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Solution Providers Stuck In The On-Premise World Are Dead Men Walking

Steven Burke

"We have sort of put the ship on warp drive right now," said the 24-year IT industry veteran, reflecting on the treacherous business model shift -- a tornado of sorts -- that has resulted in record consolidation in the solution provider market in the past several years.

The winners in the channel of 2018, Dupler said, will be nimble, agile and comfortable operating in a world where information technology innovation is moving at an exponential rate. That exponential rate of change has obliterated the old product-dominated solution provider business model in favor of a services model where annuity-based managed services/professional services with a high quotient of a partner's own intellectual property are front and center.

Making the cut for partners used to the old legacy IT product world is a Herculean task. The balance sheets of most large enterprise partners, insiders say, are dominated by on-premise infrastructure products with a services component that usually comes in at less than 10 percent of sales or at best 20 percent of sales, little of it annuity-based and with a meager 2 percent operating profit.

"The biggest challenge for people is not moving fast enough to transform their business," Dupler said.

Indeed, solution providers that do not change and change quickly are going to find it difficult to survive against a new class of cloud computing solution providers that have been built from the ground up to be a cloud services provider or those that have made big investments necessary to transform their businesses so they are leading with off-premise, annuity-based cloud services.

John Ross, a technology consultant and onetime chief technology officer of GreenPages, said his former company is one of the few that gets the dramatic business transformation that is forcing resellers to either become IT service providers or die. He predicts that 50 percent of the current crop of resellers will either be gone or have flipped their model by 2018. What's more, he said he's talked to at least 20 CIOs in the past 30 days who are in the process of buying hardware for the last time as they build their own Infrastructure- and Platform-as-a-Service models.

"This is the last time we are going to see hardware purchases through resellers for many, many years," he said.

CLOUD TSUNAMI

The new breed of cloud computing solution providers emerging as a formidable channel force is described as transformative by UBM Tech Channel, the parent company of CRN. Transformative partners are pure-play cloud players basing their business on annuity-based, off-premise services rather than capital expenditure-based, on-premise IT project sales.

Solution providers operating in the old on-premise resale model, referred to in UBM Tech Channel parlance as vintage VARs, are facing a cloud tsunami that's forcing them to navigate a business model change unprecedented in the 31-year history of the modern IT channel. The shift requires that partners add at least 50 percent more customers to derive the same amount of sales in the current on-premise model, according to UBM Tech Channel research.

Partners making huge investments in new intellectual property to succeed in the cloud computing era are what UBM Tech Channel calls progressive. Those partners, many of them cash-strapped, have to make hefty financial investments in new cloud services technical and sales expertise, new vendor partnerships and, on top of that, must increase their marketing budget by an order of magnitude under the transformative model to get new customers. It's those big investments that have resulted in a flurry of mergers and acquisitions in the solution provider market as partners scale up to compete in what some are calling the dawn of the mega solution provider.

The battle cry for solution providers is either go big or go small by offering niche services in vertical or specialized markets. Partners say the worst place to be is stuck in the middle in the midmarket, where regional infrastructure partners have thrived for many years building data centers. Those midmarket infrastructure providers are being forced to change every nook and cranny of their business, technology and go-to- market model.

NEXT: Making The Big Investment MAKING THE BIG INVESTMENT

For its part, GreenPages -- No. 153 on CRN's Solution Provider 500 with $110 million in annual sales -- was shifting to the cloud model when many colleagues and even customers were skeptical. In fact, the Kittery, Maine-based company began advocating that customers move aggressively to a cloud infrastructure back in 2008 and has invested millions of dollars of its own capital on developing its own unique intellectual property -- GreenPages Cloud Management as a Service (CMaaS).

That intellectual property and the ability to innovate with software and services offerings -- better yet Software-as-a-Service -- is the most critical factor in the success or failure in the cloud computing era, experts say. What's more, that unique solution provider intellectual property is absolutely the No. 1 factor in driving a high valuation. The cloud computing era has hit solution provider valuations hard; once-highly-valued solution provider businesses are now selling for about 20 percent of sales (see related story).

