Channel 2.0

Businesses operate quarter to quarter. They measure their progress toward goals and the success of their plans by quarterly performance.

Businesses plan annually. They set strategic objectives on a year-to-year basis and measure the success and growth of their business on year-over-year top- and bottom-line revenue.

Strategic thinking is often limited to 18 months--two years on the outside. Oftentimes, businesses are trapped in a short-term view of the world; they don't look far over the horizon to see what's coming next.

Five years ago, aside from a few visionaries, who could have predicted eroding hardware margins, conflicting software-delivery models and the ubiquity of services in the channel? Who could have predicted the emergence of vertical and technology specialization? Who could have foreseen the conflict between vendors and solution providers in delivering subscription software and managed services? And who would have thought that channel hybrids--distributors taking on solution providers, solution providers starting channel programs and direct marketers/retailers driving up the channels stack? [Click here for a five-year retrospective look at channel demographics.]

Channel 2.0--a yearlong initiative launched by VARBusiness this month--aims to define the channel of the future. A working group of vendors, solution providers, distributors, end users and market analysts will spend the next year divining the form, function and operating environment of the channel in 2013. How will vendors structure their channel programs? How will solution providers structure their businesses? What role will distributors serve? Who will control the relationships with end users? And what will support--presales, postsales, technical and marketing--mean to solution providers and vendors?

Channel 2.0 will answer these and many more questions over the course of its deliberation. VARBusiness will publish progress reports on the group's work and, this time next year, will produce the Channel 2.0 blueprint: a guide to the channel of the future, which will serve as a road map for success for all who touch the channel. To start this project,VARBusiness reached out to channel leaders with two simple questions: What would you want to know about the channel in 2013 and what do you think the channel will look like in five years?

NEXT: Brand and customer ownership

The rise of managed services in the channel is raising new questions about the relationship between vendors and solution providers. Specifically, whose brand should hold precedence in the marketplace and, by consequence, who owns the relationship with the end-user customer?

Many predict a shift in the balance of power in the channel, whereby VARs will build brand awareness among their customers and have the ability to dictate terms to vendors on how they conduct business. What could drive that shift in power is the sale of end-to-end solutions.

"The ownership of the customer is moving to who owns the greater amount of the solutions," says Stan Jaworski (left), vice president of channel marketing at Network Appliance.

Before joining NetApp, Jaworski ran channel marketing at Symbol. When Symbol introduced bar code scanning to the retail market, he witnessed a shift in the balance of power between the retailers and manufacturers. In the old world, manufacturers could dictate terms on inventory, sale prices and marketing. They could do that because consumers bought their brands--Kodak, Kraft and Coke. Today, consumers buy retailer brands--Wal-Mart, Target and Macy's. Retailers have so much information about their customers that they can dictate terms to their manufacturers.

"As the retailer collected more information on the customers, the power shifted from the goods-makers to the retailers. Product was controlled by the manufacturer, but the brand shifted to the retailer," Jaworski says. "The same thing will happen in the channel. Enablement of the solution provider isn't about entrapment in vendor channel programs; it's about making the solution provider more independent so they can sell best-of-breed products."

Many solution providers trade on the power of the vendor partner's brand. Solution-provider marketing materials trumpet vendor relationships, proudly declaring that a VAR is a certified Cisco Systems partner, Microsoft Gold partner or authorized Hewlett-Packard reseller. However, the rise of managed services is giving more power to solution providers, since they're the ones delivering the service. As VARBusiness reported last summer, many solution providers turned managed service providers say that their brand is more important than their vendors', since the technology is interchangeable on the back end. What's important, they say, is how they deliver the service to their customers.

"If we can assist our clients in achieving their goals, they're happy to pay us, and they buy the Alvaka brand," Oli Thordarson, CEO of Alvaka Networks, told VARBusiness last summer. "There are certainly underlying technologies that come from valued and important manufacturers, but that's all under the hood or behind the curtain--our clients don't ever want or care to see (the branded technology)."

Vendor brands may not disappear or become unimportant to solution providers in the next five years. Vendors will continue to market themselves and build brand affinity in the marketplace, particularly for their direct relationships. Should solution-provider brand affinity rise with their customers, they could hold more power to dictate terms to their vendors.

NEXT: Channel going global

In his book "The World Is Flat," Thomas Friedman describes how technology has leveled the competitive playing field between first- and third-world countries. Outsourcing to India and China, product sourcing through Southeast Asia, and the emergence of Russia and former Soviet satellites as development centers are evidence of world flattening.

A flat world works in both directions. American technology vendors see tremendous growth potential in emerging markets--China, India, Russia, Brazil and Eastern Europe. To reach them, they need the solution providers--native and U.S.-based--to capitalize on these potentially rich markets.

"We're looking at the world in an opportunistic fashion. The view of the world is fast-growing opportunities in fast-growing markets," says Lori Cook, vice president of worldwide services channels and emerging growth at BMC Software. "We want solution providers who can help us gain access and opportunities in these dynamic new environments because they're faster moving and less risk-adverse than we are."

