the form of scams phishing identity theft fraud and cyber stalking as perpetrators can attack from anywhere but just a computer and internet in the past three years hospitals food producers oil pipelines and even content creators have all suffered through high profile and costly cyber attacks every 14 seconds there's a new victim modern MBA itself as a company was designed with safeguards at the creative and Commercial level to minimize that same threat exposure and individuals are just as vulnerable as businesses if not more to digital crime in an area where anyone can find anything on the internet your name email address and phone number this information is made accessible thanks to data Brokers and social media who profit off the sale of your personal information to robocallers telemarketers spammers advertisers and anyone else who wants to learn about who you are aura is a leader in the online threat protection and the sponsor of this episode Aura is an all-in-one simple to use intelligent safety solution that protects you your finances your assets and personal information online 24 7. their protection is extensive or are proactively identifies some data brokers who are exposing your information online and submits opt-out requests on your behalf including junk mail and telemarketing lists in our own account Aura identified over 30 data Brokers and junk mailers that were selling our personal information and automatically submitted opt-out requests on our behalf to all of them within seconds of our registration Aura also monitors your emails and passwords to see if and when they are exposed in data breaches or on the dark web their app even includes a VPN password manager real-time credit and identity theft monitoring parental controls and malware protection Aura has almost every Internet safety tool that you'll ever need all inside one service let Aura do the hard work of keeping you safe online when you sign up right now with the link on screen or will give you a free two-week trial you'll be shocked at how much of your private information Aura fines exposed over those two weeks go to aura.com MBA to start your free trial today and to get protection of you your finances your identity and personal information online thank you to Aura for supporting modern MBA and making this episode possible at its core ADT is a service provider the cameras sensors alarms lights and sirens and various other equipment are all made by established third-party manufacturers like Honeywell what is proprietary to ADT are the central panels that connect all the equipment together and Link the system back to a Monitoring Center in the 80s and 90s these Central panels were made up of buttons a keypad and two-way audio the kind in the old movies that were mounted on walls they would scream when triggered and the main characters would scramble around kitchen counters to input codes and disarm the system later models would introduce screens better speakers and even touch screens while the camera sensors alarms sirens and motion detectors are all generic third-party products with ADT branding the ADT Central panel that connects everything together into one Hub generally locks all that equipment to be usable only with ADT that means if and when customers decide to stop using ADT the system is generally bricked and the cameras sensors motion detectors Etc cannot be reused for another security system what is also proprietary to ADT is the software front end that lives on top of these panels that enable user interaction but a majority of the back end and operating system that acts as the heart of ADT are not proprietary adt's pitch over the popular Plug and Play DIY Solutions is that its security systems are independent in the case of Amazon's ring doorbell a thief could just unplug a router or take advantage during an internet outage like all other Wi-Fi based Smart Home Solutions ring requires an active internet connection anytime Wi-Fi is interrupted the ring doorbell is effectively dead it won't record it won't store videos and it won't send notifications in comparison an ADT system will function even during an internet outage as machine to machine data transmission is done through an independent connection like a landline or cellular network in an intrusion the alarms would still ring the system would still heartbeat to a Monitoring Center and ADT staff would still be able to react and respond without internet while ADT pushes that this makes their security more stable and reliable its systems are still fundamentally dependent on the same pre-existing tech support and Effectiveness from Telecom providers like at T Verizon and Comcast even adt's new cloud-based software is licensed from closed Source vendors like alarm.com knowing what is proprietary and what is not is fundamental to understanding the business model of ADT and home security service providers adt's business is based on the core thesis that there's more money to be made in the customization installation servicing and monitoring rather than selling the products alone at the hardware or software level adt's bet is that there's a market opportunity and a premium to pay for having a company who can simplify all this complexity of picking the right security products setting up the right angles installing the equipment integrating with Telecom providers maintaining the equipment monitoring the property all into one easy digestible and hands-off service home security was otherwise too overwhelming too risky and too important for the average homeowner to figure out and connect themselves in essence ADT provides convenient home security as a service and packages it into a monthly subscription for homeowners since ADT makes its money as a monitoring subscription service and on an equipment rental one the company only makes money after a security system has been installed without a system in place there would be no monitoring to offer and nothing to justify paying a monthly subscription for as a result ADT competes on scale and speed as the biggest and fastest provider of home security ADT strategy is to make the installation as easy as possible and to make The Upfront cost as low as possible for homeowners both in the monetary and logistical sense