A New Profit Model For Cisco’s VARs

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Difficult partner reps in the field. Policing product-dumping by telcos. Determining the requirements a partner must meet before granting third-parties' "specialization" status. Those are but a few of the many trials that test Cisco partner executives. No issue they face, however, has proved to be as daunting to fix or as important to remedy as the issue pertaining to partner profitability.

Cisco has tried many things to improve the returns partners generate from working in and around its marketplace. Convincing telcos not to dump products on the open market has helped reduce price erosion, for example, although it has not eradicated the problem completely. Likewise, reducing from 6,000 to 3,400 the number of Certified partners it engages has helped ease overcrowding in certain markets. (The reduction is significant given that certified partners account for 87 percent of Cisco's indirect business.) And a new VIP program, which will put rebates into partners' hands six months after they close business and meet customer-satisfaction requirements, looks very promising. In the future, the company may even tweak its discount structure to help partners who sell more advanced technologies achieve greater margins than those who merely sell desktop-switching products. Today, margins on Cisco gear are roughly the same no matter the cost or complexity of a Cisco product.

As good as these measures are, however, they only go so far. That's because the problem with profitability is broader than mere partner policies established by Cisco. The latest attempt by the company to help partners better understand profitability comes in the form of a new model for measuring and improving return on invested capital pioneered by chemical giant DuPont. The model can help partners better understand and manage their invested capital. Cisco wants to educate them on the impact of improving inventory turns, increasing working capital (WC) intensity, etc. So, Cisco took the DuPont return on invested capital (ROIC) model (see table) and benchmarked it against its top 20 publicly held U.S. partners.

Cisco found that the average gross margins of these 20 partners was 26.4 percent, while their selling, general and administrative expenses (SG&A) were 17.9 percent. That yielded operating margins of 8.5 percent. In addition, Cisco discovered that its top 20 partners typically had 16 days worth of inventory. As for their days sales outstanding or accounts receivables (A/R), they averaged 94 days. Their accounts payables, meantime, averaged 36 days. If you take these figures and apply them to the accompanying formula, you get a working capital intensity of just 45 percent. All told, the partners averaged an 18.8 percent ROIC--not bad when you consider their high SG&A and A/R numbers.

But factoring improvements that can be had through Cisco programs, such as the VIP or eAgent program, for example, and the new productivity tools, could positively impact these numbers considerably, says Cisco vice president Paul Mountford. By selling its A/R to Cisco, for example, a partner would increase its SG&A costs by 1 percent to 18.9 percent, thanks to fees charged by the company. But the move would lower a VAR's A/R from 94 days to 30 days, resulting in a 27 percent ROIC. Doing business through the VIP program, which effectively doubles the operating margins on higher-end, advanced technologies thanks to the back-end rebates, can lift ROIC to 35.3 percent. And doing business through Cisco's eAgent program could take ROIC as high as 67.8 percent, says Cisco, even though the eAgent model will likely mean higher SG&A costs. They are more than offset by lower inventory costs and dramatically improved A/R and payables.

Whether the formula will work for your company remains to be seen. But Cisco is trying to better understand what makes your business run.

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