Calculating Channel Compensation for Cloud Services

By Lawrence M. Walsh

Cloud computing is the present and future of the channel and technology industry. IT vendors, telecommunications carriers, distributors, hosting companies, telephony agents and IT solution providers are either entering the cloud” or exploring their options in the cloud era.

And why shouldnt they? Market analysts predict the business cloud computing market will generate between $100 billion and $150 billion in annual revenue by 2015. By comparison, the global data network switching and routing market is somewhere around $40 billion. Suffice to say, the total addressable market opportunity is huge.

The challenge for solution providers isnt the technology, per se, but rather the business model. The two biggest cloud computing problems facing the channel today are understanding and mastering the complex cloud business model, and managing the financial burdens of transitioning to a cloud business.

The Channel Partners Cloud Convergence Council, a group facilitated by Channel Partners and The 2112 Group, noted these challenges in its trends study, Channel Convergence and Evolution Through Cloud Computing,” released earlier this year. Drilling deeper in the business model and financial burden issues, the council conducted during July a follow-up survey, Cloud Convergence Councils Cloud Services Margin and Compensation Study 2011,” on cloud sales compensation and service margins. Nearly 200 qualified IT solution providers, managed service providers, telephony agents and cloud services companies participated. The results reveal a still immature industry trying to define the optimal business and financial model that equals greater success in cloud services.

According to the study, most of the channel still earns relatively little revenue through the sale of cloud services, margins are not as rich as some on-premises products, most solution providers are dependent upon the margins/discounts provided by vendors for their cloud revenue and sales organizations are not focused enough on sales opportunities. Additionally, the study concludes that most vendors  be they telcos, IT vendors or colocation providers  are not doing enough to give their partners the ability to succeed in the cloud era.

The Business Model Barrier

Previous research by the Cloud Convergence Council found the biggest barrier facing the channel  IT solution providers and telephony agents alike  is understanding the cloud computing business model. Roughly one-quarter of channel partners surveyed in December 2010 cited challenges as they enter the cloud computing era.

The cloud computing business model is relatively straightforward and actually has been in use for years in the telecommunications and hosting industries, as well as the IT managed services segment: A customer contracts for the delivery of IT-as-a-service, which is then billed on a recurring basis often monthly or quarterly.

The challenge isnt so much understanding the underlying mechanics of the cloud business model, but rather how to make a robust and profitable business around cloud services.

In previous technology and communications services, the product came with few options, such as Internet connectivity and bandwidth services, and was often sold directly to the customer. Other technology vendors, solution providers and agents would then sell add-on technologies to leverage the service and bring business value to the entire system of integrated products.

In the cloud model  particularly for public clouds  the delivered service does have intrinsic value, and much of the maintenance and support is self-contained within the offering. This often means the value (revenue and profit) opportunity is accounted for within one price and engagement.

As a result, channel partners often are operating on razor-thin margins with few aftermarket products and services to accrete additional value and profitability. This partly explains why nearly 40 percent of the channel, according to the latest Cloud Convergence Council survey, earns less than 10 percent of their revenue from cloud computing services.

Cloud proponents argue that cloud services are inevitably more productive and profitable than on-premises product services. Its true. Unlike a server or software sale that is a one-time event, customers must pay a recurring fee for service. And because the failure to pay will result in a service disruption, customers will continue to pay long after what would have been the end-of-life date for a conventional product.

The problem many channel partners face is waiting for the cloud payday. A cloud engagement will yield more revenue over time, but the provider and reseller bear all the operating costs upfront. Many channel partners say a typical cloud account doesnt become profitable  the covering of all operating costs  until nine to 12 months into the engagement.

And, based on the results of the previous Cloud Convergence Council study, it makes sense that the second biggest problem facing the channel in the cloud is managing the protracted revenues and return on investment in other words, covering expense obligations while waiting for the cloud revenue to pile up. This probably explains why only 6 percent of the channel earns 100 percent of their income from cloud services, according to the latest study.

