Solution providers say out in front of decades-long increase in channel sales
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VARBusiness took its annual dive deep into the minds of IT VARs to examine the state of the market going into the new year. What we learned from the CMP Channel State of the Market 2008 study is that, despite jitters felt across the national economy, the channel still feels sanguine about the year to come.
The IT channel seems justified in feeling more optimistic than IT manufacturers with a large emphasis on direct sales. The indirect channel has grown faster over the past 10 years than the IT manufacturing industry upstream from it. In 1997, indirect sales were 15 percent greater than direct. Now, indirect sales are 100 percent greater than direct, according to Gartner Dataquest.
And all indications are that indirect sales will continue to outpace direct. Major manufacturing executives such as Cisco Systems' John Chambers are reporting that enterprise sales growth is "lumpy" while the middle market is taking on greater importance. And who better to command the increasingly important SMB space than the channel? Even Dell has been dancing this past year or more in an awkward attempt to woo the channel, and mixed-model vendors are publicly proclaiming in unequivocal terms that they are more committed than ever to the channel.
For example, Jerry Lumpkin, vice president of business channel sales for Toshiba America Information Systems, said in November during his CMP Channel Virtual Trade Show presentation, "Unlike some of our past channel strategies, Toshiba absolutely will not compete with you. We are here for one purpose and one purpose only, and that is to grow our business through our channel partners."
Solution providers are driving growth because they can serve the growing SMB market best. According to State of the Market 2008 data, solution providers that saw a net gain of customers in 2007 were the rule rather than the exception: 53 percent increased their customer base while only 11 percent suffered a net loss of customers. The size of the overall channel customer base grew 10.4 percent in 2007.
But even while adding new customers, solution providers aren't seeing business from existing customers declining. In fact, it's quite the opposite. Even when adding new accounts, VARs realized a greater percentage of revenue from existing customers this year vs. last. New customers provided 27 percent of 2007 revenue but 33 percent of 2006 revenue.
Solution providers accurately projected this growth when surveyed for this project last year: 81 percent expected to see their revenue grow by at least 5 percent in 2007 vs. 2006. And the year before, in 2005, solution providers foresaw the gains coming in 2006: 79 percent expected to grow revenue more than 5 percent. That past accuracy makes it all the more important to heed the slight faltering of confidence apparent this year, when a large but diminished 73 percent expect to grow significantly. However, considering the general economic gloom cast by the credit crisis, rising oil prices and the falling dollar, the level of optimism among solution providers indicates that this industry is, for the time being, more resilient than many others in the face of these broad economic challenges.
"Despite budget cuts and continuing resolution, we expect 2008 to be a significant growth year," said Craig Abod, president of Carahsoft Technology in Reston, Va. "Our emphasis on delivering compelling technologies that can provide tremendous ROI continues to be of interest to our customers," Abod continued.
Better than the mildness of the dip in growth expectations is the fact that solution providers expect to grow profit nearly as much in 2008 as they did in 2007. While 65 percent expected profit to grow by more than 5 percent in 2007, a nearly equal 64 percent expects such growth again in 2008. This intent to grow profitably demonstrates a confidence that this growth can come without disproportionately large new investments.
Vendors that aren't yet working very hard to align partner interests with their own may begin to feel the pain soon. Vendors have an opportunity to benefit from solution providers' advantageous positioning in the midmarket as VARs are partnering with greater numbers of vendors. Unfortunately for vendors, there's also some churn. Although solution providers added an average of 3.1 vendors in 2007, they dropped an average of 1.6. And when a VAR drops a vendor, six times out of 10 they will not notify the vendor.
"If a vendor really lets you down, I think there are enough choices out there that you can build a relationship with somebody else. And everybody's hungry for the business," said Brian Deeley, a principal of Graymar Business Solutions in Timonium, Md.
When adding new vendors, VARs' top consideration is the relevance of the technology to their customers. About two out of three VARs rate this as very important. After that, the two most important considerations are product innovation and the opportunity to capture a larger profit margin. These are ranked high by more than half of all VARs.
