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Analyzing whether free software solutions can grow VAR margins

As customers evolve toward commodity hardware purchases, cutting VAR revenues, can VARs add free software solutions to their portfolios to recover their margins? Learn how to analyze free software options and determine if it can be a good value add for your business.

Value added resellers (VARs) and distributors have had to deal with commodity hardware being used in data centers and networking infrastructure over the past few years. So VARs adapted by offering more hardware options, services, software, and in some cases managed services.

Now there is more pressure on the channel as software, especially “infrastructure” software such as operating systems, databases, and middleware has become freely available and is often open source. Free software means smaller margins for solution providers and this free software push can disrupt the status quo in technology. This can cause a loss or gain of profits for VARs. In this tip you will learn how researching your margins can help you decide if free software makes sense.

How does the channel best prepare itself for shrinking margins on infrastructure software while positioning itself for the disruption caused by new technology? Solution providers should granularly analyze their business margins and consider free, competitive solutions that are viable in their solution offerings.

Per unit margin analysis
You should take revenue out of the equation when calculating margins because it involves taking on more credit to impress business partners, and doesn’t account for long term viability. If you don’t have adequate margins to back up the revenue numbers, it doesn’t matter.

VAR margin analysis should be based on areas of concentration -- usually two to five total for most companies. For example, you may focus on server rooms and small-sized data center build outs, and offer server and backup integration. When reviewing financials you may realize that you are only making 3-4% on 1-inch rack models that account for 50% of your revenue, and that you are making 70% margin on automated backup robots, but that it only makes up 3% of your revenue. 

During the initial margin analysis, stick purely with the margins recorded for asset value, such as pricing. After you have identified individual element’s margins, you should capture any additional revenue granted from specials and rebates as well as any costs such as short-term financing costs, or postal costs if you’re staging equipment on your location prior to delivery. Having a solid grasp on how to analyze margins per unit is the fundamental requirement for understanding the opportunity and risk created by “free” software. 

Solution-based margin analysis
The next step is to determine what the margins are for your typical solution offerings. This cannot be an exact number because it’s likely that you customize each solution based on the customer’s perception of how well the included elements scale, as well as other internal bits of information they may not be providing. 

But this solution-based margin analysis must be understood to determine the effect of competitive pressure from free software, or your own decision to apply free software to a solution to increase profits. Using the example above, one of your solutions may be a pre-configured 19-inch rack with structured cabling, access network equipment, a tape robot and servers.

There will be rebates and initiatives in your solution that you may or may not share with the customer that increase your margins dramatically. For example, a backup vendor may provide five free backup licenses, and five anti-virus server licenses in the configuration that knocks off thousands of dollars on the solution if they were to be purchased separately.

There may also be partner initiatives, like referrals on financing and ongoing revenue from maintenance agreements. You need to consider the complete picture and create a solid single page calculation table for each solution.

When can “free” software hit you in the wallet?
Once you have a strong understanding of where money is earned, you can then analyze viable free software as an alternative to your solutions using a competitive mindset. Using the example above with the rack, let’s assume a typical use of the pre-configured rack is an e-commerce solution based upon Red Hat Enterprise Linux with Apache for Web services, an Oracle database server running on Red Hat, and JBoss for the application services. There are free alternatives to each of these, and in this particular situation, some very viable free alternatives. For example, CentOS is basically a free alternative to Red Hat. Although not a simple replacement, Tomcat and MySQL can be used to replace the application and database servers, respectively. 

If you don’t have the in-house expertise to determine how easy it is to replace elements in your solutions, you may (depending on the approach you choose below) wish to seek out partners that specialize in this area. They can help migrate from existing platforms to free solutions to help you with risk assessment and creating a strategy to exploit free software.

The matrix you create from free software alternatives can be used for four different approaches: Engaging in a price war, focusing on value and not price, joining them with caution and value add and “drinking the Kool-Aid,” (which entails implementing free solutions into your portfolio).

Price war
Simply removing margins until you can match the competitor’s solution with “free” software elements is a feasible but short-lived approach. Unfortunately, you’ll be starting off at a major disadvantage because your competition can still cut margins to underbid you, so you will most likely need to cut margins twice. 

