Channel companies pressured to change

Anton Vukic, Phoenix Distribution.

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According to a recent ITWeb article, "Hardware channel faces shrinking margins", increasing pressure of margins, especially hardware, seems to be driving channel companies to additional revenue streams, such as offering services in addition to products. The article uses the example of VOIP providers bolstering their offerings with maintenance and support services.

According to Nick Christodoulou, regional partner manager at EMC Southern Africa, customers are continuously looking for new, innovative ways of creating value from IT, and in particular, from data. "It's not about acquiring more storage, but rather about offering a complete solution around data management."

He explains: "There is an increasing tendency for EMC partners to come to us and say, 'If we cannot sell, implement and support your product, we are not interested'. The reason for this trend lies in the perception of value by the customer. Prices have declined and so have margins. Now it's about training, integration, management and optimisation - in one word, services."

Jacques van Wyk, GM of indirect operations at Ricoh SA, agrees that everyone is trying to provide a service. "The reality is that, in some instances, based on geographic location, the move is a bit slower. That's due to the slow process of business transformation, which is largely due to access to the information and skills channel companies need in order to make the transformation."

According to Garth Hayward, regional manager for Africa at Kaseya, the shift towards a services-centric reseller market has steadily been happening over the last five years. "Many of our partners realised a while ago, as did most resellers, that a pure hardware channel play was delivering diminishing returns, and that this model would soon become unsustainable. As such, they adopted and skilled up on software solutions and, through a natural progression, went on to launch services divisions that could support the hardware and software solutions they were implementing," he explains.

Hayward believes this was the only logical move to ensure the sustainability of their businesses in the face of diminishing capital expenditure on hardware and a move to cloud-based software solutions. "However, this shift has posed various challenges and is not a silver bullet for all resellers," he says.

Hayward explains cloud-based software solutions to be a totally different business, which requires changes in human resources, billing models and operational requirements. "Finding and keeping the right staff with the skills required to run a successful services-based business is often the biggest challenge facing this market," he says.

Wesley Lynch, Realmdigital.

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Graham Duxbury, CEO of Duxbury Networking, says most channel companies have provided services for many years, but now, with the advent of cloud computing, they are placing added emphasis on services-based initiatives. "They can take on a physical form - such as system installation, commissioning and management - or be virtualised and include cloud-based system management and other hosted services," he says.

According to Anton Vukic, sales director at Phoenix Distribution, the market has slowed down considerably as a result of the tougher economic environment, so resellers are fighting to secure business from the same customers. "We see many resellers reducing their margins to win deals on a daily basis, and more and more of the top resellers are offering services to their clients as a way to secure future business and increase revenue. Resellers cannot just differentiate themselves on price anymore, and need to win business on services and making sure they're a one-stop shop for their customers," he explains.

"This means that additional services and customer experience are key moving forward, and often where we are seeing all the margin made in today's channels. The move is happening fast. As an example, we as a distributor are seeing great opportunities from 'provisioning' providers supplying cloud-based content/product," he says.

Resellers cannot just differentiate themselves on price anymore, Anton Vukic, Phoenix Distribution.

"Currently, the move towards services for channel companies is not very widespread, but it is certainly beginning to take off," says Wesley Lynch, CEO of Realmdigital. "A lot of the traditional channel companies are not yet seeing it as a core additional revenue stream, although they do see it as a value-added differentiator. The move is being driven by companies that are traditional hardware companies like Apple; bringing about the app store has certainly worked well for them," he explains.

Although most channel companies seem to be on board with the service-offering trend, many are not quite there yet, and this can cause them to fall dangerously behind their competitors.

"While the move towards services for channel companies has been fairly widespread, it's surprising to note that there are still a large number of companies that are yet to make the decision on whether to adopt or move towards a services strategy," explains Dean Kerr, sales manager, VCP and IS Direct, Internet Solutions. "Margins are being squeezed continuously, and every tier of the distribution channel has been seeing reducing profits on the same turnover for quite some time. By moving towards services, companies create a niche where they can remain relevant in the market. Those channel companies that have not begun building skills that will allow sales and services to run side-by-side must be starting to feel the pinch."