Next: Infrastructure Catagories
The three infrastructure solution categories VARs are most focused on right now are VoIP, security hardware and wireless networking, by two different measures. For all three of these solution areas, 28 percent of all solution providers are planning to grow their business by adding new vendor relationships.
When you look just at VARs not already involved in VoIP solutions, almost one in five, 17 percent, put VoIP highest on their list of technologies to add to their solutions portfolio before the end of 2008. The comparable percentage for security hardware is 13 percent and for wireless networking is 11 percent. The numbers are smaller for all other infrastructure solutions.
Of these top infrastructure solution categories, VAR offerings are expanding most quickly in the wireless networking space. Two out of five VARs that already offer wireless networking plan to expand those offerings in the next year, possibly because customers are compelled to keep up with advances in wireless networking capabilities. Just under a third plan to expand their security hardware offerings, and one in five will expand their VoIP portfolio.
Keen interest and hot growth projections don't necessarily correlate with a large share of business. For example, security hardware currently generates only about 9 percent of all hardware revenue in the channel, while network hardware brings in 18 percent. Personal computer and server systems still garner the lion's share of hardware revenue at 40 percent. Systems revenue may begin this year to slip toward networking hardware because of virtualization: Not only has virtualization started to show signs of cutting into vendor server revenue, but solution providers indicate high interest in nascent network virtualization, which moves certain services traditionally housed on servers directly into network hardware. In a separate study conducted by CMP Channel on the virtualization technology market in October, 47 percent of VARs already involved in virtualization offer or plan in 2008 to offer network virtualization solutions.
While State of the Market 2008 results indicate nearly one-quarter of all solution providers are involved in virtualization, either selling or recommending, virtualization software itself is not a rich source of revenue. Virtualization software brings in just 2 percent of software revenue. However, virtualization software can facilitate or sweeten deals by decreasing customer hardware costs, increasing availability/uptime or improving disaster recovery.
The chief source of software revenue is still business applications (32 percent), followed by desktop/productivity applications (15 percent). While Software-as-a-Service (SaaS) has posed a potential threat to this revenue, it has so far seen widespread adoption only in the relatively newer segments of customer relationship management (CRM) and Web conferencing.
According to Gartner Dataquest, in August 2007 adoption of SaaS in the enterprise applications space has been spotty and represents only 1 percent of manufacturing and operations applications but 30 percent of supply chain sourcing, a segment of supply chain management (SCM). However, Gartner projects SaaS sales will be outpacing the growth of on-premises software sales. Gartner projects sales of ERP SaaS to expand at an annual compound growth rate of 15.9 percent between 2006 and 2011.
The newest space Gartner has identified for SaaS is "office suites and digital content creation," or basically personal productivity apps, which the research firm expects will grow at an astounding rate of 95.7 percent per year compounded annually between 2006 and 2011, with sales totaling $1.4 billion by 2011. Given that State of the Market 2008 shows 48 percent of all solution providers sell these types of applications as on-premises software, many will start to notice this encroachment within the next few years.
How the solution provider is dealing with the changes SaaS is bringing is covered in more detail in "SaaS Smarts" on page 40.
One of the ways to deal with SaaS is to increase emphasis on consulting. Already, the industry has shifted significantly over the past few decades such that consulting and professional services account for a quarter of all solution-provider revenue. All services account for half of the revenue while hardware and software split the remaining half. Of services revenue, managed services are now a significant slice, at 18 percent, but break/fix still brings in more--31 percent (see "Revenue Generators" chart, this page).
What's most important to staying on top of such transitions is to really understand the customer's business well. This is the channel's strength and the reason it has grown so quickly relative to the direct side of the IT market. More and more, the channel is selling to business owners, executives and line of business managers, not to the IT organization.
And remember, averages say nothing about individual cases. While vendors are reporting trouble with the enterprise space, solution providers who know their customers well enough to find solutions they consider worth investing in can still do well with large customers in 2008.
Said Mike Thompson, president and CEO of Groupware Technology in Campbell, Calif., "Specific to Cisco, we are seeing more opportunities in the midmarket in 2008, but that is our focus with Cisco. We actually are seeing an uptick in both our enterprise and midmarket space as the end of year approaches."