Despite a weakening economy, solution providers expect higher profits in the new year.
If the economy is about to take a dive, solution providers don't seem all that worried. Nearly three-fourths of channel companies polled in Ziff Davis Enterprise's Channel Outlook 2008 study said they anticipate higher profits in the next 12 months, and many expect to achieve that with new customers, a sharpened focus on solution sales and services, and increased business with existing customers.
Despite economic indicators pointing to a down-turn, including the ongoing mortgage crisis, it seems many solution providers are feeling immune to macroeconomic factors as they work to diversify their portfolios with a strong emphasis on sales and services offerings while de-emphasizing stand-alone product deals. The technologies of sharpened focus include things like security, application integration and mobility solutions, around which providers can wrap high-margin services.
The survey results point to the channel's overall efforts to emphasize value and specialization, said Bob Dutkowsky, CEO of distributor Tech Data. As solution providers find some level of economic security by seeking out higher-margin, higher-value specializations, they naturally feel better about business prospects, Dutkowsky said.
"Any time companies anticipate improved profitability, that is a good thing because that says they're focused on adding value rather than driving down prices," he said.
Such is the case with Greg Starr, owner of I.T. Works, in New Boston, Texas, who, despite some trepidation over possible spillover effects from the mortgage crisis, said he feels good about the coming year.
"We're moving more and more into managed-services recurring-fee contracts," Starr said. "The more we do that, the more profitable we are becoming. We're taking the business to the next level with the client."
Tiffani Bova, research director of IT Channel Programs, Sales and Alliances Worldwide at Gartner, called the focus on profitability, rather than top-line growth, a good sign. "If VARs are starting to look at real profitability, then it means we will have a healthier channel," Bova said. "It's good to see that they are tracking real profitability, adding in costs for time of sale, logistics, support and other services, and not just working from cost of buying to cost of selling."
Diane Krakora, president and CEO of analyst company Amazon Consulting, said the channel is an optimistic place in general. "It's not just the VARs who are optimistic," Krakora said. "The vendors are too. We are hearing nothing but great expectations as vendors increasingly look to investing in their partners and partner strategy." Staying profitable
Sixty-two percent of the 393 solution providers that participated in the Outlook 2008 survey said they expect increased profitability of at least 10 percent from 2007, and they are looking at a variety of ways to make that happen.
Acquiring new customers was cited by 54 percent of survey respondents as a profit-boosting strategy, followed distantly by increasing solution-based sales (24 percent), increased sales to existing customers (24 percent) and new and incremental services revenue (21 percent). Managed services came in at 17 percent, which is respectable for a still-emerging area.
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The emphasis on new customer acquisition makes sense, said Dan Schwab, vice president of marketing at D&H Distributing. Because the bulk of channel companies focuses on small and midsize clients, they are always recruiting customers among newly opened restaurants, doctors' offices, law firms or real estate offices, Schwab said.
According to the survey, small companies of 99 and fewer seats will make up 29 percent of expected revenue for solution providers, and medium companies, with 100 to 999 seats, 23 percent. In comparison, large customers are expected to produce 22 percent of revenue; government/education/public organizations, 15 percent; and consumers, 11 percent.
"The lifeblood of your business is always acquiring new customers," Schwab said.
Starr, of I.T. Works, agreed: "You have to have a constant new customer acquisition strategy in place." Starr, whose company has a strong focus on networking, telephony and mobility, said he gets many new customers from other solution providers who refer their clients to I.T. Works for that type of work. "We do a lot of partnering," he said.
The Outlook 2008 survey also found that most solution providers aren't focused on reducing costs or increasing markups. Many channel companies in recent years have worked to reduce costs and the poll seems to indicate VARs are mostly satisfied with their cost structures. Only one-fifth of solution providers said they will focus on lowering costs to boost profits.
Meanwhile, 14 percent said they intend to achieve profit growth through increased markups. Not surprisingly, this is not a popular strategy because of its inherent risks. "Increasing prices is simply a shortsighted fix to a long-term profitability problem," Bova of Gartner said. "Raising prices means that everything still revolves around price, and VARs are still thinking of their value and profitability based solely on price."
