The Changing Channel

Why resellers can no longer resist the shift to services

It’s a difficult task, but if you still haven’t migrated to a services-based business model, you’d better hurry-time is running out.

Nathan Morton strode to the podium in a packed meeting room at the Las Vegas Convention Center. It was November 1990, and Morton, president of an up-and-coming computer retail chain called Soft Warehouse, was about to address an overflow crowd at Comdex, the high-tech industry’s annual shindig. For the next 45 minutes, Morton told a rapt audience about an important trend that he’d seen play out years earlier in other industries. He called it “The Bankruptcy Gap” and predicted, unequivocally, that it would eventually plague the computer industry.

Specifically, Morton said long-term survival by technology resellers could only be accomplished by focusing on business models designed either for very-high-volume product transactions or for higher-margin services. Any company that failed to negotiate its way to one end of the spectrum or the other would inevitably fall into the Bankruptcy Gap, a hellish abyss where operating margins are squeezed mercilessly by declining product margins on one end and rising costs of delivering value-based services on the other.
Morton-whose company soon was renamed CompUSA, the iconic big-box computer retailer-knew what he was talking about. Morton passed away last November at the age of 57, but if he were around today, he’d be chuckling to himself about how VARs, integrators and solutions providers are still struggling mightily to make that transition to the services end of the spectrum.

Just as the Bankruptcy Gap wasn’t a new business concept, neither is the notion that high-tech solutions providers should transform into services experts. It’s a concept that’s been written and talked about for more than 20 years, to the days when proprietary minicomputer solutions began to give way to PC-based networks. Way back in September 1986, one of the first issues of the new magazine VARBusiness asked in a cover headline: “Is Hardware Worth It?”

Why Not?

So why is the technology industry still yakking about “transition to services?” With billions of dollars spent annually by product vendors, distributors and others to help channel companies get over the hump, why hasn’t it happened yet?

A Few Reasons

No Urgency: “Transitioning to services became a talking point about 10 years ago, but companies weren’t really feeling threatened by declining prices and margins on hardware,” recalls Tricia Wurts, president of channel consulting firm Wurts and Associates and a former Tech Data executive. For years, the Internet boom and Y2K buying orgy kept hopes alive and companies afloat. “If you didn’t make the transition back then, it didn’t mean you were in financial trouble, because you could still make a good living selling products.”

No Pain: Wurts and others liken product margin erosion to scientific experiments with frogs and boiling water: Put them in boiling water and they’ll jump out, sensing the extreme heat and danger; but put them in room-temperature water and gradually turn up the heat, and by the time they figure out it’s boiling…well, you can figure it out. “When margins went from 28 points to 25 points, it was no big deal,” says Wurts. But when those margins continued to decline during the 1990s until today-down to single digits for the most popular technology products -it raised the bar for channel companies. “The margin crunch went from something that was an annoyance to a matter of survival.”

No Clue: Before margin erosion, the formula for building a business was simpler: Grow revenue, and profits would come. Some VARs and resellers haven’t changed that mindset. “I used to ask VARs whether it was more important for them to drive revenue or profit, and I’d get blank stares, as though they really didn’t know why I was asking,” says Bob O’Malley, chief marketing officer of Tech Data Corp. “They really didn’t understand that there was a big difference; they felt that as long as they were selling more stuff, the profits would grow accordingly. You have to understand that you drive profit through services, much more than through product sales.”

No Plan: Frankly, the main reason most VARs haven’t made the transition to services is because it is brutally difficult. It requires new business models, new skills, new technology approaches, new salespeople, new project managers: In some cases, it might even require a new CEO. In fact, we asked several VARs what’s most difficult in making the transition to services. Our favorite response came from Brian Okur, director of strategic partnerships at Chips Computer Consulting, Lake Success, N.Y. His answer: “Everything.”

How Hard Is It?

What does “everything” include? Try this laundry list:

Best Practices For Making The Move

SURE, IT’S NOT EASY TO MOVE FROM HAWKING BOXES to selling services. So here are a few suggestions from the experts to make the transition a little smoother.

1 –
GO SLOWLY.

No one can go from delivering products to becoming the next Accenture or EDS overnight-so don’t try. “Take baby steps-don’t try to do it all at once,” notes Mark Romanowski, executive vice president of ASI Systems Integration. Start with something close to your product orientation, like reselling manufacturers’ extended-warranty programs, or adding an outsourced help desk function. You can always expand from there.

