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ESG defines vendor relationship strategies for channel firms

A report by Enterprise Strategy Group identifies what MSPs should seek in their cloud vendor relationships. The report warns that some alliances can undermine key business goals.

As one of the most transformative technologies of the last decade, cloud computing has undoubtedly had a significant impact on how enterprises conduct business, but it has also impacted the role of traditional channel firms.

A newly released report from technology research firm Enterprise Strategy Group (ESG) highlights how partners need to evolve their business models and maintain healthy vendor relationships if they are to continue to thrive financially in the modern marketplace.

Kevin Rhone, channel acceleration practice director, Enterprise Strategy GroupKevin Rhone

"Progressive, effective partnering strategies are needed to capture this opportunity, and forward-looking tech vendors recognize that leading partners have a new set of priorities and challenges when serving their customers while maintaining profitability in the transformed world of IT," states author Kevin Rhone, ESG's channel acceleration practice director, in the report, "Trends in Creating MSP Value -- A 2020 View."

The incentive is there: The global managed services market is projected to increase at an 11.5% CAGR from 2019 through 2024, reaching U.S. $319 billion, according to the report.

Defining healthy IT vendor relationships

Today, many partners broker a vendor's cloud offering like Microsoft's Office 365 or Salesforce products. In these vendor-partner relationships, the underlying vendor generally knows who the customer is. This is a big deal, according to Eran Farajun, executive vice president at cloud backup and recovery vendor Asigra, which commissioned the ESG report.

"It's now unfortunately becoming common for underlying cloud providers to market, provide and sell to customers directly, rather than asking the MSP [to do this] even if the vendor has a 'channel-only' relationship," Farajun said. "The vendor might come out with a new shiny offering" and want to sell it directly to the end customer. "The MSP needs to think about whether this is a healthy relationship. Some remain in [vendor relationships] that aren't good for them."

Eran Farajun, executive vice president at AsigraEran Farajun

Vendor-partner relationships also have longer-term implications for channel businesses, according to Farajun. When a partner wants to sell their business, a buyer is going to examine the partner's customer list and ask how many of those customers the partner brokers cloud services to and how many they control themselves, he said.

For cloud brokerage businesses, "the buyer will have to spend a lot more energy and money to make sure the customer won't leave once he buys," Farajun explained. "The brokerage ones aren't as sticky."

In the long run, these customer retention demands on the buyer will reduce the purchase price, Farajun said. "So being a broker in a non-healthy channel model is lowering the ultimate value of your business."

A healthy vendor relationship involves various elements, Rhone said. Is the MSP adding true value to the vendor's offerings? Does the offering differentiate their business in the eyes of the MSP's clients? Partners need to evaluate their vendor relationships' long-term potential. Rhone advises partners look at three factors to drive success: revenue, margins and earnings.

"Healthy IT partners today are transitioning their revenue streams to focus on generating a high level of recurring revenue, securing attractive gross margins that are generated by MRR [monthly recurring revenue] agreements, and delivering as much of their value as possible as a recurring as-a-service offering," Rhone states in the report.

The transition involves moving existing client agreements to service-level agreements, developing or partnering to add innovative new products, and even moving away from unprofitable customers, he said.

"These actions define healthy business models," Rhone said. Based on interviews he did with several MSPs, "they can make the difference between VARs [and] MSPs generating gross margins in the 20% to 30% range as compared to as much as the 40% to 55% seen with high-value services or recurring [revenue]-focused MSPs."

When vendor relationships become unhealthy

In the cloud solution provider (CSP) brokerage model, partners act more like resellers than true MSPs -- a move many partners have embraced. But the brokering model is a double-edged sword. Often, MSPs do not recognize that this approach can undermine three factors for sustainable success: competitive differentiation, putting repeatable processes in place to ensure high customer renewals, and high-value revenue streams, according to Rhone.

With the CSP brokerage model, it is more difficult for partners to set their own pricing and margins. Additionally, they lose control over the ability to create differentiation; cultivate, expand and protect their customer base; and set the branding, terms and level of unique as-a-service offerings, Rhone said.

"MSP partners are often required to disclose the names of their customers [to their cloud vendors], which opens the door to having the [vendor] form direct financial relationships and offer additional products and services that the MSP could have provided," Rhone noted. When that happens, MSPs start to look more like reselling, transactional partners, and that's when they can only generate the revenues and gross margins typically in the 20% to 30% range, he said.

Vendors do things that aren't always in best interest of their channel partners, even when they have channel [sales] models.
Eran FarajunExecutive vice president, Asigra

"Vendors do things that aren't always in best interest of their channel partners, even when they have channel [sales] models," Farajun agreed. "A channel-healthy model is one that mitigates some of this risk [to partners] by the vendor not having the end customer's name and contact information."

Rhone is seeing more vendor-partner relationships where the vendors are the service providers "and they want to retain branding and motivate their partners to sell their branded services around the cloud or some other product," he said. "It's an [unhealthy] relationship. But it's incumbent upon the partner to identify the relationship they can then make healthy by making their own services or becoming a services provider."

Two areas where partners can develop their own intellectual property and provide high-value services are in incident detection and response and compliance and security analysis, Rhone noted. 

Vendor relationship management: Advice for partners

"Partners should seek out vendor relationships that allow for partner independence in their design, those that have built-in ease of management, and those that generate profitability led by the ability to set their own prices and margins," Rhone states in the ESG report.

Additionally, partners should make sure that they maintain and control customer loyalty, with increasing customer ownership across a breadth of service offerings over time as a primary goal.

Instead of the model where the MSP is treated as a reseller, a healthy model is one where the MSP acts also as a CSP for a set of high-value services, according to the report. The advantages of this approach include the following:

  • ability to set or adjust price or margins;
  • direction of all communications with clients;
  • protection of customer relationships and contacts;
  • ability to grow the value of the MSP business; and
  • higher value and price upon the sale of the MSP business.

In a healthy vendor relationship, incremental margin that would otherwise benefit the cloud provider is transferred to the partner when they deliver the service themselves using their own people, infrastructure and dedicated data center, the report stated. The MSP also retains the ability to evolve and adapt the right services, pricing and margin mix to serve their markets and customers. This protects them from margin erosion over time due to issues outside of their control, Rhone said.

"It's all about the business model and ... I think [partners] can be successful in a couple of different ways as a managed services provider -- being sales and marketing focused and managing your business around lower gross margins ... or you can be tech-differentiation focused, which is a harder road, but it's potentially more lucrative from a profit and margin standpoint," Rhone said.

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