Dupler has made the GreenPages CMaaS product the centerpiece of an ambitious five-year plan to build a $300 million business. He forecasts CMaaS will grow at an astronomical 857 percent rate over the next five years. That is expected to drive GreenPages annuity-based services from just $7 million today to $60 million in 2018.

"Our professional services are growing significantly over that time as well because what we see is tremendous appetite for customers that need planning and integration services to create private and hybrid cloud platforms," said Dupler. "Our product sales we are actually keeping relatively flat through that period of time. There is product that is part of this transformation but, by and large, on a long-term basis, we believe product sales are going to start tailing off for people in the solution provider community."

The thought of on-premise product sales tailing off would be heresy for solution providers that rode the reseller revolution in the latter half of the 20th century with PCs, local area networks and client/server computing and then the Internet revolution, which initially resulted in a huge on-premise infrastructure build-out. Dupler said he doesn't see product sales ever going away, but make no mistake about it: The future for GreenPages and other partners is a services-led business. "We are not looking to get out of the product business," said Dupler. "But we have to be and want to be a thriving, profitable business with zero product sales."

For GreenPages, the future lies not in any vendor product offering but in its own unique CMaaS concept of planning, building, running and governing IT in a cloud world "The solution provider channel for many years has made its money off of the fact that infrastructure fundamentally doesn't work very well," added Dupler. "It used to be all about architecting and integrating physical technologies and software platforms to support the apps and data that add value to the business. In the cloud world, it is about integrating service platforms as opposed to physical technologies."

Dupler said far too many of his colleagues are hanging on to the past. Worse, he said, they are selling solutions to customers that put profits in their own pockets at the customers' expense. "The biggest mistake I see right now is people continuing to evangelize solutions to customers that aren't necessarily right by the customer, but conform to what partners know and drive the most profit for their organizations," he said.

"Short-term gain isn't going to drive long-term customer value," Dupler added. "We need to lead the customers forward through this transformation as opposed to perpetuating the past."

NEXT: Buying Rather Than Building BUYING RATHER THAN BUILDING

Dimension Data Americas, a $5.8 billion global behemoth that was No. 11 on the SP500 list, also has moved aggressively away from the old IT reseller model toward a cloud computing services model. But rather than build that all-important unique intellectual property itself, the company has completely redefined itself as a cloud computing power in the same league with Amazon Web Services with acquisitions that have forever changed the character of the company.

Dimension Data, which is owned by Japanese telecommunications giant Nippon Telegraph and Telephone Corporation, leveraged NTT's financial muscle to acquire well-respected cloud services provider OpSource and cloud expense management provider Xigo. Those deals have put the global solution provider, based in Johannesburg, South Africa, into another weight class. In fact, IT market researcher Gartner put Dimension Data into its Magic Quadrant for cloud Infrastructure-as-a-Service, competing with the likes of Amazon Web Services. "Not one of my competitors is even listed on that quadrant," boasted Dimension Data Americas CEO Jere Brown.

Competing against Amazon Web Services, said Brown, means not relying on the traditional feet-on-the-street sales model, but rather using "marketing analytics" to capture new customers. "It's a different delivery model than a traditional VAR has," he said. "If you are looking to transform your business to create a business that is less product-centric to one that is solutions- and services-led, it requires a business transformation and a whole new way of doing business. It means every part of your organization has to go through that transformation."

Brown, a 35-year IT services veteran, has implemented that kind of dramatic business transformation at Dimension Data over the past three years. The transformation has taken Dimension Data from what was once a reseller of IT products into a full-fledged IT services organization -- a technology services-led business with its own unique cloud computing services.

"We started out three years ago and said, 'What do we want our business to look like?' " said Brown. "We wanted to be solution- and services-led. We wanted to have deeper client penetration. We wanted to be a leader in the Gartner Magic Quadrant. We wanted to have high levels of client satisfaction. We wanted low employee turnover. We wanted to increase our go-to-market effectiveness, particularly our selling effectiveness. And we wanted to increase our profitable returns. Then we had a plan on how we were going to go about doing that, what we needed to change and how we were going to go about that change. We followed a very structured change-management process, a transformational program that had multiple work streams."