JJ Swanepoel, executive: channel sales, marketing and components at AxizWorkgroup, urges: "Channel-centric distributors have to move their traditional business models to a more services-orientated offering, in order to drive higher levels of customer value-add and margin retention. Focusing on more of the value chain will enable these traditional distributors to not only survive, but indeed to prosper within this ever-changing landscape.

Offering services as a part of a channel company's business model has tremendous competitive advantages, including an increase in revenue, greater business opportunities and a better relationship with the client overall.

Jeremy Waterman, Softline

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According to Kerr, services are an excellent mechanism to increase revenue, especially in the long term. "Offering services provides additional depth and value to a client that a typical buy-and-sell transactional relationship cannot offer. By providing services, a company is also able to differentiate itself in the market and to a customer by means other than just price, which typically ends in decreased revenues and margins for the provider. With the increasing number of competitors in the hardware channel, margins are continuously decreasing. By offering services, a typical hardware company is able to find a lot more profitable long-term revenue streams, as well as a more strategic value-adding engagement with their customers," he says.

Offering services is not only a means of increasing revenue, but is also a way for channel partners to grow their businesses and stake a claim in the market of the future, believes Christodoulou. "Not only are the profit margins more attractive, but there is greater opportunity to add tangible value and contribute meaningfully to the customer's strategic objectives," he says.

Jeremy Waterman, MD of Sage ERP Africa and Middle East, believes services are always a better model, as they tend to generate annuity revenue and encourage a high attachment rate with the client, but it does mean an upfront cash sacrifice. "The world of IT is changing and that creates opportunity for the channel to develop new revenue-creating solutions," he says.

According to Lynch, offering services within the channel market is definitely a competitive advantage and the way to go. "However," he continues, "it does have certain challenges and will not work for all companies - but is definitely worth looking into. A lot of companies will struggle to make the transition to a service-based rather than product-based [offering], and some may even fail - it has much to do with their particular business model and value propositions, and also whether they will be able to offer the kind of after-sale service and support that is required."

Now it's about training, integration, management and optimisation - in one word, services, Nick Christodoulou, EMC Southern Africa.

There is no doubt that there has been a marked move towards this model, as resellers look to diversify and create sustainable businesses, explains Hayward. "While there are challenges, if they can be addressed and overcome, and companies can get the right skills in place, then it can certainly increase revenue. In addition, this revenue is monthly based against annual contracts, which creates important annuity type income streams, much in the same way that software licensing and hardware maintenance has done. This obviously gives resellers a more stable business model than the basic time and materials and box-dropping model of old," he explains.

Although much pressure lies on the hardware channel to provide services, experts' opinions vary with regards to similar pressure on the software channel. Some believe the software channel is largely free of this added stress, while others believe it to be just as pressured to provide services as the hardware channel. Some even regard the pressure placed on the software channel to be greater than that of its hardware counterpart.

Kerr, for instance, believes the hardware channel has and is going to experience the most pressure in the move towards services. "With the global shift towards cloud services, the hardware channel has been placed under a lot more pressure than that of the software channel. Cloud has given businesses of all sizes the ability to increase their compute power with a much lower investment in hardware. As such, many businesses have chosen to re-map their data storage and hosting strategies with a clear trend to move towards cloud services. Even though organisations amass a great deal more data now than they used to in the past, their spend on hardware is not increasing at the same rate. Combine this trend with the margin squeeze, and the hardware channel is under enormous pressure," he explains.

Jacques van Wyk, Ricoh SA.

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Hayward also doesn't think there has been as much pressure in the software distribution network. "The value is still there when software is sold as part of a project or solution. Innovative software solutions are also helping to solve some of the pain-points experienced by resellers. There has also been a strong drive from software vendors to help their partners make the transition to a services-centric model. This includes assistance with brand building, as well as a focus on education and training on the solution sets they adopt, implement and manage. While that's not to say that hardware vendors don't do the same, the scope and impact these initiatives can have in the software sector is far greater."

According to Christodoulou, software is a lot more complex in terms of the integration, customisation and training that is required to successfully deploy within an organisation. "The new breed of applications will become commoditised once complexity is taken out of the system. Think of your smartphone - if you want an application, you go onto an app store, choose the one you want, buy and provision it - all in a couple of minutes at a low cost. What is stopping enterprise applications from being provisioned and consumed in the same way?" he asks.