promising next day service and installation to any home around the country but the pure installation and setup of security systems and cameras is a service that many companies offer so ADT uses its scale size and resources to beat these local players to the punch through faster service free quotes and deferred installation costs there are only so many homes in America there are only so many homeowners and a home can only accommodate one security system and one vendor in order to achieve such speed and coverage ADT employs the largest sales force and technician team in the entire industry the company relies on two sales channels a direct team of three thousand salesmen in the field who go door to door all over the country the direct sales channel is supported by 450 employees at call centers who Hammer the phones every day chasing leads yet it's the indirect sales channel that has driven a significant portion of adt's growth for the past few decades what ADT does is behind the scenes is that it lines itself with select local independent security companies through the authorized dealer program these independent third parties generate customers to ADT these local companies on the surface operate as your friendly local neighborhood security company in name but in reality they have exclusive arrangements with ADT to install only ADT equipment and sell ADT Services whenever these local dealers successfully sign a customer ADT provides the monitoring Services as it always does while the homeowner interacts with the local company but behind the scenes ADT gets the option to buy off that customer's account from the dealer and recognize those revenues from that customer in full for itself what this does is it minimizes the amount of capital that ADT has to invest in its direct marketing and sales arms to generate customers it maximizes the company's footprint and it maintains its speed the indirect sales Channel bubbles up customer accounts in a passive cost efficient way for 8 DT and it serves as a hedge for its direct sales Channel third-party companies who participate in adt's dealer program enjoy this Arrangement because they get to maintain their independence and keep things simple rather than offering every possible security system and vendor Under the Sun and building up their own local credibility these dealers can Source it all from ADT if these small business owners can generate enough accounts then ADT will take some off their hands and the dealer gets a payout for every customer account that they sell to ADT there are some checks built in if ADT buys a customer account from a dealer but that same customer ends up canceling within their first 12 to 15 months then that dealer must refund the payment or provide another customer account to ADT for free this clause in theory protects ADT from inheriting low quality customer accounts and discourages dealers from selling to low credit customers yet the independent third parties and adt's dealer program who are all eager to close deals and maintain the accounts long enough to sell them to ADT have been regularly accused of using beta and switch tactics to lock customers into long multi-year contracts there are thousands of stories and complaints online from homeowners about unexplained fees unexpected charges and misrepresentation while the subscription price itself is set by ADT the installation costs and scope can vary dramatically from dealer to dealer one dealer might install an old system while another installs a newer one in the same home while not all third-party dealers by Nature are scummy the reality is that ADT ultimately needs them to sustain growth the indirect sales Channel generates fifty percent of adt's new customer accounts every year and authorized dealers have been a critical part of the company's growth in the pursuit of cash flow ADT has no choice but to turn a blind eye towards this externality this is a bit like franchising and fast food except that this situation is far more chaotic as the parent company only wields carrots while subscription services in the modern day have evolved to be month-to-month billing with flexible cancellations ADT continues to push Legacy multi-year contracts where customers are locked into three to five years at a minimum with heavy cancellation fees for early termination and with payments due every month while ADT publicly advertises its rates online as anywhere from 40 to 80 a month depending on the package the fine print is that those prices are only valid for the first year after the first year ADT has the right to and will generally raise those monthly prices on your contract when it comes to installation customers can choose to pay the setup fees upfront or defer those costs into higher monthly payments yet monitoring not installation is what ADT uses to justify subscription pricing and is the only service that the company has any real profit margin on even though the company marks up the equipment the hundreds or the thousands of dollars that it charges homeowners for installation is not enough to make up the cost of the product and the cost of employing thousands of sales people and technicians around the country to install a security system within one day's notice ADT makes this no secret openly stating that the company only breaks even at the two to three year mark of every customer's contract since ADT is already a brand name it's not just the cost of installation and the cost of equipment and the overhead of monitoring but also the cost of customer acquisition that must be factored in quote we operate our business with the goal of retaining customers for long periods of time to recoup our initial investment in new customers and we generally recoup our initial investment in less than three years our long-term profitability is dependent on Long customer tenure ADT loses money on the first year of every customer's contract and doesn't make money until year two or year three of the contract with those price hikes with a three-year contract being the most common form that means that future profits for the company only come in the case of a renewal at the surface everything looks fine with this business model adt's overall revenue is growing year over year at a measured pace of eight percent on average for the past six years the revenue generated from the installation fees are minimal and such cost is intentionally subsidized in order to drive subscription monitoring revenue from installation on average accounts for just 13 of Revenue in the past seven years from a dollar perspective the income from installation fees doesn't even come close to offsetting the cost of sales and administration even with 34 to 39 gross margins the revenue from one-time installations barely offsets the annual cost of the equipment setup and advertising adt's bottom line is an equally confusing picture s indicate that adt's annual operating margin on average is just five percent and then you throw in half a billion dollars of debt repayments every year and it's no surprise that the company is declaring net losses left and right the complication here is that ADT reports over 1.5 billion dollars of depreciation