2 –
HIRE INDUSTRY EXPERTS.

“We’ve been fortunate to be able to hire people who not only know technology, but more importantly, they’ve worked in the apparel industry,” says Art Krulish, director of business development for Sky IT Group. “They’ve had to live and breathe the business problem, and they have a lot more credibility with the customer.”

3 –
THINK ABOUT DROPPING HARDWARE SALES ALTOGETHER.

It sounds radical, but depending on your competitive environment and how strong a sense of urgency you feel, it might be the smartest decision. “The hardware business requires a completely different approach than services does,” says Victor Fabry, director of business development at Excel Partner, a Montvale, N.J.-based IT consulting firm. “Trying to merge a hardware sales mentality and a services mentality has the potential to be a horribly destructive process.”

4 –
DON’T BE A LONE RANGER-LOOK FOR PARTNERSHIPS.

“We offer a lot of our services at a discount to our partners so they can offer a broader selection of services to their own clients,” says Karen Sigman, VP of worldwide channels at Hitachi Data Systems. Jason Beal, group manager for the Ingram Micro Services Network, adds: “Through our network, we can help VARs go out and win professional services business throughout North America.”

5 –
BE BRUTALLY HONEST ABOUT YOUR TEAM’S TALENTS- INCLUDING YOUR OWN.

“It’s a real emotional hurdle for the CEO of a VAR or reseller,” says Paul Dippell, CEO of Service Leadership. “He thinks to himself, ‘What I grew up on was selling product, and that’s a lot less relevant today.'”

6 –
TAKE ADVANTAGE OF RESOURCES FROM DISTRIBUTORS AND PRODUCT VENDORS.

“Ingram Micro’s Venture Tech Network helped us learn how to develop our services business, especially in the SMB space,” notes Brian Okur, director of strategic partnerships at Chips Computer Consulting. “We learned a lot from their program, as well as from other solutions providers participating in the program.”

“Selling hardware is pretty easy, because you’re generally responding to something the client tells you they need,” says Pat Esposito, CEO of Impact Management, a solutions provider in East Islip, N.Y. “They need PCs or servers or a network, and VARs and resellers know what the specification is for them to respond to. But services are much tougher for those companies, because the customer often doesn’t know what he wants, and if there’s a specification, it isn’t nearly as clear or consistent.”

VARs and solutions providers also struggle because many manufacturers still build their reseller pricing and compensation models around product purchasing volumes, even though they want their resellers to move to services.”A big part of the problem is how product vendors treat the channel,” says Marshall Toplansky, a former marketing executive at U.S. Robotics and Hayes Communications, who now helps product vendors design channel strategies as CEO of consultancy Core Strategies. “Even to this day, much of the way vendors incent channel behavior is through purchasing volumes. They find it difficult to measure the value that channel-delivered services bring using that incentive model, so they made some changes by encouraging or mandating certifications. That’s a step in the right direction, but it still doesn’t fully reward the channel for the thing that matters most-customer satisfaction.”

VARs and resellers that have started down this path point out that companies must be willing to make real, tangible investments in changing their model-investments in money, staff development, hiring more technical staff and seasoned consultants and technical infrastructure. For instance, you may need to hire technical talent such as programmers or specialists in enterprise applications such as SAP or Oracle. Project managers will be an absolute necessity for ensuring the timely and efficient completion of lengthy, complex projects, and experts with hands-on experience in specific business problems within vertical markets also are essential to fulfilling a services mandate.

Now or Never

Despite the challenges, for most VARs there’s no choice but to make the transition to services: Their business survival demands it and their customers require it.

Death of a Salesman

Determining whether you have the right sales team can be a very difficult-yet critical-factor in determining how successful you’ll be in making the transition to services. “The biggest problem isn’t the reluctance of the owner of a successful VAR to be willing to consider a new business model; it’s the sales force,” says channel consultant Tricia Wurts. “A services model requires a different kind of salesperson.”

In many cases it may not merely require a “different kind” of salesperson but different salespeople: “With a services model, the sales guy no longer is the most important reason that the company exists,” says Paul Dippell, CEO of Service Leadership. “That’s a huge cultural shift. The customer now is gravitating to your services team-the smart guys who are solving the customer’s business problem. Your sales guy is sitting between your brainy services guy and their brainy business guy, and he often has no idea what they’re talking about.”