The companywide transformation has redefined every aspect of Dimension Data's business, even its vendor relationships, said Brown. First and foremost, it means Dimension Data is putting its own unique services intellectual property front and center with its own annuity-based managed services, said Brown. That has dramatically shifted "the balance of where our revenue comes from, what we sell, how we sell and how we attract new clients," he said.

It all comes down to a higher amount of the content and value created by Dimension Data, said Brown. "For us, enabling our relationships with our clients to drive long-term value around the services we deliver with our people, our systems and tools is really important in the decisions that we make around the partners we do business with."

The problem is many solution providers have hit the wall and don't have the financial means to make the transition to the cloud computing model, he said. "Some VARs that have been acquired have hit a ceiling relative to their ability to grow," said Brown, who has had discussions with a number of competitors regarding potential deals and found their economic and shareholder value wanting. "They don't have the financial means [to make the transition to the cloud model]. They don't have access to capital. They maybe don't have the right kind of leadership. So they are losing business to competitors who have gotten bigger or new competitors that are taking their clients by offering some of these new capabilities we are talking about."

NEXT: Destroying Old Business Models DESTROYING OLD BUSINESS MODELS

Many solution providers stuck in the on-premise world are indeed losing business bit by bit to transformative cloud solution providers that were built as startups to tear apart the vintage on-premise model. '"These guys are dead men walking," said Dave Rice, co-founder and CTO of TrueCloud, a Tempe, Ariz.-based cloud computing services provider, referring to vintage VARs. "Frankly, they are the milkmen of the 21st century. It's not even that they don't know they need to change. It's just really too hard to change a business built on an entirely set of different principles."

Rice, a former CIO for $5 billion on-premise solution provider/IT product provider Insight, believes that fewer than 20 percent of the current crop of solution providers will be able to make the transition to the transformative cloud model. "It's like trying to put lipstick on a pig," said Rice. "The solutions these guys are offering right now are antiquated and aren't going to last. It's just not in their DNA to change. For the most part they grew up around the single-tenant client/server model stemming back to late '80s and early '90s."

Rice has doubled or tripled his sales every year since he founded the company in 2008, winning business primarily with the NetSuite ERP SaaS suite against partners selling on-premise offerings. He said he simply can't remember losing a deal to an on-premise solution provider.

Many of those on-premise midmarket infrastructure solution providers operating under the old model have built a business around capital expenditure-based deals that run several hundreds of thousands of dollars and sometimes even more than a million dollars with hefty up-front payments and commissions. Those organizations are used to selling high-priced deals and moving on to the next big deal. That's a drastically different model than the subscription-based model from TrueCloud. "Think about the sales guys and how it affects their commission," said Rice. "Do you think they are going to want to sell subscription software or are they going to be more inclined to sell the servers and IT equipment the way they have for the last 10 to 15 years?"

"This is as big a change as when the PC was introduced to the enterprise back in late '80s," said Rice. "It is transformational. Think about how many major minicomputer and mainframe companies tried to make the change in that client/server era and then look at how many actually made it. If you look back, all of them thought they would make the transition but very few did. It is not easy to change your stripes even if you intellectually understand that it is the right thing to do. It's extremely difficult to try to go back into an organization and retool it."

At the same time that partners are moving to the transformative model, their customers are adopting the cloud model at a rapid clip. The change is being driven in large part by a subscription-based model that is saving customers 30 percent to 35 percent right out of the gate, said Rice. And when customers make the cloud services plunge, they end up shifting those resources that were being used to maintain on-premise IT equipment to their core business serving customers. "A lot of the pain points that come from traditional on-premise stuff get removed from the customer and they start to see they want to let go of as much of that as they possibly can to focus on their own business," said Rice. "They don't want a server room anymore. They see it as an impediment."

