The channel: Suckers for punishment

The IT reseller channel has long been a strange beast. King(s) of the hill are a few large and fairly successful service-oriented companies - the Dimension Datas, Datatecs and Comparexes of this world. But the average reseller is one of a staggering multitude of small-business operations, that has been under stiff competitive pressure even while vendors have been raking in profits and investors have been sending their stocks through the stratosphere in the process.

"Staggering multitude" is no over-statement either. Vendor estimates hover around a figure of 6 000 active resellers in SA. Some say 4 000, some say 9 000. Either way, the market isn`t consolidating.

This means there is one reseller for every 7 000 people - men, women and children - in the country. Apply some thumb-suck percentages of the likely number of corporate and individual buyers of IT among these 7 000, and one realises why not everyone who sells IT is staggeringly rich.

With the return of sanity to the technology markets comes the realisation of over-enthusiastic corporate IT spending, and the consequent pressure of spending slowdowns. While ITWeb has been unable to obtain accurate local figures, US estimates of the slowdown are deeply worrying.

Reporting on US first quarter GDP figures, the Economist, in its issue of 5 May 2001, states: "Investment in IT equipment and software fell at an annual rate of 6.5% in real terms. In nominal terms, IT spending plunged by 13%, because prices of computers and the like fell sharply. That was the first decline in hi-tech spending for a decade."

It also quotes a study by Credit Suisse First Boston, which says American firms overspent on IT by $190 billion in the last two years. The bank reckons that IT investment needs to fall by an average of 16% in volume terms this year and next to eliminate that overhang.

In a market where gross margins often dip low into single figures, this is the stuff insomnia is made of. But then, many dealers have been suckers for punishment for years. Despite vocal calls for the need to add value, and the need to sell services for which consulting rates can be charged, many resellers still eke out a living selling product at 5% gross margin.

Says Anton Jacobsz, Microsoft`s recently appointed channel manager: "There is still a huge breadth of smaller dealers in the channel. There is a perception that IT is a good business to be in, but many don`t understand the challenges."

Alex Harper, distribution manager at imaging and copying hardware vendor Minolta, says that instead of improving, value-add has gotten worse in the last five years.

"The channel is its own worst enemy," says Darryl Brick, Hewlett-Packard`s GM for channels, partners and alliances. "They are short on focus. They need to sell solutions where they can add value, and they need to know what their business is. Too many resellers are still trying to be all things to all people."

This tendency means that all resellers compete with all others on the lowest common denominator: price. Few have real strategic differentiators, even though any strategy text book will point out that the first step in building a successful business is identifying and developing one aspect of a business that you can do better than anyone else.

Jacobsz agrees. "Our partners have to position on focus, because margin isn`t enough. Generating service-based sales is very important."

"There is still a disease of box-moving in the channel," laments Brick. "We need to get the channel to understand solutions. Selling a box must be a consequence of the solution."

Maintaining multiple vendor relationships costs the channel a fortune.

Darryl Brick, GM, channels, partners and alliances, HP

He believes that while many resellers shop around on price in an attempt to offer competitive deals to their customers and perhaps add a point or two of margin to the deal, they aren`t concentrating on the total cost of doing business.

"Many resellers still have multiple vendors in a single solution," says Brick. "This might bring down the total price of the package, but it costs money to maintain vendor relationships. It requires higher investment in training, the cost of credit is higher - it costs the channel a fortune. Yet, we`re not seeing a rationalisation of vendor relationships."

Some vendors have made fundamental changes in their approach to the channel - not only to enhance their own profitability, but also to nurture a loyal channel with higher margins and repeat revenue streams.

Pete Whalley, MD of Brilliant Business Systems, an accounting software vendor, recalls vividly the day in 1997 when his company introduced what amounts to a subscription model for its product.

"We got clapped in 1997 for going to a service model, and for two years, things were quite rocky," he relates. "But with hindsight, it was the best thing to do."

In the 10 years leading up to 1997, accounting software vendors were growing on the back of increasing office automation. Companies were computerising their paper-based accounting systems. However, this source of growth has largely dried up.

"Now," Whalley says, "under 20% of companies upgrade their accounting software. All accounting software vendors face this problem. The consequences are that revenue for vendors and their channel partners is hard to come by, and that new version development doesn`t pay off."