Instead, Bova said, solution providers should do business in smarter ways. "VARs need to streamline their back office, reduce their number of vendors, which will in return reduce the support costs and training costs, and start partnering with other VARs." Focus on marketing
Bova said identifying and selling to new customers should be a result of a change in behavior for VARs. "To get new customers, solution providers have to start marketing," she said. "They will have to raise awareness of their brands and invest in marketing personnel."
Even solution providers that employ someone part time have to handle the marketing coming in and out from vendors and distributors. "Strategy drives structure," Bova said. "Aspiring to get new customers is the right thing to aim for, but VARs will have to change their internal structures to do this to handle their messaging."
But according to the survey, only half of solution providers today rate their companies' marketing initiatives as very important to their 2008 business prospects.
Vendor-sponsored programs are considered very important by only three in 10, so clearly channel marketers are not relying on those programs alone. As the channel seeks new customers through a new service-oriented approach, marketing is not a major component in this effort.
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Whether they call it "marketing" or something else, though, solution providers are emphasizing numerous homegrown initiatives in 2008 instead of relying on vendors. Sixty-two percent cite their Web sites as a primary vehicle; 55 percent, customer-demand generation; 52 percent, e-mail; and 50 percent, lead generation.
Krakora said while it's important for vendors to drive marketing and leads, it is also vital for them to help solution providers drive their own. "Reseller marketing is currently lacking in capability," she said. But she added that vendors are starting to provide more than just marketing tools. Cisco Systems, for example, is offering actual resources to help execute marketing campaigns. Services first
Mike Novotny, president and CEO of InterTech Computer Products, said he is projecting 15 to 18 percent revenue and 20 percent net income growth as his company continues to put more energy into expanding its services business, now at 40 percent of overall revenue.
"Our real net new customer growth is coming as a result of leading with professional services, with managed services being part of our professional services portfolio," Novotny said. Managed services make up about half of the company's overall services, he added.
But not everyone in the channel has figured out the managed services opportunity. Many VARs remain reactionary, rather than proactive, about services, Bova said.
"Whether VARs are delivering real managed services, such as remote monitoring and patch management, outside of their traditional break/fix contracts, is still a question," she said.
Krakora said managed services can be tough for channel players to get into because of the change in business model, supporting SLAs, and lack of customer readiness to accept the model. "Managed services is an opportunity to increase profitability, but 2008 is likely to still be a transition year," she said.
Ian Cook, CEO of solution provider Logicalis, said it is challenging for VARs to achieve the right mix of managed services with their traditional business model. However, he added that the U.S payroll is the lowest it has been since 2004, so managed services is there because VARs are managing IT systems without companies having to employ staff. "As the complexity of IT infrastructures increases, companies are saying more and more that they need someone to come in and look after it on their behalf," Cook said.
In addition to the focus on services, some providers may also be planning to add customers as a result of mergers and acquisitions. According to Outlook 2008, one in six channel companies are likely to be acquiring another business in the coming year, with 62 percent of those expecting to acquire saying that new customers are the first priority for acquisitions. Other objectives were adding new products and technical capabilities, expanding geographic reach, and improving existing services. Logicalis is one of the companies that has publicly stated its intentions to grow through acquisitions next year.
But Cook saw imbalance with this approach, saying that finding new customers through acquisition works only if the acquiring solution provider has something to offer the customers. "If you do have something to offer the customers, then why not just approach that customer anyway," he said. "Acquisitions should be done really to gain new areas of expertise and new skills sets, so long as you can hang onto the staff." Furthermore, Krakora said there should be three primary reasons for buying a company.
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"Talent is the No. 1 reason," she said. "Second is the methodology or product sets and third is the customer base."
Krakora said providers should not assume customers will remain with an acquired company. Acquisitions can often inspire them to look around or attempt to change their contracts, she said. Customers often worry if the management changes, and technology changes can make them nervous, opening them up to exploring other options.
Keith Blake, president of Timpanogos Technologies had another take on the challenges with an acquisition strategy. "Consolidation is a trend that will continue, but there will always be a place for the smaller companies who drive innovation," Blake said.
"Larger companies will acquire for customer sets and they do have increased efficiencies, but they cannot drive innovation like a smaller company."