Globalization may force solution providers to rethink their growth strategies and target markets. A VARBusiness globalization survey conducted last spring found that 18 percent of U.S. solution providers are doing business internationally, the majority in Western Europe. At the time, 54 percent said they had no plans to expand internationally, but that may change over time.

For instance, IBM is investing heavily in pairing partners across its different international regions to build solutions and facilitate growth. And an increasing number of solution providers are establishing development offices overseas to cut costs. Perficient (VARBusiness 500 No. 233) acquired a custom software lab in Macedonia that employs 50 engineers and will grow to more than 150 over the next 12 to 18 months.

"To do offshoring right, you have to have a scale that provides full end-to-end solutions," says Jack McDonald, Perficient's chairman and CEO.

And some international growth will be driven by distribution. Over the past several years, the major distributors have seen tremendous organic and acquisition growth in overseas markets. As distributors expand in Asia-Pacific, Europe and the Middle East, they'll bring VARs with them.

"The bigger value-added distributors are becoming bigger and starting to reach out into the global community, and we're seeing the same things with the VARs," says Doug Kennedy, Oracle's vice president of worldwide alliances and channels.

NEXT: End of the middle class?

By many estimates, there are well in excess of 100,000 channel companies in North America. The top 1 percent comprise the VARBusiness 500, solution providers that generate between $20 million (No. 500: Pacific Rim Capital) and $47 billion (No. 1: IBM Global Services). The bulk of the channel is made up of small VARs--with less than $2 million in annual revenue--with a moderate band of middle-class solution providers between the two extremes.

While everyone today is trying to figure out how to effectively reach the midmarket, VARBusiness re-search confirmed that midsize solution providers have the best relationships with midsize customers. Nevertheless, some predict that pressure to operate efficiently will force solution providers to consolidate. In fact, some predict a period of hyperconsolidation over the next five years that will create two classes of solution providers--a handful of mega-VARs that operate on a national and international level and hundreds (not thousands) of smaller local and regional VARs.

"There will be 10 mega-VARs that own 75 percent of the space, with 25 percent of the market served by regional or specialty VARs," predicts Mike Cox, CEO of Logicalis (VARBusiness 500 No. 83).

Market pressures may not be the only consolidation driver. Solution-provider owners reaching retirement age is another significant factor. Some call them "lifestyle VARs," people who make a good living reselling products but have no real desire to grow their business beyond self-sustaining revenue. As they approach retirement age, they're looking for exit strategies. Selling their businesses to larger VARs will give them nice nest eggs.

Cox is seeing it with his own business. Logicalis made no acquisitions for two years. Then the company went on a buying spree because many small and midtier VARs started shopping around their businesses.

"Potentially, a lot of VARs in the $5 million to $10 million range are going to retire. They're going to retire or simply dry up and blow away," Cox says.

Hyperconsolidation isn't too far-fetched. Labor shortages and the need for deeper geographic reach will drive many larger VARs to either acquire local companies or subcontract to small VARs to reach small and midmarket customers.

"One trend I see is the increase in 'boutique services companies' focused on SMB as a result of the baby-boomer exit from corporate America," says Chris Forman, Oki Data's senior vice president of U.S. sales. "Labor will be scarce, and these mom-and-pop outfits are going to fill critical infrastructure consulting needs for companies. I also see existing service companies moving upstream as they continue to develop capabilities beyond their current core, and these existing organizations filling more subcontracting roles for the larger services organizations that support enterprise today. This, I believe, will leave a void in the SMB market, which will be filled by the baby boomers."

But the future of middle-class VARs may not be so bleak. The alternative may be an increasing amount of partnership between solution providers to increase their technical capabilities, marketing power and geographic strength. Over the past five years, according to the annual VARBusiness State of the Market reports, intersolution-provider partnerships and revenue from these partnerships have steadily increased.

Smaller VARs could retain their independence from acquisition by banding together, thus giving them a greater ability to act cooperatively to negotiate with vendors and compete against the mega-VARs.

NEXT: Evolving business models

CDW's acquisition of Berbee Information Networks (VARBusiness 500 No. 112) last September sent shock waves through the channel. Suddenly, the big DMR was diving headlong into solution selling on the VAR level.

The reality is that such deals may be a harbinger of changing business models within the channel. Five years ago, solution providers relied heavily on hardware sales to carry their business. Today, solutions and complementary services are where they make their money. Five years from now, solution providers will adopt and compete against what may seem today like a strange array of business models: distributors as solution providers, vendors collaborating with end users to deliver integration services, solution providers assuming the role of ISVs, solution providers acting like vendors in the delivery of managed services, retailers acting as solution providers and vendors marginalizing the channel with software as a service (SaaS).

Take vendor services, for instance. At its partner conference last summer, Microsoft unveiled the workings of its Windows and Office Live program. Partners were told that they could host the service or resell the service, or customers could buy the service directly from Microsoft. The model has left many solution providers puzzled over the direction SaaS will take.

