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Channel business model: Transition time for IT partners

Partners may pursue a number of business model transitions over the course of their business lives, including resell to services, services to managed services and MSP to cloud.

The old adage, "All good things must come to an end," is certainly something partner companies can relate to, since many find themselves having to change their channel business model to meet the demands of clients and the rapid pace of technology development. But change can be risky -- and it can be expensive. And it doesn't always pan out for partners.

Nearly two out of three IT channel companies have made a significant structural change to their business model in the past 18 months, according to CompTIA. For those contemplating a change, the process needs to start with an awareness that it's time to transition, then identifying a viable new platform and defining a step-by-step approach for learning how to do something new, according to a 2014 CompTIA report, Managing a Successful Business Transformation.

"Perhaps the most encouraging sign that you can be successful is the inherent volatility of the technology industry, and your previous demonstrated ability to ride the waves of change," the report stated. "After all, as an IT company, you're keeping up with new products, features and even entirely new technologies every day."

Diane Krakora, CEO, PartnerPathDiane Krakora

Partners make business model transitions three to four times during the course of their careers, depending on where they started out, noted Diane Krakora, CEO of PartnerPath, a partner development firm in Menlo Park, Calif. The most common is the move from resell into services of any kind, she said. Some 60% of solutions providers primarily in the U.S. have made at least a channel business model shift so the majority of their revenues are coming from services, rather than the old resell model, since the margin on resell "has really been squished in the past five years."

Yet, Krakora is quick to add that there are "definitely the stalwarts" in the resell model, and she said she anticipates "there are several dozens of solutions providers that will stay in resell."

Some 41% of partners' overall revenue was in resell in 2015, compared with 53% in 2014, according to an IDC survey of 500 partners in the U.S. that resell hardware, infrastructure software or services. "It's not that their resell is going down; it's that the pie is getting bigger, and they're doing more in services," said Paul Edwards, director of infrastructure channels and ecosystems at IDC.

With a significant move toward software as a service and software on-demand, partners are not getting as many big projects in installing and supporting hardware as in the past, Krakora said. She tends to see partners moving their businesses from resell into services, and then transitioning from services to managed services. The latter set of services have a methodology around them and may be hosted, "offering capabilities to customers they've built as a repeatable business practice, where they certainly have some scalability and profitability," Krakora explained.

Another transition is from managed services into creating intellectual property, meaning partners are building their own software in addition to selling other people's technology, she said. "In some cases, they're almost moving into ISVs [independent software vendors] or vendors themselves. We're seeing some partners moving into this and creating their own cutting-edge [software] and connectors that gives them their own ISV."

MSP to cloud is the latest transition. "We're seeing a lot of partners talk about offering managed services in terms of how they position themselves, but not as many being cloud providers; that seems to be a bigger step for them," she observed. That's because it requires an investment in infrastructure. Partners have to have a lot of expertise in cloud technology, and because it is relatively new, "it's very hard to find people with that expertise, so you have to grow your own, and it takes lot of time to gain that expertise."

It's also a new way to sell. "Instead of selling the speeds and feeds of a Cisco router, you have to sell business outcome for cloud infrastructure," she said. "It's very difficult, and certainly one of the hardest things we see for solution providers as they're making these transitions is talent, talent, talent, and how do they grow these people, because they're still a services business, and they're still only as good as their people are."

PartnerPath recently surveyed clients, asking how many are planning to invest in cloud next year, and 10% of respondents said they are not very likely or not likely at all to make the investment, she said.

Another interesting trend Krakora is seeing is more partner-to-partner partnering this year than ever. "It used to be a huge heresy for partners to work with competitors, and now, they have to find bench strength, as well as finding tech expertise and geographic reach."

Paul Edwards, director of infrastructure channels and ecosystems, IDCPaul Edwards

The digitization of IT is another huge trend, according to Edwards. "If you're a channel partner, you cannot avoid this. It's impossible." So, it's become very much front and center for a lot of channel partners, he said, and there are a fair number that have planned and executed a strategy relative to shifting their business along these lines. Other partners, whom he referred to as "the classic laggards," will start to focus on it from a reactive position when they hear from customers.

"I can't imagine any business out there wanting to do business with a channel partner that doesn't understand how the digitization of everything impacts a business," Edwards said.

IDC is forecasting that growth will be tremendous in what it calls the third platform. "So, if you're a channel partner focused on the second platform, you're going to grow only by eating into the business of your competitors," he said, but he added that they will, because it's a shrinking pie.

