Many business owners today are fooling themselves. Frustrated with feeble returns on product sales, they have embraced the popular notion that augmenting their product sales with services alone will produce greater profits. Sadly, though, many have overlooked the hidden costs and unimagined burdens that accompany such a move. Rather than enjoying riches, far too many are enduring hardships never before imagined.
"I'm not aware of any of the large resellers in the country that are doing services well," says Ken Wasmer, president of Wasmer Business Solutions. A professional business consultant based in Alexandria, Va., Wasmer has consulted with more than 400 resellers in 13 years. What he has discovered is startling: Rather than saving many reseller companies, service business units are actually killing them.
"Contrary to what you see out there in reseller trade magazines, services are not profitable the way the average reseller runs its services department," Wasmer says.
He points to the case of Inacom as a perfect example of what can go wrong when a reseller tries to save a failing product business with service sales. The once $1 billion Omaha, Neb.-based company filed for Chapter 11 bankruptcy after poor operating results caused a severe cash shortage. Contrary to popular belief, its service sales--not its product sales--doomed the company, says Wasmer, who adds that, ironically, only the product sales arm survived the collapse of the company.
"The real problem right now is that the Inacom model is so pervasive within the reseller community because it was seen as the future model," Wasmer says. "But it doesn't work."
Taking steps to avoid these and other mistakes is paying dividends. Netforce Technologies, Austin, Texas, for example, completely replaced its sales team when it made the transition to service sales from product sales. Doing so meant saying goodbye to many longtime friends and associates. But it saved the company's business, says president and founder Tommy Wald.
Founded in 1993, Netforce Technologies once made 20-point to 30-point margins on products. Those margins accounted for 90 percent of its revenue. Not anymore. This year, product sales will account for no more than 60 percent of total sales. The remaining balance of services will comprise consulting, storage, thin-client and wireless solutions.
Not until Wald turned over his sales team did his services business begin to perform as hoped. Although the new team he brought in afterward was less experienced, it executed better.
"It was a very painful transition," recalls Wald, but well worth the effort. Netforce's revenue more than doubled from $5.6 million in 1999 to $11.6 million last year.
Other resellers, however, have struggled. Many haven't grasped the economic ramifications associated with making the transition from a product-centric business to a services-centric one. It's a completely different business model, experts say.
"You're looking at having a bigger company, and you have to put in different organizational structures," explains Henry Haddad, founder of VARometer, a research publication that focuses on computer resellers and integrators. According to Haddad, product companies often generate as much as $1 million in sales per employee. Services companies, however, rarely generate that much revenue per employee. Typically, service-oriented companies top out around $200,000 per employee.
Despite the disparity, more reseller organizations are looking to augment their product sales with service sales. And who could blame them? After all, the North American IT services market is projected to grow to $712 billion in 2005 from $345 billion in 2000, according to Dataquest. That growth, obviously, is much greater than the growth predicted for product sales.
The average service-centric solution provider expects to see a 46 percent compound annual growth rate from 1999 through 2001, according to a December 2000 report by Manhasset, N.Y.-based Reality Research & Consulting. Most notable among these service-centric solution providers are those that sell to enterprise customers. Those solution-provider organizations are typically much larger.
Despite the opportunities, many resellers are kicking themselves for entering the services game unprepared. Looking back, Wald says there are several things he would have done differently. If he had the chance to do things over, he would have focused earlier on industry-specific vertical solutions in banking and health care. He would also have developed a better consulting/sales force and hired more technicians with sales expertise.
He's hardly alone. Other solution providers continue to struggle with recruiting and training costs, or are stymied with utilization rates. Gia McNutt, president and CEO at Special Order Systems, says most resellers lose their shirts in services because of a lack of understanding of all the intricacies in the business.
"Most of us have been product people in the past and we try to make services a product," she says. "We set it up as a fixed cost of goods, and that's just wrong."
Many of her colleagues, she adds, have an unrealistic view when it comes to utilization. For example, the utilization rate for engineers can never be 100 percent because they take vacations as well as sick time off.
Of the mistakes VARs make, however, it's poor billing rates that upend the most, she says. Failure to align service rates and employee salaries can kill a company. "You have to charge somebody three times what the person costs you to be profitable," McNutt says. "Hardly anybody understands that."
McNutt's service revenue was nowhere near three times her monthly service department costs. So she contacted Wasmer, who set her straight about the simple economics of running a service business.
What a difference the advice made. Revenue for the company was $13 million in 2000, up from $8 million in 1999, thanks to several large government projects. Ironically, McNutt co-founded Special Order Systems in 1992 with intentions of becoming services-centric. Despite this, Special Order Systems remains a product-centric company, with 85 percent of its sales coming from hardware and software reselling. Only after consulting with Wasmer two years ago did McNutt's company begin to see profitability.
Others who have benefitted from a careful transition of product sales to service sales include Sequoia NET.com CEO John Bamberger, who founded the company in 1990 as a Unisys reseller with $50,000 of his own money and another $50,000 from employees. Later, he entered the PC market. Revenue then was roughly $700,000. Today, revenue is nearly $70 million, largely due to services.
Sometime in 1996, Bamberger began to transition the company, which had an 80 percent hardware mix and a 20 percent services mix, from a product-centric company to a services-centric company. Just one year later, the hardware mix dropped to 42 percent, while revenue remained steady between $29 million and $30 million throughout that transition. By 1999, Sequoia's services mix soared to 85 percent.
Bamberger made the decision to change his business, which today focuses on network-infrastructure services, for simple economic reasons. "I couldn't afford to sell a million dollars in hardware to make 2 percent, then not have a company pay me for 60 days," he says.
One thing Bamberger did to make the transition run smoother was adjust the compensation of his salespeople. Initially, that was tough, because his sales professionals found it difficult to meet sales expectations without product sales bolstering their top-line contributions. Once they found out how profitable service sales could be, however, they came around to the new way of doing business. Alas, one issue remains: You've got to make a lot of calls to rack up substantial service sales. And for Sequoia, which employs 140 people in sales and some 5,000 consultants throughout the United States, that's a lot of persistence that needs to be harnessed week-in and week-out.
One company that has harnessed its potential, analysts say, is Pomeroy Computer Resources, one of many resellers that has tried shifting to a services-centric company. One way that has been accomplished is through acquisitions, says CFO Dino Lucarelli. The high-end systems network solution provider has made more than 15 acquisitions in recent years, including Memphis, Tenn.-based Access Technologies in December 1998.
"We believe it is strategically appropriate to buy those skills because you will already have a resonant customer base and a center of excellence, so to speak, in those particular technologies," Lucarelli says.
With revenue of $925 million in 2000, Pomeroy still provides its customers standard hardware reseller services such as break-fix, while migrating toward network integration services by handling products from Cisco, Oracle and Sun.
Although considered low-end, break-fix services still remain a standby for many. "Break-fix is still profitable for us and will continue to be a core service that we're going to provide for our customers always, but we are evolving into the higher-level services as well," says Jeff Sopp, CEO of Sarcom, whose company had revenue of slightly more than $600 million in 2000.
Although he won't discuss what kind of profit margins Sarcom receives on break-fix services, Sopp says it's Sarcom's methodology and project management that differentiate his company. Sarcom's customer satisfaction program, which began in 1987, helps achieve that goal, he adds.
"We've been recognized nationally and worldwide for our program," Sopp says. "We've really kept to the tenets of our program, and...that's one of the main staying powers and sustainable reasons we continue to grow revenue in services."
That and meager returns on product reselling.