Marginalizing Profits in the Cloud

Where is the channel engaging in the cloud? Not surprisingly, in the public cloud and, more specifically, the resale of cloud services developed and delivered by vendors, such as Microsofts Office 365 and Google Apps. 

More than half (55 percent) of the channel resells vendor cloud services as their primary engagement in cloud computing. Only 39 percent host their own cloud services, and 29 percent are specialized in developing, integrating and hosting hybrid cloud implementations.

The heavy reliance on vendor cloud products as the solution to their customers cloud demands correlates with channel complaints about margins. When asked how cloud providers could make their services more profitable, solution providers and telephony agents overwhelmingly (57 percent) said they should increase margins on cloud services.

Cloud margins are a sensitive subject in the channel because theres no real consistency in the distribution of margins and discounts to partners. Some cloud vendors are offering up to 80 percent margins to their resellers, while others are keeping margins tight sometimes in the single digits.

Survey participants report IT vendors as providing cloud services with the slimmest margins in the channel less than 20 percent of gross sale price. Telecommunications carriers and colocation-hosting companies provide their partners with slightly better margins 11 to 20 percent on average.

Channel partners hardly can be called satisfied with these margins. Most who resell cloud services give fair” to poor” ratings for the margins offered by IT vendors and colocation companies. However, most are generally satisfied with the margins provided by telecom carriers.

The channel never has operated on the premise that the vendor is responsible for all of the partners profitability. Margins  or discounts on products  are only the starting point for the channel to build revenue and profits through the accretion of multiple products and value-added services. In the survey, though, channel partners indicate vendors arent building cloud systems that allow for the bundling of multiple services or products, or provide professional services in the traditional sense.

The Cloud Convergence Council discussed this issue in one of its meetings and concurred with the survey findings: Many cloud vendors market their offerings as simple and easy-to-implement; their intent is to sign partners quickly. Partners either shy away because they recognize the complexity before them or get trapped into a poor service offering.

What channel partners want are clear road maps for how to bundle and support multiple cloud services in public, hybrid and private cloud implementations.

Compensating Cloud Sales

Making money on cloud computing isnt just a problem for channel partners, but for their salespeople, as well.

Channel partners struggle with crafting compensation plans that are equitable to their sales staff and balanced with their revenue stream. Survey participants rate this as the biggest challenge (55 percent) in their sales strategy and execution.

A strong selling point of cloud computing to end-users is the conversion of IT from a capital expense to an operational expense. That means IT is purchased not at a one-time fixed cost that depreciates over time, but as a recurring operational expense with greater tax and budget benefits. The lower amortized cost makes cloud services more affordable in the short term.

The trouble facing sales managers and channel partner owners is devising a sales compensation plan based on this formula. The recurring revenue is lower than a lump-sum payment, so a percentage of the recurring revenue doesnt amount to much. For instance, if a salesperson with a 10 percent commission sells a $1,200 server, theyll receive $120 commission. But if they sell a hosted virtual server for $100 per month, theyll only receive a $10 commission.

Most channel partners pay commissions based on the recurring revenue stream. Roughly one in four channel partners gives salespeople a percentage of the recurring fees, while another quarter pay a one-time commission based on the total value of the contract plus a piece of the recurring revenue. Only 19 percent pay a one-time commission against the value of the cloud contract, and 17 percent pay no commission at all, compensating salespeople exclusively through a base salary.

Complicating the compensation equation are base salaries. The Cloud Convergence Council survey found that the average salespersons base salary is between $50,000 and $69,000 annually. Channel partners must generate enough sales to cover this, plus pay commissions out of what essentially is a fractionalized revenue stream compared to the sale of conventional hardware and software products.

Relatively few channel partners are dedicating sales resources to cloud computing. Only 6 percent of the survey participants have salespeople exclusively devoted to cloud computing products. Most channel salespeople are selling hardware, software, managed services, professional services and telephony services concurrently with cloud. Interestingly, the lowest overlap between cloud and other products are telephony services; managed services had the highest overlap.