every year of capitalized equipment which enables the company to take on significant losses to reduce their taxable income the real profits are in the monitoring and the real business is in the cash flow monitoring has made up 85 percent of adt's Revenue on average for the past seven years adt's monitoring centers are expensive in both operations and Designs but they're also one-time Investments the company employs staff to monitor millions of customers security systems around the clock and build these facilities with backup generators and baked in server internet and data redundancy capabilities Capital expenditures aside the monitoring gross margins are massive sitting on average at 80 percent for the past three years 80 cents of every one dollar painted in a monitoring subscription every month is gross profit adt's business model in essence is to accelerate the installation of security systems in homes subsidize the cost of that equipment and the cost of installation so you can get it in as many places as possible as quickly as possible with as little direct human capital as possible than to lock in customers to multi-year contracts increase subscription prices in year two and year 3 to maximize those profits used appreciation to aggressively reduce taxable income and then keep on hammering phones and doors to grow customers pay off the third party dealers to keep acquiring new accounts and then secure renewals when the contracts expire all this would work if customers were renewing but adt's business is dying the company reports its Revenue attrition as a measure of customers that are choosing not to renew every year adt's Revenue attrition has improved relatively over time from 14.8 percent churn in 2016 to 12.5 percent turn in 2022 but double digit Revenue attrition in the low teens is still troubling one interpretation is that 13 of adt's customers on average every year for the past seven years choose not to renew their contract and despite the sunk cost these same customers would rather have no security system at all than to maintain the monthly payments to ADT acquiring and converting new customers is always more expensive than maintaining existing customers at 13 annual churn in seven years time ninety one percent of Revenue that ADT gets today from existing customers will disappear and must be replaced by either revenue from new accounts and or Price hikes to remaining customers this creates a cascading pressure on the direct sales and the indirect dealers to generate accounts in excess in order to offset attrition in the world of subscription software a 13 to 15 churn is par for the course for small SAS startups but in the physical world of atoms thirteen percent churn for the clear market leader with five times the market share as the next largest competitor suggests problems with home security business as a whole adt's customer base has declined 10 percent from 7.2 million accounts in 2017 to 6.5 Million by 2019. in an effort to maintain Top Line and to offset Revenue loss from customer attrition the company has resorted to increasing prices when we take annual monitoring revenue and divide it by the customer base ADT customers paid on average 46.60 cents a month for monitoring two years later by 2019 the 10 smaller customer base was paying 55.20 per month on average every month a
near 20 percent increase in subscription pricing but none of these struggles are unique to ADT when we look at other smaller home security and smart home service providers we see comparable attrition Vivint the second largest player in home security reported 11 to 12 percent turn every year from 2020 to 2022 and their customers who chose to cancel rather than renew their services despite being a much newer company without the Legacy and the tech debt of ADT Vivint still signs customers into multi-year contracts with far more aggressive minimums of five years their business model is also identical to that of ADT with subsidized installation and masses 77 to 79 gross margins for their monitoring Subscription Service when every home security service provider charges customers on strict multi-year contracts with penalties for early cancellation there is clearly Something Fishy below the surface with public churn rates and a frosty reputation the only thing ADT has going for it is cash flow cash flow is what matters in today's markets and adt's leaders make every effort to make sure investors are aware of it quote we benefit from a stable Revenue profile with more than 90 percent of our Revenue coming from recurring contractually committed monthly payments under contracts with initial terms that are generally three to five years in length the stability of our revenues is further driven by our industry's resilience to economic recessions as demonstrated by positive market growth in every year through the 2008 to 2010 economic crisis we are able to generate significant cash flow from operating activities as a result of our high margins limited cash taxes and limited working capital needs from 2017 to 2020 ADT generated cash flow from its monitoring subscription Services of over a billion dollars every year of this one plus billion dollars in cash flowing in every year the company was spending on average over half of that buying up customer accounts from its dealers in the same