There's Strength In Numbers

As the slowing economy has forced technology buyers to cut costs, channel partners may be bracing for a difficult end to a disappointing

year. With lagging demand, falling production and downward price pressure in the product arena, solution providers are searching for ways to triumph over a lack of volume and the profitability problem it causes.

In an effort to assess the status of the prevailing solution- provider marketplace, and in the wake of terror, VARBusiness commissioned Reality Research & Consulting to conduct the 14th annual State of the Market (SOM) research survey of North American solution providers. Based on recent events, this year's study includes a set of pre- and post-Sept. 11 Internet-based interviews that offer insight into the ways current events are affecting solution providers' businesses today and shaping them for 2002.

A Market In Flux

As financial woes threaten the hardware sector, particularly PCs and Unix servers, solution providers are increasingly turning to consulting services to augment their revenue and income growth. According to VARBusiness' post-attack SOM research, following total or custom solutions (37 percent), nearly two in five solution providers (36 percent) expect to place more emphasis on consulting services next year, up 5 percentage points from pre-attack results. Typically, consulting services yield higher margins, and a consulting-focused business model can lend itself to lower overhead, both strong incentives for VARs to give the consulting model a closer look in the year to come.

Products including systems (22 percent), software (19 percent), network hardware (15 percent) and storage (7 percent) are expected to comprise a majority (63 percent) of solution providers' 2001 year-end revenue, while the remaining 37 percent is expected to come from services and consulting. Correspondingly, 40 percent of gross profits will likely be attributed to the service and consulting sector. And not surprisingly this year, since the Internet bubble has effectively burst, VARs' revenue will come from existing brick-and-mortar businesses more often than from Internet spin-offs.

As solution providers move into 2002, long-term relationships will be more critical than ever, and VARs will continue to rely on existing customers for the majority of their business. VARBusiness' SOM study indicates that a solution provider, on average, has worked with a typical client for approximately six years to date. According to the SOM research, 69 percent of the solution provider's total revenue will come from existing customers in 2001, climbing 6 percentage points since 1997. And more than half of solution- provider revenue (54 percent), in general, will be attributed to larger, rather than smaller, end users.

Effectively servicing the end customer sometimes requires a partnership between solution providers who would normally be competitors. Overcoming resource limitations this year, nearly two in three solution providers (64 percent) are accelerating their own outsourcing by partnering with other solution providers. Pre-Sept. 11, aside from resource limitations, the most popular reasons for partnering were to act as a subcontractor, to gain technical expertise and to work on larger-scale projects. But post-attack, expanding into new markets climbed 17 percentage points to 49 percent, becoming a top reason for partnering.

Meanwhile, solution providers look to add new products in troubled times. The majority of VARs queried expect to add new vendor product lines next year. In fact, since the attack on America, nearly three in five (57 percent) plans to add new vendor products, up 2 percentage points since Sept. 11. The top two reasons for adding new product lines, solution providers say, are to capitalize on state-of-the-art technology that is an extension of their own core competencies (71 percent) and to take advantage of strategic opportunities (68 percent).

What's In Store For 2002?

Before the terrorist attacks, when solution providers were asked to identify the top markets that present the greatest opportunity in the next three years, SOM data shows that more than one in five VARs cited health care (27 percent) and manufacturing (25 percent),traditional VAR mainstays,as their best options. After the attacks, banking and finance (21 percent) joined health care (29 percent) and manufacturing (23 percent) at the top of VARs' priority lists, followed closely by the federal government (19 percent).

After all, continuing to boost the bottom line is most solution providers' main concern,and rightly so,in 2001's down economy. Despite the absence of strong sales growth, solution providers' gross profit margins may have bucked the downward trend for two-thirds of the year, maintaining secure margins, due, in part, to the success of consulting services,which may also account for the rise in interest in the consulting model today. Nonetheless, post-attack, the average solution provider's gross profit margin estimate for 2001 slipped from 28 percent to 24 percent, its lowest rate in the past four years.

Gloom aside, solution providers seem to have a better financial outlook for 2002 than they had for the close of 2001. In fact, many expect their financial conditions to improve in the coming year. According to our research, while approximately half of the solution providers polled (48 percent) are expected to decrease their 2001 end-of-year business projections, more than two-thirds (69 percent) expect their financial projections for business in 2002 to remain the same or increase,good news at a time when it's needed most.

Estimates are more conservative when it comes to projecting end customers' IT budgets in 2002, however. A third (34 percent) of the solution providers polled since Sept. 11 say they expect their clients to decrease their IT spending in 2002; before the attacks, only 13 percent were predicting decreases in the next 12 months, a clear indicator that solution providers do think the current political turmoil has and will continue to affect their end customers for some time to come.

There is, however, in every dark cloud, a silver lining. The threat of future attacks is swaying many firms to increase their IT budgets for technologies such as security and disaster recovery regardless of the country's current economic woes. According to VARBusiness' SOM research, security (at 70 percent) has become the most popular technology deployed in customer solutions. Not surprisingly, security software is the top software deployment supported by VARs today, and SOM research shows that antivirus (90 percent) and firewall (86 percent) are currently the two most popular types of security applications. Other technologies emerging victorious for the latter part of 2001 and the beginning of 2002 include wireless, mobile computing and storage management. And while the dot-com craze may have ended, Web-based applications are expected to heat up as well.

Doubling its claim in the past year, wireless gained in popularity since Sept. 11. According to VARBusiness' 2002 SOM research, 57 percent of solution providers expect to deploy more wireless technologies in customer solutions during the next 12 months, up from 46 percent pre-attack. The most popular wireless applications currently being deployed by solution providers include access to e-mail (80 percent), access to the Internet (59 percent) and access to internal financial and operations information (46 percent), signifying the importance end users are placing on staying connected and informed.

But perhaps the biggest question on people's minds today is whether an economic recovery lies close at hand. The analyst community is divided on the answer. Some analysts are encouraged, citing up-and-coming technologies as reason to expect a relatively quick end to the current IT slowdown. Those less optimistic see few signs the economy will be back on track anytime soon. The best solution providers can do is continually reassess their business models, the technologies they sell and recommend, and the customers they do business with, keeping an eye on the future and a heavy hand on cost controls.

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