Brilliant has created a model whereby its customers pay an annual fee for the use of its software. If the sale was generated through a "value-added service provider", a rebate over three years, amounting to 20% of the subscription fee per year, is paid back to the reseller. This model has been extended over a further three years, at 15% of revenue per year, and the goal is to move - within a year or so - to a permanent "insurance" model for resellers.

The model has several advantages, in addition to guaranteeing a rather more generous margin than is usual for moving boxes.

Although Brilliant does still sell 50% of its product direct, it does so at a fixed retail price, which avoids undercutting its channel. "We have to balance the costs. It is cheaper to sell direct over 60 days, but over the longer term, the costs appear. We`d prefer to focus on development and our call centre, and let the channel handle service and support."

This model, according to Whalley, forces its channel to add value, bill consulting rates, and sell services such as reporting, stationery fulfilment and training. At the same time, it creates a three-way communication channel between Brilliant`s relationship manager, its channel, and the end-users, facilitating levels of CRM that are often difficult when the channel completely shields vendors from the end-users.

Larger dealers quote with the benefit of free delivery, training, better dealer pricing - everything favours them.

Alex Harper, distribution manager, Minolta

Minolta has a different approach to the same problem. "The printer industry is a typical box-moving environment," explains Harper. "The trouble is that the low margin on a box gets wiped out the first time a printer comes in for repair. In addition, larger dealers quote with the benefit of free delivery, training, better dealer pricing - everything favours larger dealers. So smaller dealers simply can`t compete on margin."

Harper`s solution is to reinvest some of Minolta`s own margin into establishing service centres in the major centres to back up its dealer channels. In addition, it offers product training "to any dealer who wants it, for free, on-site, as often as they like".

He says: "Competitors tend to neglect smaller dealers. We want to provide for all dealers, whether or not they have infrastructure for service, or can afford to employ certified staff. This is ideal for new black empowerment entrants, for example."

The model trades operating margins for volume. "Once people are used to our service," Harper adds, "customers will become more loyal, and we raise the barriers to competition."

One or two mistakes, and news spreads. It`s a small market.

Anton Jacobsz, channel manager, Microsoft SA

This model also goes a long way to addressing another challenge resellers face. According to Microsoft`s Jacobsz, who himself spent several years in the channel, being able to open their doors the next day, and being seen as reliable, is what keeps resellers up at night. "One or two mistakes, and news spreads. It`s a small market."

His company likewise has embarked on a programme to "reinvigorate our partner asset base to drive market share".

As part of a communications package it calls an "action pack", the company offers "partner guides", which defines how Microsoft sees partner opportunities. The aim is to develop a channel of varied partners that can command a premium because of their specialisation.

"For example," he says, "some resellers may be good at supplying 50 boxes in three days. Others have software implementation skills. Smaller dealers have the upper hand on agility."

As if resellers don`t have enough other issues on their plates, a crunch seems to loom on the horizon.

Profitability remains a challenge. Especially small resellers who turn over small volumes, find that overheads and unexpected costs loom larger than they would perhaps wish.

The absence of working capital is now acute.

Darryl Brick, GM, channels, partners and alliances, HP

Investment in skills can significantly enhance reseller revenues. It enables them to offer high-margin services such as consulting, implementation and custom software development. However, skills are expensive, and it often proves hard and costly to retain skilled people.

Competition with retail outlets can also make life difficult. For example, resellers often pay the same for consumables as corporate end-users pay through retail. This makes consumables unviable as a revenue stream. Some vendors have put checks in place to deal with this problem and develop a loyal consumables channel. But the purchasing clout of retailers remains a bugbear for smaller dealers.

Retaining customers is another challenge that keeps resellers troubled. Customer relationship management is easy with few customers, but few customers is a recipe for wildly varying revenues from month to month. In addition, there are no more sacred accounts, so tying up key accounts is a bigger challenge than ever. The technology required to not only manage but create loyalty among a large number of customers can quickly become prohibitively expensive.

Currency fluctuations can be a killer too. The initial, unexpected slump from the good old days of R3.65 to the dollar burnt many, and most vendors and distributors are investing in certain levels of forward cover. But this remains expensive, and sudden rises in the cost of imports can easily wrong-foot resellers in their dealings with customers.

The channel will remain a battlefield for some time to come, but HP`s Brick believes that a long-predicted shakeout is now closer than ever.

"The economy is playing a role in a lack of working capital, especially among distributors. This affects payment terms to resellers. Banks are pretty much closed for business to the IT channel, so the absence of working capital is now acute. There will be a significant channel washout in the next 12 to 18 months," is his ominous prediction.