Van Wyk states the software channel has had a good ride, but competition and pressure are mounting with the shift away from desktop-hosted software to cloud-hosted software that is seeing software become a service instead of a product. "I think SA is around 12 to 18 months behind the rest of the world, but salesforce.com, which is probably the fastest-growing CRM solution in the world, is purely a cloud solution in SA. Even Adobe has developed the Creative Cloud concept that has all of its creative products available through a cloud service. One of the constraints we face is the relatively high cost of bandwidth or the lack of fixed-line options in some parts of the country," he says.

According to Lynch: "There has definitely been pressure on the software channel, as many software providers have now moved over to digital distribution instead of distributing through wholesalers, distributors or even retailers. One of the biggest shifts we've seen is Adobe's move to Creative Cloud, where you can now buy licences online, as well as subscription services to software packages that would have previously been sold on a licensing basis."

Vukic believes there has been pressure in the software channel to offer services, specifically in the consumer sector. "Software sales in this segment are down worldwide. The upside to the software business, however, is that there are infinitely more ways to generate income, even in a declining market, specifically if you consider the migration to ESD and SaaS. Most licences sold are annuity income, whereas hardware life cycles are growing longer and longer. As long as you have the flexibility to adjust your business model, you can continue to generate income via software," he says.

Swanepoel concurs: "The software channel has margin pressures, some as a result of direct vendor engagement with certain end-users, and some through the inevitable commoditisation of certain products. So, in short, yes, there is pressure."

By moving towards services, companies create a niche where they can remain relevant in the market, Dean Kerr, Internet Solutions.

Both the software channel and the hardware channel are under pressure, according to Waterman. "The software channel [is under pressure] specifically because of changing models such as cloud computing, SaaS and subscription-based services. These changes mean less upfront revenue, and therefore, the channel is forced to investigate and implement different business models for creating revenue.

"Companies within the software channel need to work hard to find new business, and many of them are doing well," according to Waterman. "However, the software channel is facing different challenges as the software delivery models continue to evolve, and in some cases, are revolutionised. This is particularly true of the SaaS model, where software solutions are being offered as a subscription service in the cloud and the traditional channel is being bypassed," he explains.

Duxbury believes the pressure must be greater on the software channel. "Today, customers are looking for more cost-effective software options and often consider virtualised, co-locator solutions, resulting in lost revenue. Moreover, instead of buying a complete software package, they may rent an individual module. Perhaps the margins in the hardware channel have eroded to a certain extent, but hardware is still required to liberate software functionality," he explains.

Despite the general difference of opinion in the software versus hardware debate, opinions regarding the future of product-only resellers are unanimous.

Says Swanepoel: "Product-only resellers will face a difficult future because price, product and place simply is not enough, and the margins in this space will continue to be eroded. A reseller has to be able to differentiate itself and its offerings, and clearly articulate value if it is to survive and grow."

Christodoulou envisions an extremely limited future for product-only resellers. "Anyone working in the channel today is aware that the roles and responsibilities of the different organisations have started to overlap. Increasingly, we see service integrators becoming resellers; resellers becoming service providers; and even end-users becoming service providers. This evolution is unprecedented, but it is only the beginning of the journey we have embarked on. Any partner that is determined to remain a product-only concern is limiting its scope and reach in the market unnecessarily," he explains. "As hardware becomes more commoditised, the future becomes increasingly bleak for the hardware reseller. Commoditised hardware will lead to alternative methods of procurement."

"Quite frankly, I don't see a future for them at all," says Van Wyk. "At this point, the annuity revenues in the channel from distributors to partners and resellers rely on added value via software and services. Those that don't provide [this value] will not survive. It follows the global trend to outsource non-core operational functions to IT and print services organisations that provide those offerings. Companies don't retain the in-house expertise and skills to maintain those services themselves, so they won't be in a position to buy just the equipment and provide the value-added services themselves."

