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Analysis of leading cloud partners offers lessons, warnings

Vendors haven't exactly been soft-pedaling the cloud mantra with partners, but they're now presenting stats and testimony that are hard for lagging cloud partners and channel partners to ignore.

While vendors' previous efforts to get VARs and MSPs onboard with the cloud seem to have been friendly reminders that they should consider making changes to their business model, some of last week's cloud discussions at Microsoft's Worldwide Partner Conference in Washington, D.C., seemed designed to scare partners into taking the message seriously.

Analysts from Gartner and IDC, as well as Alex Brown, CEO of born-in-the-cloud company 10th Magnitude, had dire warnings for attendees during breakout sessions this week.

"I wouldn't want to be on the back end of this trend," said IDC's Darren Bibby, vice president of channels and alliances, during a session on Monday.

"We continue to manage the business as it always has been managed, and we get into trouble," said Gartner's Tiffani Bova, vice president and distinguished analyst of research, during another cloud-related breakout session.

If you don't understand the cash flow of cloud, it'll whipsaw you during your transition.
Alex BrownCEO, 10th Magnitude

"If you don't understand the cash flow of cloud, it'll whipsaw you during your transition," Brown said. Brown sat on the panel of Bibby's breakout session and led his own presentation, titled "10,000 Cloud Providers: Bumps, Bruises and Band Aids."

For those that make the transition early and successfully, the rewards are great. But the partners that lag behind or have trouble managing the transition risk the very future of their businesses.

Bibby's session at Microsoft's Worldwide Partner Conference (WPC), titled "Successful Cloud Partners 2.0," went in depth on how successful cloud partners differ from partners that lag behind, dividing these companies into two categories: followers and leaders.

Successful cloud partners are more profitable than their less-cloud-savvy counterparts, Bibby said, citing a study this year by IDC of more than 700 Microsoft partners worldwide with cloud practices. He said channel partners that have 50% or more of their revenue coming from the cloud have 1.5 times more gross profit compared with other partners. They have 1.7 times more gross profit than those with less than 10% of their revenue from the cloud.

IDC's study showed a similar correlation in revenue growth. Those companies with 50% or more of their revenue from the cloud had a 14% revenue growth rate versus only 7% for those with 10% or less of their revenue coming from the cloud.

Successful cloud partners also get more new customers and more recurring revenue, Bibby said. The IDC research showed that companies with more than 50% of their revenue from the cloud have 1.6 times the recurring revenue -- as a portion of total revenue -- compared with other partners. They have 1.8 times the recurring revenue as those with 10% or less of their revenue from the cloud. The new-customer ratios were 1.3 times for those with 50% or more of their revenue from cloud, and 1.8 times more than those with 10% or less of their revenue from the cloud.

But why exactly does a cloud model mean a better bottom line for partners? According to the experts, customers typically move into the cloud slowly but steadily, one project at a time. They tend to add on cloud services project by project, and in greater volumes. As they increase their use of cloud services, recurring revenue payments to partners also increase. And as cloud partners add customers, the effect is magnified over time.

Reaching that nirvana seems a treacherous course for many companies. Bibby pointed out the basic problem that traditional VARs and MSPs face in transitioning to the cloud: Recurring revenue deals lack the big, upfront infrastructure purchases of on-premises purchases, yet it takes time to acquire enough recurring revenue to support the cloud portion of the business, so there's an inevitable cash flow problem to be solved.

"[We're beating] the folks … still doing elephant hunting, because we're coming in and proposing a right-sized engagement in opex [operating expenses] dollars," Brown said. "The challenge becomes, how do you live through three or four years to get … enough … revenue?"

The answer, Brown said, is to always be selling. "If you think about over a three-year period how many accounts you need to onboard, you need to keep building up these layers of revenue."

Bibby warned attendees that there is not an unlimited supply of potential customers in the new cloud order. "You've got to get in as soon as you can," he said. "One partner told me, 'Each of my deal sizes for what I'm going after on net-new cloud are half of what they used to be, so I have to get twice as many customers.' If you extend that out to the entire population, it's only going to be the first 50% of partners that get to cloud that are going to get those deals," Bibby said.

Bibby laid out some advice for those channel partners that need to plan for the transition to the cloud:

  • Manage short-term pain for long-term gain. This means you need to delay gratification and plan for lower revenue in the first two to five years of your transition to the cloud. "Say no to the second-platform deal -- the on-premise, the hardware, the license sale. And say yes to this ongoing stream of recurring revenue," Bibby said.
  • Understand the recurring revenue model. Know that there is typically a cash flow "trough" during the transition to cloud services, as transaction-based revenue drops and recurring revenue starts out slowly before growing.
  • Stop what you're doing and figure out your cloud plan. You may be comfortable with a transaction-based business in the short-term, but things will get very uncomfortable for you as the pace to the cloud quickens and you're still on a transaction-based model.
  • Analyze your profit areas. Understand which of your revenue streams have the biggest profits and consider what they will look like in the future.
  • Don't wait to adopt cloud. The longer you delay transitioning to cloud, the more deals the cloud leaders will take away from you.

Bibby also shared some advice for creating a successful cloud strategy:

  • You may not have to change everything. Not all partner types should feel pressured to adopt cloud immediately. Those relying on professional services to big enterprises can take more time developing a plan for the cloud.
  • Choose between going big and going small. Being successful with small and medium-sized businesses requires different operational competencies than being successful with big companies. Trying to do both at the same time is distracting to the task at hand.
  • Use the cloud internally. "We don't have any equipment. We have laptops, a printer, that's it. I can't credibly tell my customers that they can entrust me to run their highly proprietary data on [the cloud] if we don't do the same," Brown said.
  • Stay one step ahead. Given how young the cloud market still is, being just a step or two ahead of the rest can give you a competitive advantage.
  • Consider company structure. Some successful cloud partners start out with a separate division but integrate it with the on-premises division as the cloud group matures.
  • Differentiate by domain expertise. Specialize your offerings with a focus on either business process or vertical industry. Vertical industry work can generate unique intellectual property that you can then leverage going forward.
  • Build your recurring revenue. Recurring revenue doesn't have to be cloud-related to be good for your company.
  • Increase your company's valuation with recurring revenue. Bibby said: "The stock market values companies with more regular cash flow more highly. The revenues are the same, the costs the same, the profits the same. Moving from a variable revenue stream, such as selling upgrades, to a more regular one, like subscriptions, will boost the value of the company."

In addition to these points, Bibby also had advice for partners on crafting strategies around cloud sales and marketing, cloud managed services and intellectual property. IDC's "Successful Cloud Partners 2.0" report can be downloaded here from Microsoft.

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Are you worried that you might have missed the boat on providing cloud services to customers?
Very insightful. Do you think it will be easier for those VARs and others already used to a recurring revenue model such as Open source subscriptions (for example)?
@ZBelcher, Yes, it stands to reason that VARs that are already reselling software on a subscription model will have an easier time transitioning the whole business to a cloud-based model. Transitioning salespeople is a big part of the equation (many experts advise traditional VARs to literally replace their entire sales team in the transition to cloud, or to hire new different salespeople to handle cloud-related sales), so if a VAR has already gotten past that hurdle, they're that much more ahead of the game.