time frame ADT reported that it was working with 200 to 300 dealers in its authorized dealer program if we assume that that means to 250 dealers on average every year that means that the average dealer was making over 2 million dollars a year just from selling accounts to ADT that's a good business to be in as a dealer you go out you knock on some doors you close some deals you maintain those customers long enough so that they don't cancel on you in the first 12 to 15 months and then you sell them off to ADT for a payout for two million dollars a year in supplemental income that's not bad at all for a day's work another 500 million went towards subsidizing the cost of equipment and installation and 100 million went towards buying up new equipment that leaves adt's free cash flow at around half a million dollars every year while the money going to dealers appears to have gone down significantly that's only because ADT bought out its biggest and most successful independent dealer for 400 million dollars in 2020. this dealer single-handedly had driven 55 percent of the indirect sales business for the past decade if you add that 400 million dollar acquisition price tag back in ADT paid out more to Independent dealers for customer accounts in 2020 than it did in any year of its history so what do you do if you're ADT a legacy service provider with the highest market share and a relatively stable cash flow for the foreseeable future but whose products service and pricing are behind the times you can make profits through monitoring subscriptions but your churn rate is high less homeowners are signing up half of your sales force is beyond your control you charge 4 to 10 times the cost of your competitors you don't build the hardware and you're not good at software you're getting squeezed by big Tech on one side by Amazon with cheaper easier to use DIY Smart Home plug-and-play Solutions and on the other side you're getting squeezed by the Telecom networks that your systems rely on when at T and Verizon shut down 2G and 3G EDT was forced to spend 300 million dollars in a single year to upgrade its Legacy customers to 4G so that their systems would remain usable but most of all it doesn't seem like there's any light at the end of the tunnel as no service provider in home security has been able to figure out how to make a business that doesn't involve anti-year lock-in contracts and aggressive sales ADT recently partnered with Google with the goal of tapping into the company's technological leadership and to integrate with established smart home devices versus their historical approach of attempting to build around them Google benefits from this partnership by having a brand name like ADT push adoption of their smart home devices over Amazon's to older generations of homeowners ADT has also started offering packages that lean into the DIY internet-based piecemeal approach towards home security but even with a self-set up smart home systems that don't require technicians and only need Wi-Fi the same old tricks still remain with ADT multi-year contracts with mandatory subscription monitoring ADT has also taken on investment from State Farm and partnered with Ford to expand towards Motor Vehicles the long-term hope is that State Farm and other insurance companies can eventually offer incentives like lower home insurance rates to people who sign up for a security monitoring like ADT but both the State Farm and the Ford Partnerships feel more like moonshots than substantial product development when companies ultimately reach the scale of Google ADT and State Farm these organizations are ultimately too big too slow and bureaucratic that large visible high-profile handshake deals are the only way to drive progress forward growth for ADT these days is a scatter shot of finding any adjacent Market it can think of and offering any service that a homeowner would be willing to pay for in an era where data breaches and threats are increasingly more digital Than Physical ADT has acquired multiple cyber security companies but the goal of one day cross-selling a commercial software solution for firms who already pay ADT to monitor their Office Buildings the hottest things these days for homeowners is solar panels and ADT solar is the company's newest business line ADT solar brought in nearly a billion dollars in his first full year in 2022 and will single-handedly responsible for growing the company's Top Line by 20 but the gross margins in solar installation look just as rough as the gross margins for security installation and this is not even getting into the race to zero that happens in overcrowded markets like solar but as long as the top line is ticking up and solar can help offset churn in home security more dollars are coming in ADT will take that win in the hopes that some big conglomerate values cash flow high enough in this economy to acquire the company the business of ADT and other service providers in home security worked in an era where customers were unsophisticated and information was not accessible so the fear of home invasions and burglaries were magnified and the only possible solution that people could fathom to counter such threats were the full-service monitoring subscriptions advertised on television like ADT in reality protection these days requires far more than an ADT subscription or even a doorbell camera home protection means parking in plain view knowing your neighbors maintaining your yard showing presence and keeping awareness of both you and your surroundings what people ultimately value out of any security system is being able to take proactive measures and monitoring with the way that ADT has designed itself over the decades is that that's just a reactive service the tale of ADT is a Timeless story of why Service First businesses are ultimately not as successful at scale as product first businesses without a product you are significantly more susceptible to shifts in a market once you have a product you can sell as many services as you want over it but not the other way around the best thing in a gold rush is to sell shovels and in the case of home security The Only Winners are the ones who manufacture the products not the dying service providers like ADT
2023-04-26 13:02