With margins dropping on a daily basis, companies cannot survive without offering software and services to make their margins, explains Vukic. "It is getting tougher, because a lot of resellers are making their margins on the service and not the product. This makes it a lot harder to be competitive. But there will always be 'pockets of excellence' within a niche offering environment. Pushing tin, for margin, will be a challenge. The industry is alive with opportunities for resellers at the moment. Owners just need to carefully stay in tune with where the 'new tech' is emerging. It is crucial that all resellers start working with distributors and vendors to play in the software and services space," he says.

As distribution becomes easier, Lynch believes, a lot of disintermediation will take place, and many of the traditional channel relationships will fall away. "The usual market rules that used to apply, with regards to geography or reach, just don't really apply anymore. Companies will need to re-evaluate those partnerships and their validity in the current market," he says.

According to Duxbury, the future is bright for resellers that are niche focused or that trade online. "There are certain places, particularly in remote areas, where it's impractical to establish a branch office staffed by services-orientated personnel. In these cases, a product-only strategy is the best solution. Take the mining industry, for example. Selling into this sector - where there is a preponderance of industrial Ethernet - is not 'rocket science'. Key marketing strategies need only centre on providing an online showcase of product offerings and an ability to ship orders as quickly as possible," he explains.

Hayward believes product-only resellers are few and far between these days, and that business model will fade out in the near future. "In our experience, all our partners have implementation and managed services divisions now. The increasing adoption of cloud computing and the delivery of SaaS is going to make conditions extremely difficult for product-only resellers, he says.

In the next 10 years, Waterman believes the technology channel is going to have to become more services-orientated and add value as a trusted advisor and consultant, as it becomes more and more bypassed by both hardware and software vendors.

"This is particularly true of many software solutions that are going to be cloud offerings with little or no involvement from the channel in terms of physical delivery - of course, the delivery of cloud solutions does not obviate the need for implementation services," he says.

According to Christodoulou, in the next decade, enterprise customers will run hybrid cloud technologies - private cloud for their core applications onsite, and public cloud for their non-core applications. "There will be a few true system integrators that will work with these customers to build, provision and manage these environments. They will be highly skilled and highly services-enabled. The SME market will be dominated by cloud, and we will have a mix of local cloud providers and international cloud providers selling their services through a vast number of resellers to hundreds of thousands of small businesses. Some partners will choose to become service providers themselves to offer cloud services to their customers," he states.

Over the next 10 years, we can expect the distribution market to standardise across this current trend of services-focused business models, according to Hayward. "I also expect that resellers will form partnerships with the telcos and content players to on-sell services, content and infrastructure as part of an end-to-end solution. Enabling mobility and managing cloud environments will be the mass market in the next 10 years, in my opinion. There may be one or two niche players at that stage, who specialise in particularly technical and complicated areas, like security. The key to success will be building on the loyalty of the person, not the device, as hardware fragmentation is eroding the value proposition of IT service providers that specialise in supporting one type of IT environment," he notes.

"We are going to see a large amount of consolidation in the next 10 years, with the bigger global players and less so with the smaller players," Lynch believes. "It will not really be about what will channel markets look like in SA, but rather a broader global market. There will be more direct sales to consumers, less of a tiered structure, and a lot more products repositioned as services, as a pay-as-you-go or subscription service, and considerably less licensing."

Consolidation will continue to take place within the existing value chain, with an increasing return to 'vertically integrated' businesses, Swanepoel agrees. "In turn, this will drive further change in the traditional reseller and distributor landscape, with larger groupings continuing to emerge," he says.

According to Vukic, we should see a huge consolidation from a supplier perspective. "We should also see increased levels of specialisation, and more Web-only centric business emerging. I really believe that the resellers who are successful will be the ones who have adapted the best to offering software and services, and built a large technical team specialising in local and cloud-based solutions. I also think that the majority of resellers in the IT industry will never have to leave the office as their customers' IT health will be looked after and doctored remotely," he says.

Van Wyk thinks consolidation in the market is likely, because, 10 years from today, products won't exist as they do today - they will become a part of a solution. "As a result, we will see some channel businesses cease to exist. Those that succeed will be the ones that realise today that they need to figure out what their customers are looking for, take a hard look at what they're providing, and bring the two into alignment. At the moment, there is an enormous drive to reduce costs and outsource services, so channel companies need to be in tune with those requirements and provide what customers are looking for if they want to prosper," he concludes.