Another issue Edwards sees is more partners are focused on reselling vendor services, because "they're starting to offload lower-value services like support to the vendor. So, they'll resell vendor services and get a little margin for that. Then, they're reselling professional services so they shadow vendor services people," and learn to offer the services themselves.

Ready to make a channel business model switch? Here are a few factors to consider:

In-house expertise vs. finding the right people

Anurag Agrawal, founder and CEO, Techaisle Anurag Agrawal

Partners have to both train and hire personnel to pursue a new channel business model, as well as form partnerships to plug the gaps, according to Anurag Agrawal, founder and CEO of small and medium-sized business IT and channel partner research firm Techaisle LLC in San Jose, Calif.

"It is not an either/or option," he said.

Business transformation will always involve staff changes, CompTIA's report stated. "Either current staff will need to learn new skills/do new work, or new staff will need to be added for the new responsibilities. No matter how lucrative the new opportunity may be, if your people don't buy in to the change, you simply can't succeed."

Finding the right people and "consistently being on the lookout for the next generation that understands an on-demand model, and can sell it and market to it" is probably the No. 1 concern partners have during the shift to a new channel business model, Krakora said.

Pricing strategies

Channels must have a mix of recurring, nonrecurring, product-led and services-led contracts to generate healthy margins for investment.
Anurag Agrawalfounder and CEO, Techaisle

As the VAR-MSP shift generally involves transitioning from fixed-fee billing to a subscription billing model, partners have to come up with strategies for a new pricing model. "It cannot be and should not be a 100% subscription model," Agrawal maintained. The "rapidly changing IT landscape will require continuous investment over the next five years; channels must have a mix of recurring, nonrecurring, product-led and services-led contracts to generate healthy margins for investment."

It is also very difficult in terms of cash flow and a hard conversation to have with your bank as a solution provider, "because you're no longer taking hundreds of thousands of dollars in on a project basis," and instead are seeing a $5 per-user, per-month type of revenue stream, Krakora added. Cash flow is also greatly affected if a partner used to take in a half million dollars per project, which affects their topline revenue number, too, she said.

"Many of these companies would consider themselves a $20 million reseller of gear every year ... but now, they may have only $1 million in overall margin." In a subscription model, they may only be making $5 million as a topline number. It also impacts credit lines and loans, she added. "Every one of these solutions providers in the $20 to $50 million range has a monthly conversation with their banker."

Handling infrastructure requirements

Another issue partners need to address as they make the transition to MSP or cloud is how they will handle infrastructure needs. Most channel partners will not have the capacity and the capability to build data centers, Agrawal observed.

"The best alternative for them is to partner with data center providers. More and more companies are shifting to cloud services." For example, in 2013, only 40% of channel partners were successful in selling cloud services, whereas in 2015, the number jumped to 63%, he said.

Krakora characterized infrastructure requirements as "a big roadblock. It's one of those hurdles partners have to overcome as they move into cloud," and one of the reasons they haven't been adopting it or becoming a cloud services partner is because of the huge investment required. "It's slowing that transition into cloud for many of these guys," she said. "Many are trying to partner."

They also need to have the skill sets to be able to provide the deep technological knowledge required for cloud. "So, there's the acquisition of infrastructure [needed], as well as the ability to understand it and put it all together."

Marketing and selling in a new way

As partners build a new business, they also have to figure out a new way to sell themselves, Krakora said. They're not having CIO breakfasts or educating someone over Danish anymore."

Gartner said 65% of the decision to buy a product has already been made before anyone reaches out to a salesperson or channel salesperson because of the amount of research being done online, she noted. As a result, partners have to hire new salespeople and marketers who are familiar with the digital age, and technical people who can put new systems together, which is not without its challenges. "Across the board, it's almost building a different company."

Specialization: Finding a niche

One of the issues that gets overlooked as partners consider transitioning to new channel business models is the idea of specialization, Krakora said. "People pay for specialists. The idea is a small regional bank in the Pacific Northwest wants to work with someone who's had experience working with small regional banks in the Pacific Northwest. People want to buy a specialist, and I think a lot of partners are still generalists."

Customers want niche providers, she maintained -- and they want to be able to find them online. She also suggested partners find what they have a passion for or skill sets in. If they are already a security expert "in the old reseller way," they should think about finding a niche in managed services security. Take your successes and continue to build on them by developing best practices and increasing marketing efforts, she said.

"Solution providers move from idea to idea to idea," Krakora said. "Go be awesome at something."

Next Steps

Read about the pressures channel partners face to change their business model

Learn about cloud support services business models and opportunities for the channel

Find out what vendors are doing to facilitate partners' cloud transitions

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