New investments in encryption applications by research organizations, VCs and corporations bode well for security vendors -- if they can keep prices down and solve interoperability problems, according to Technical Insights, a unit of IT researcher Frost & Sullivan.

The need to send sensitive data over the Internet, coupled with the cost savings of doing business online, is driving the demand, said James Smith, an analyst with the San Jose firm.

Specifically, public key infrastructure technology, Virtual private networks and e-mail encryption applications should see strong demand.

Cost, however, still remains an obstacle for many potential buyers. Vendors must show the financial returns of safeguarding networks and the data, Smith said.

Related to return-on-investment is interoperability. Software that works with other business applications is more useful than products that need customization or worse, can't be made compatible.

In the VPN market, the Internet Protocol (IP) standard is being helped by major projects such as the automotive network exchange extranet, Smith said. It remains unclear if this standard will provide interoperability.

"Standardizing on IP security will enable multi-vendor interoperability that will allow the market to explode," Smith said.

For e-mails, vendors are looking to the secure multipurpose Internet mail extension standards from major e-mail client and brower companies. And in the PKI market, emerging standards such as on-line certificate status protocols, are likely to gain recognition in two years.

Other applications that could see increased demand are intrusion detection systems, tools that protect specific applications on corporate networks, and vulnerability-assessment software and services.