Closing The Gap On Partner Profitability

is the ongoing disparity that exists between what vendors typically get for a sale of a product and what their downstream partners receive.

That's a topic that comes up whenever the disparity grows and a great divide exists. In some cases, it does today. Take Microsoft, for example, the software behemoth that has so much cash that it literally is handing back money to shareholders in the form of a record dividend. For the year ending June 30, 2004, Microsoft recorded record revenue of $36.8 billion and profits of $8.2 billion. That means for every dollar in sales Microsoft amassed, it generated 22 cents in profit.

Compare that to some of Microsoft's best partners, and you'll see an obvious disparity between what Microsoft generates in profits and what its best partners generate. Case in point: Quest Software, which, among other things, was singled out at Microsoft's Velocity partner event in Toronto for its application-management solutions and was named Global ISV Partner of the Year for 2004. Last year, Quest's sales climbed 19 percent to $304.3 million, while profits more than doubled to $21.5 million. Not bad? Of course not. But not exactly Microsoftesque, either. For every dollar of revenue Quest generated, it amassed only 7 cents in profits.

It's not an anomaly, either. Consider another Microsoft partner of the year, nCipher. In fiscal 2003, the company's revenue climbed 9 percent to 13 million pounds ($23.4 million). But profitability was out of reach as the company lost more than 800,000 pounds ($618,263).

On more than one occasion, I have mentioned this disparity to the CEOs of some of the largest industry companies, who are concerned about the profitability of their solution providers"a.k.a. their extended sales forces. That includes Microsoft CEO Steve Ballmer. When I asked Ballmer about the disparity this summer at his partner event, he had this to say on the issue: "We're in different businesses. We need a healthy, profitable partner channel, but it's not like we can substitute one for the other. The fact is, they are independent businesses with independent economics. If we cut our prices 3 percent or 5 percent, it would have a monumental profit impact on us, but at the same time I don't think it would benefit our partners an iota because they still compete on a different basis."

He's right, of course. But it is, nonetheless, interesting to compare the economics of vendor companies that depend heavily on channel companies with those of channel companies that depend heavily on vendors. Now, I'm not trying to single out Microsoft, which, in fact, along with Cisco has some of the more sophisticated ways of recognizing and rewarding partners. Microsoft, after all, could dig up more than a few partners that are making more money per revenue dollar than it is. But more often than not, IT vendors are making more money than their downstream solution-provider partners.

It's that way in many fields, too. Ballmer, for one, points out that that's the case in the health-care industry. "Pharmaceutical companies have higher margins than the health-care delivery systems," he notes. "It doesn't matter what you do with pharmaceutical prices"that fundamental fact is not going to change."

Maybe, maybe not. There are those who believe that the disparity is eroding and that the pendulum could actually be swinging the way of the solution-provider community. Denver-based circa65, a market consultancy that helps vendors, solution providers and others more effectively take their products to market, tracks this sort of thing. President Ryan Morris says that downstream business partners make more in profits than upstream manufacturers and allies in several, more mature industries. Case in point: automobiles.

For the past decade or more, many car-dealer auto groups have posted bigger profits proportionately than upstream car makers and/or car-parts manufacturers. This wasn't always the case, and it didn't come about until after much change. But after decades of consolidation brought on by mergers and acquisitions, not to mention changing customer buying habits, surviving downstream partners have found their way to sustainable profitability. Will it happen in IT? Let me know what you think: tcdoyle@cmp.com.