Balancing revenue and sales compensations  or general operating expenses  is particularly challenging, which is why some channel partners force their sales staff to live off the land. The survey found nearly one-third of the channel does not pay their salespeople a base salary. Their entire compensation is based on commissions. The average commission for a channel salesperson with a base salary is less than 5 percent of gross, while the average commission for a salesperson working without a base salary is 25 percent or greater of the gross sale.

One in five channel partners  particularly in the telephony channel  does not exclusively have their own sales team. Many use outside salespeople and partners to sell their products and services. For the most part, they do not provide a base salary for such salespeople, but rather pay a straight commission for the sale of cloud services. The average commission paid to indirect sales teams falls between 6 and 10 percent, while some get as much as 15 percent. This range is in line with the margins provided by cloud vendors to their partners.

A looming compensation challenge focuses on how to incent and reward cloud contract renewals. Forty-three percent of channel partners say theyre vexed by the problem of rewarding sales for cloud contract renewals that many presume are virtually automatic. Anecdotally, channel partners say they pay lower commissions on renewals because they take less work to close. Salespeople, on the other hand, often believe theyre entitled to a full commission on renewals because theyve been charged with managing and maintaining the customer relationship. And, in some cases, contract renewal time is a competitive event wherein other vendors are brought in to challenge the incumbent.

The sales compensation challenge is universal to all channel partners, but is probably more acute in smaller organizations. Nine percent of the survey participants have no sales staff. Their entire sales operation is the responsibility of the owner/operator of the business. These channel partners tend to be smaller and more reliant on their technical than business resources.

Making the Cloud Profitable

The Cloud Convergence Council survey reveals ample evidence of the challenges in cloud profitability and compensation but there is equal evidence showing how the cloud will become a productive and net contributor to the fiscal health and profitability of channel partners.

Channel partners in the survey said they want a greater ability to bundle cloud products and services to create systems with more value. They also said the cloud products at their disposal today do not have enough margins to produce viable profit contributions. This is reflected in the cloud services they deem more profitable today.

The cloud service with the best margins, according to survey participants, is hosted VoIP and telephony services. Falling far behind in the margin ratings are services such as business continuity and disaster recovery, hosted IT services, storage, security and consultation.

By 2015, though, the perception of cloud services margins may shift from point products to systems. Channel partners anticipate hosted IT services as having the best margins. Unlike the perception today, though, they anticipate other services having strong margins, too, including hosted infrastructure, storage and backup. The indication is that cloud services will evolve quickly from single solutions to holistic systems.

Whats clear from the Cloud Convergence Council survey is that, from a compensation perspective, more guidance is needed to bring clarity to the cloud computing model. Vendors need to find ways to improve the profitability of cloud services either through margin increases or value-add opportunities. And channel partners need to do more to define their cloud value and create stable cloud revenue streams that support their businesses.

Lawrence M. Walsh is CEO and president of The 2112 Group , a technology business advisory service that specializes in optimizing indirect channels and partner relationships, and principal blogger at Channelnomics. Hes also the executive director of the Channel Vanguard Council and moderator of the Channel Partners Cloud Convergence Council . He is the former publisher of Channel Insider and editor of VARBusiness Magazine.

The Channel Partners Cloud Convergence Council is a group of industry thought leaders who represent IT vendors, telephony carriers, hosting companies, telephony agents and IT solution providers engaged in cloud services. The council is facilitated by Channel Partners, the leading publication of IT and telephony channels, and The 2112 Group, a strategic services firm specializing in channel optimization and communications. The councils mission is to explore the coming together of the IT and telephony channels in the cloud computing era and to provide expert guidance and best practices for success. The articles in this months issue are a result of the councils study on cloud margins and compensation. Look for more articles and reports from the Cloud Convergence Council at www.channelpartnersonline.com/cloud-convergence-council.