Pat Esposito, CEO of Impact Management, agrees: “VARs selling product get into a rhythm-contact, quote, negotiate, close. There aren’t too many variables, and a good product sales guy, who’s usually getting sales training for key product vendors, knows how to do that. But how do you even get that product sales guy to even recognize a services opportunity, especially if it’s a guy who is very focused on the quota he needs to hit so he can make his sales commission?”

Mark Romanowski, executive vice president of ASI Systems Integration, a New York-based integrator, adds: “Product salespeople usually don’t know how to sell services. At very least, you’ll need to give them some very focused training so they can start thinking about services from the start, and do a better job at spotting the opportunities.”

“Take a quick look at the P&L of a company with 90 percent of their revenue coming from products, and you’ll see they’re generally putting 2 to 3 percent to the bottom line,” says Paul Dippell, CEO of Service Leadership, a company that helps resellers and other channel companies develop their services business. “But the company that’s 90 percent services is probably driving 18 to 20 percent to the bottom line. Even if you’re not selling your company, you certainly would like to have that extra cash flow.”

Marty Wolf, whose securities firm specializes in mergers and acquisitions of channel companies (see page 47), notes that many companies get stuck in the no-man’s land of “some product, some services.” He recounted a recent acquisition he helped engineer for a company with revenue of more than $200 million, but where services accounted for only 5 percent of that revenue. “The services part of the business alone was probably worth $10 million in valuation, but the company only sold for $8 million; the large volume of product sales actually drove down the value of the company.”

Ultimately, the VAR’s customer gains the most from a switch to services, says Art Krulish, director of business development at Sky IT Group, a New York-based solutions provider specializing in business intelligence solutions for the apparel industry. “You can’t make a transition to services unless you implicitly understand the business challenges and directions of your clients, because in the end, that’s what they really care about,” Krulish says. “Vendors, solutions providers, and even customers often are way too much into their technology. Technology expertise is relatively easy to come by, and if you can get the customer to see the business value your services can bring, then you’ll see the gleam in their eyes.”

If all that weren’t enough, resellers focused on product sales are facing much tougher challenges than ever before. First, there are the extremely large and extremely efficient product delivery models of manufacturers such as Dell and full-line resellers such as Computer Discount Warehouse. “Honestly, I don’t feel there’s a viable long-term business model for moving hardware without sufficient economies of scale,” says Jason Beal, group manager for the Ingram Micro Services Network. “If you can’t match the economies of scale of those much-larger competitors, it’s hard to see how you can grow your hardware sales business. Ultimately, you’re going to need a services portfolio to be the customer’s trusted advisor.”

Second, there’s a wave of new and more aggressive competitors that don’t have ties to legacy hardware resale practices. Plus they’re already concentrating on delivering the kinds of services many older resellers have either dabbled with or have eschewed, from managed services like outsourced help desk to SAP consulting or compliance practices. “It’s the new guys these established VARs and resellers should be worried about,” says Tech Data’s O’Malley. “They’re committed to the services model from the start, and they’re playing by a different set of rules.”

As baseball philosopher Satchel Paige once said, “Don’t look back; something might be gaining on you.”

So, will the VARs and resellers finally conquer their fears and obstacles? Let’s fast-forward 20 years. It’s the 10th anniversary of ServDEX, the IT Services Expo, the successor to the original Comdex trade show launched in 1979 by Sheldon Adelson. The Las Vegas Convention Center is filled to capacity with booths, applications demonstrations and proof-of-concept displays assembled by thousands of IT services companies of every imaginable size, skill and geography.

Stepping to the podium to deliver his keynote presentation is Sheldon Adelson III, thrilled to see the cavernous LVCC finally filled again more than two decades after the demise of the original Comdex. He acknowledges the trade show’s headline sponsors: Network Services Corp., IT-To-Go Inc., and Global Services Aggregators, a joint venture of Google, FedEx and Wal-Mart. Adelson looks out at the overflow crowd, smiles and begins: “Let me tell you a story of a time when people charged premium prices for hardware and gave away their services for little or nothing.” The crowd roars in laughter….