I generally don’t care for this approach because at some levels it says that everything within IT is commodity. There are a few instances in which this approach works best (in the order of easiest to hardest to determine):

1. The customer is well-versed in both your solution and the “free” element alternatives. 

2. Loss of the particular sale could impact your status with the customer.

3. Your win will most likely sour your competitor’s desire to compete with you for the customer anymore.

Value not price
The most common competitive response regardless of the reason (free software, aggressive competition, disruptive distributors, etc…) is to present your value solution based on your solution’s proven track record, your proven track record and the industry’s take on your solution. You’ll likely feel most comfortable with this approach. If the customer or project lends themselves well to this approach, then stick with value not price. But if the “free” hurdle is too hard to overcome then one of the following two approaches are likely better.

Join them with caution and value add
Another competitive approach is to include free elements that will work for your solution if an apple-to-apple comparison is necessary. The major disadvantage is that you can be perceived as saying “oh me too” when you say “oh we do that also.” Using the Red Hat and CentOS example again, you can pop in the replacement CentOS. But when presenting, you can explain the drawbacks of this option. 

So, for example, you can state that CentOS is a replacement but there is a caveat. CentOS is currently compatible with Red Hat 5.5 butRed Hat is now on version 6.0, two releases ahead, and CentOS is likely six to 12 months out on support of those platforms. Is the $400-per-year savings per server worth it to you to wait on the CentOS cycle? Be sure and stick with facts and avoid fear, uncertainty and doubt tactics. Provide the customer information and let them decide.

The “new” solution should be presented as a viable option with what value you will bring based on your understanding of the customer. For example, if you’re bidding in a CentOS replacement, then a value-add could be to help configure and test the software agents for backups, monitoring and altering to ensure the solution works with their previously-purchased enterprise solutions. The attitude should be “Yes, although we don’t think it is as viable as our solution based on our experience. We can make it work for you, but we need to help you with x, y, z.” These value adds can be “free” if you’re wanting to push back with “free” or they can be additional revenue to offset the loss of margin for the free replacement.

If this is the first deployment of the new technology for the customer, then there is actually much more opportunity available than this approach, and the drink the Kool-Aid approach may be best.

Drink the Kool-Aid
Free infrastructure software is here to stay, and major infrastructure areas where “free” is getting a lot of play include servers, the Web and databases. In some circumstances it may make sense to simply buy into the “free” and integrate it into your solutions. Based upon your margin analysis, you can accurately determine where you need to make up lost margins (and possibly profitability if your business is marginally profitable.) Unlike the first round from above where your thinking was focused on competitiveness, this planning should be on keeping solutions viable. 

If you have a strong integration or consulting practice, you most likely will want to identify service solutions to assist with the migration to “free”. Your migration services should approach two distinct paths: New customers, and existing customers. Most of the skill set will be the same regardless of whether the migration is for a new or existing customer. But with existing customers you will likely need to assist them with some ROI calculations and possibly even tie migrations to their normal hardware cycle to maximize their savings.

Although the Kool-Aid approach may do quite well, especially on large migrations from one platform to another, VARs still need to proceed with caution on this approach. Customers still need to maintain support and maintenance on their systems, so exotic configurations and choices should be avoided. Many customers expect their hardware vendor to support them on the operating system, so ensure your technical staff has covered the bases with your solution hardware and software vendors.

This article has provided methods to identify where free software can hurt and help you the most. You learned to plan for the appropriate changes to your solutions and deal with an ever growing free software environment. Training and certifications will also be important to your customers, so having a solid understanding and offering on this front will help you maintain your customer’s loyalty. These approaches can help you minimize margin loss and create new opportunities through the disruption caused by free software.

About the author
Ronald McCarty is a freelance writer, information technology consultant, and the owner of Your Net Guard LLC, an IT consulting company located in Dallas, Texas. He has written for numerous publications and websites including TechTarget, CMP, Cisco Press, and New Riders. Ron is also the author of Ubuntu Linux System Administration.

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