At Your Service

Guess again. Unisys is enjoying more than a modest recovery. Let's call it semirobust. Its shares have recently traded around $15, right at their 52-week high, while sales and earnings have improved. In the third quarter, revenue grew 9 percent to $1.45 billion, while earnings totaled $56.2 million.

So how is it that an IT giant that fell on hard times rebuilt its business so well? Simple. By being selective in the opportunities it pursues and by concentrating on services, says chairman, president and CEO Lawrence Weinbach.

"I was particularly pleased with the performance of our services business, where revenue grew 12 percent in the second quarter, and where we have made good progress in our three key priority areas of outsourcing, consulting and systems integration, and security services," Weinbach said in a recent statement.

Not only is Unisys' outsourcing business delivering double-digit growth, the company is also seeing growth in its consulting and systems integration, as well as enterprise security solutions businesses. And while Unisys continues to produce products--it recently unveiled a new suite of identity-management solutions for Microsoft Windows-based environments and new members of its high-end ES7000 server family that feature Intel's new 64-bit Itanium 2 processors--initiatives such as its recently unveiled Business Blueprinting, which helps customers create digital blueprints for their organizations, are driving sales and attracting new customers, including the U.S. Department of Homeland Security.

The Unisys success story is but one example of how integrators, both big and small, are depending on services more than ever to goose their sales, according to VARBusiness' 2004 State of the Market research. Services, in fact, now account for more than 40 percent of the typical solution provider's business and are an increasingly important part of the mix across small, midsize and large VARs. However, smaller VARs--those with annual sales of less than $1 million--tell us that services revenue now accounts for 56 percent of all sales. That's up an astonishing 10 percentage points from a year ago.

Similarly, but less dramatic, is the services uptick among midsize VARs. Services sales as a percent of revenue climbed to 46 percent this year from 42 percent last year among those companies that generate annual sales between $1 million and $10 million.

And large integrators, while least dependent on services revenue among all VARs, still make certain to offer services as a value-add (44 percent of their sales) and, as important, a way to distinguish themselves in a market moving toward commodity pricing. Take Los Angeles-based Dynamic Systems, No. 390 on the 2003 VARBusiness 500. President Mardi Norman has seen a surge in the number of companies targeting her core market--the federal government, widely seen as more stable than the corporate sector with low-ball prices on equipment. But she's not too concerned. That's because with her extensive background in government accounts, she can focus her company on what customers need most: cost-effective maintenance services, she says. So while she still resells products by the boatload, those sales are not as strategic for the company's well-being as they once were.

"The turn for Dynamic Systems, and where our business leads, is in maintenance services and extended warranties," Norman told VARBusiness.

The motivations for turning to services are well-documented by now. Shrinking margins of hardware and software products have made profitable product reselling next to impossible for all but the highest volume-producing and most efficient reselling operations, such as CDW and Insight. But even in the case of the latter, the company is looking to expand its portfolio of managed services, financing options and other services offerings, says Insight North America president Dino Farfante. And VARs of all sizes know that services offer a better opportunity for repeat and add-on sales, and that they generally provide better profit margins.

According to our research, sales from services accounts for at least half of the average VAR's gross profits today. In comparison, software accounts for nearly one-fourth of gross profits, while hardware represents nearly one-fifth of a VAR's gross profits. Interestingly, services account for a higher proportion of gross profits for small firms than for midsize or large firms. For small VARs, services account for nearly two-thirds (63 percent) of gross profits, according to our study. That helps explain why gross-profit margins for small solution providers were higher than those for midsize and large enterprise companies, 32 percent compared with 25 percent and 26 percent, respectively.

Alas, the not-so-good news regarding services is that everybody already knows the good news. With so many companies concentrating more on services, it's no wonder competition has increased and margins have come under pressure. At Unisys, for example, operating margins for services declined 0.3 percentage points from a year ago in the second quarter to 5.5 percent.

Pressure on these margins is not only coming from local sources, but in many cases, from offshore providers as well. India-based Infosys, for example, reports that price competition for its national business, which is later delivered to American and other global customers, has driven down labor rates by as much as 20 percent in recent quarters. It seems China and other low-cost markets are doing to India what India did to the United States,it drove labor rates through the floor and made it more difficult for service providers to charge customers enough to produce profits.

Fortunately, that most likely doesn't affect small U.S. providers. Experts and executives, including Microsoft CEO Steve Ballmer, say they expect mostly larger providers that cater to global-enterprise clients to be impacted by low-cost, offshore labor rates. Small providers that work one-on-one with customers aren't likely to be upended by the phenomenon, Ballmer told VARBusiness.