Cloud providers such as TrueCloud are often selling to business owners and chief financial officers, said Rice. "The people we are dealing with are not IT people," he said. "It is a different conversation with them than with IT. They are entirely comfortable with the idea they are able to operate without having to rely on the traditional form of on-premise IT." In contrast, vintage solution providers are still selling to IT and many of them simply do not know how to have that more strategic conversation, particularly since it was those solution providers that loaded the customer up with costly on-premise infrastructure solutions.

"It is very hard to go back to your client base and say there has been a substantial IT change and going forward we are going to be recommending an entirely different set of practices on how we run our firm, what we sell and how we deal with customers," said Rice. "It's a very difficult conversation to have. How do you approach your customers and tell them you sold them all this on-premise IT stuff that is no longer suitable or supportable for the long haul?"

NEXT: Don't Eat The Single Cookie Now DON'T EAT THE SINGLE COOKIE NOW

Not only do most solution providers not want to have that difficult conversation with customers, they refuse to cannibalize their existing profitable infrastructure business, said Christopher Hertz, founder and CEO of New Signature, a Washington, D.C., solution provider. Those solution providers not moving to the transformative cloud services model are not stupid people, said Hertz. "Those VARs are still making a lot of money on the resale of on-premise infrastructure hardware and software and look at getting into cloud services as gutting their on-premise revenue. What they see is there is still enough business in the on-premise model to hang onto."

Those vintage solution providers are taking the "path of least resistance," said Hertz. "It's like water. The rule of nature is things go the path of least resistance," he said. "People are lazy. If they can make money easier selling on-premise infrastructure, that is what they are going to do."

Hertz compares the plight of the on-premise infrastructure provider to a child that can either have a single cookie that is put in front of them or four cookies if they can resist the single cookie in front of them for a certain period of time. Those child development tests, he said, show that children with the willpower to wait for the four cookies will ultimately be more successful as they grow up and become adults. The same is true, he said, for solution providers that are willing to make the heavy investments necessary to compete in the cloud services era even if it cannibalizes their current business. "It's difficult to go out and make that investment to get that cloud talent," said Hertz.

The key to thriving in the channel in 2018 is to have a clear vision and detailed plan on how to evolve the business in a fast-moving IT market, said Hertz. New Signature, which is celebrating its 10th anniversary in March, grew 50 percent in sales last year to $10 million by offering on-premise infrastructure, annuity-based cloud services and robust software application development services with about 65 percent of sales coming from system integration services, 10 percent from hardware/software resale and 25 percent from application development.

Hertz is planning for that application development business to nearly double to 45 percent of sales in 2018 with 50 percent from systems integration services and the remaining 5 percent from hardware/software resale. What's more, he said, by 2023, 70 percent of New Signature's sales will come from application development, 30 percent from system integration and none from hardware/software resale. He sees as many as 50 percent of the current crop of solution providers not making it to 2023.

"In 10 years it is unlikely that customers are going to have servers in their office or at a data center," said Hertz. "If your business is predicated on selling that on-premise hardware and software, you have a problem. The opportunity to live in this new cloud services ecosystem is no longer around building infrastructure, it is around building applications."

That's why New Signature has invested heavily in application development, delivering Web services applications such as Votifi.com, billed as a platform for modern political exchange. Votifi.com allows people to exchange ideas and provide feedback on specific issues. New Signature has also developed ioby.org, a micro-funding services site aimed at allowing local eco-friendly projects to get funding.

New Signature has made the big investment in application development services, Hertz said, using the same willpower analogy as the child development test with the cookies. "The choice is do I want to eat one cookie now or four cookies five years from now?" said Hertz. "We're making the investment and taking the long view."

Many solution providers sticking with the old model think they will have time to change and avoid the shakeout, said Hertz. But then there's a tipping point, where it is too late and their business is failing. "You have to be willing to think about what you can do better even if it means tearing down a business that is doing well," said Hertz. "That is not something that comes naturally for people. It is easy to live in the moment, but to succeed in this business you have to constantly reinvent yourself."

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