Microsoft recently announced a deal in which retailer CompUSA would serve as an exclusive provider of goods and services to very small businesses (typically, with fewer than 20 employees). After the first year, Microsoft expects to open the program to other retailers, which may include Best Buy, Office Max and Circuit City. Best Buy (Geek Squad) and Circuit City (FireDog) already offer integration and support services to small businesses.

"You can see this becoming a challenge to the traditional channel," says David Roberts, Websense's vice president of sales Americas.

SaaS vendors such as Salesforce.com and Citrix Online pay solution providers referral fees for leads that are turned into direct sales. Salesforce.com has developed its Application Exchange, where ISVs can develop and market their add-on modules to the subscription-based Salesforce.com applications.

For SaaS vendors, the evolution of the channel is putting the customers' needs first and putting "value" back in the term VAR.

"VARs pride themselves on their long-term relationships with their customers. You have to make the customer successful. If they're not successful, they'll turn you off," says Bobby Napiltonia (right), Salesforce.com's senior vice president of worldwide sales and alliances.

Software solution providers may find opportunity at the expense of ISVs. The cost of developing custom software--particularly through offshoring arrangements--is falling rapidly. Already, solution providers are taking deals away from ISVs because they're able to deliver lower-cost, custom applications.

"The amount of stuff that you can get done for less than $5 million is increasing, and that's going to benefit solution providers like Perficient," McDonald says.

Managed services are also a game changer. Most of the major distributors are building managed-service infrastructures that solution providers can buy or lease space in, alleviating them of the time and expense of entering the managed-service market. Some worry that the distributors could take these services direct to end users, but the distributors almost universally pledge never to do this.

"The services we're investing in are the ones that will enable VARs and will scale so they'll be the most efficient," says Roy Vallee, chairman and CEO of distributor Avnet. "The services that require presence on the ground--we won't be doing those--and we're trying to encourage our VARs to develop those for their customers."

Managed services may also turn VARs into vendors, of sorts. VARs turned service providers are already developing channel programs of their own to sell their services. Since they've made the infrastructure investment, it makes sense for them to partner with other VARs to extend their sales reach.

Over the next five years, the definition of a VAR will probably change more dramatically--and potentially be more obscure--than at any time in the history of the channel.

NEXT: Rethinking channel programs

Assuming that there's some level of consolidation among solution providers, a shift in brand affinity and customer ownership, and an increasing level of partnership among solution providers, what form will channel programs take in 2013?

Perhaps no other issue is more vexing in the Channel 2.0 quest than this. Obviously, channel programs must evolve to meet the changing and dynamic channel ecosystem. But what those changes will be and how they'll impact the channel marketplace could take myriad courses. If there's a keyword for the future, it's flexibility.

"As manufacturers, we're not going to be setting the rules of commerce; they'll be dictated by the purchasers," says John DiLullo, vice president of worldwide sales at SonicWall.

Today's channel programs are too rigid and inflexible for future performance. End users are becoming savvier in their purchasing, and solution providers are the conduit for customization. Vendors will have to become more flexible in what they're willing to sell and how they're going to deliver it if they want solution providers' business, DiLullo says.

Likewise, vendor programs will have to become more flexible. The contemporary vendor channel program is structured around providing solution providers with discounted prices so they can resell with a reasonable margin. Vendor services can be boiled down to essential components: technical support, presales and postsales support, and marketing support. As solution providers evolve, they may become less dependent on vendor support mechanisms and look for better ways of delivering products and services. This will force vendors to become less rigid in the way they treat solution providers and concede better terms in discounts, rebates and MDF.

"The IT reseller channel is going to look like other channels that are direct or quasi-direct," says Gary Gillam, Xerox's vice president of channel operations.

Evolution doesn't mean that the vendor-solution provider relationship will weaken. In fact, stronger solution providers may actually increase the partnership bonds. Vendors could be freed of the expense associated with supporting solution providers' businesses, enabling the channel to function more as an extended salesforce that sells more products and delivers higher-value services. For this to happen, vendors will have to enable their partners more than they are today.

"To make that transformation will require a lot of training and knowledge transfer," says Roberts. "We'll need to create the tools to make sure solution providers can participate in the full solution."

Some solution providers are already feeling the transfer of responsibility. HP CEO Mark Hurd continues to press for greater operational efficiency to drive down the cost of sales and widen margins. Resellers say this is translating into fewer field reps and greater pressure to generate more business on their own.

"It's becoming the responsibility of the reseller to find the business, develop the proofs-of-concept and follow the deal from inception to the end," says J. Javier Uribe, president and co-founder of Mobius Partners Enterprise Solutions (VARBusiness 500 No. 435).

Vendors and solution providers agree that the channel will remain the best conduit for reaching smaller and midmarket customers. Regardless of who owns the customer relationship, vendors will continue to make products and solution providers will sell. How that relationship develops will be the subject of much discussion as VARBusiness' Channel 2.0 project evolves.