Blake said his company is happy being a small software development business working in the education space, growing steadily and being a place where employees feel valued, something bigger companies also find hard, he said. Getting credit
Despite some worries in recent months that the mortgage crisis would prompt lending institutions to tighten credit not only in the housing market but also in other areas, the Outlook 2008 survey indicated that many solution providers are relatively confident about credit availability.
Thirty-two percent said credit availability is better than a year earlier, and 47 percent said it was better than three years earlier. Looking forward, 44 percent said they expect credit access to be better in one year, and 50 percent said it would be so in three years.
Asked about credit sources, 52 percent named local banks; 26 percent, national finance companies; 24 percent, vendors; and 19 percent, distributors.
Dutkowsky speculated the lack of credit worry may be because many of the respondents hadn't quite processed the potential ramifications of the mortgage crisis.
"That was the one issue in the survey that really caught my attention," he said.
Tech Data, he said, will continue to provide credit to its solution providers and has no plans to pull back. The same goes for Ingram Micro, said Keith Bradley, president of the distributor's North America operations, who added that his company has consultants in the field working closely with solution providers, assessing their business and doing analyses on cash flow, rather than just relying on spreadsheets to make credit decisions.
Confident in that information, Ingram Micro expects no changes in how much credit it extends, Bradley said.
However, VARs are still feeling the pinch, according to Timpanogos Technologies' Blake. "Credit is an issue and we are all feeling some strain from that," he said. "If we want to expand, we need capital to do that, and investors are nervous right now. We have looked at the equity market, which I think will open up more, but there is always risk in equity and companies will have to prove they have a good business track record if they want to get capital or investment." Tempered optimism
That said, overall channel optimism about 2008 is in line with what Bradley said he is seeing in the IT channel. Channel members may still have stars in their eyes, however, from the opportunities and gross margins represented by new services revenue. Bradley cautioned that it will be harder to make money in 2008 than it has been in the past, as solution providers focus more on higher-margin deals with longer sales cycles.
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Customers that have spent money in recent years for technology refreshes will be doing less of that, so the onus will be on channel companies to pitch services and solutions combining different technologies. "It's a different sales process; it's a longer sales process," Bradley said.
Still, those channel companies that have laid a foundation to pursue higher-margin, higher-value business have stronger prospects of increased profitability. "You should be in a position to go mine all that foundational work you've done in the last couple of years," Bradley said.
D&H's Schwab said the channel's economic health depends largely on small and midsize businesses, which are likely to continue spending on technology. "There's still some optimism, especially in the SMB space, even though the economy is weak," he said.
Solution providers, however, say they have started to feel some pull-back among customers on capital expenses, which means a lot of product sales could be delayed as budgets tighten. Starr, for one, has been pushing his staff to close as many product deals as possible in anticipation of slower product sales.
Nevertheless, Starr said he felt more optimistic about sales prospects after President George W. Bush signed a mortgage relief bill to help some homeowners refinance the terms of their loans to prevent foreclosures. Starr has already seen some effects of the mortgage crisis with some of his clients in the financial sector.
Curiously, in the Outlook 2008 survey, financial services remains one of the key markets of focus for the channel. Thirty-one percent of respondents identified it as a currently significant vertical; but more importantly, going into 2008, 59 percent more respondents see increased focus than see decreased focus on the financial sector.
However, Cook of Logicalis, said he believes the financial services market will have tight budgets next year. "We will still be feeling the effects of the credit crunch, banks will be tightening their belts and vendors will start to feel this too," he said. But other market verticals are likely to grow, he said.
The research found the highest growth area will be professional services (like doctors, lawyer and architects), with 38 percent of respondents expecting increased focus in 2008; followed by IT/telecom, electronics and computers, at 32 percent; government, at 31 percent; and health care, at 30 percent.
But concern about the mortgage situation is evident in the planned decrease of emphasis on the construction vertical, where 21 percent of respondents expect a decrease in focus. Other areas of planned decreased focus include utilities, consumer packaged goods, chemical/mining and travel and leisure.
Still, with solution providers forecasting profit growth of nearly 30 percent on average, the positives are definitely outweighing the negatives as far as the outlook for 2008.
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