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Why VARs Fail--And How You Can Avoid The Same Fate

Less than a year ago, Guy Fessenden ran a highly regarded computer solutions and integrations company. In fact, he ran one of the 225 largest companies of its kind

in North America. As of last month, however, the former CEO of DIS Research, a New York-based technology integrator and reseller, was home trying to sort out what happened to his business. Instead of flourishing in 2001, DIS Research, No. 220 on last year's VARBusiness ranking of the 500 largest VARs, solution providers and consultants, closed its doors. Although 35 of its employees were picked up by Forsythe Technology, the remainder of Fessenden's company, which racked up sales of $137 million in 2000, essentially disbanded.

It's hardly alone.

As the anticipated recovery of 2002 begins to take shape, it's clear that many solution providers won't be around to see it materialize. After more than three decades in business, for example, ComputersAmerica is shutting its doors, says John Kalleen IV. The grandson of the company's original founder, Kalleen says he and his father found 2001 to be a "tough time to be hawking computers when so many vendors were pushing direct sales." So much for the company that prided itself on "making IT easy for more than 30 years."

Plenty of reasons explain why VARs have failed lately. Certainly, the economic recession made worse by the tragic events of Sept. 11 contributed to the downfall of many. But so did other factors, including poor management, bad execution, shaky finances and dreadful customer service, just to name a few. After buying some assets of Kissane Business Systems, a failed Chicago-area integrator, Chip Miceli has a better handle on what causes VARs to collapse. Miceli, one of the principals at Des Plaines Office Equipment, says some of Kissane's service technicians earned upward of $150,000 per year. When its utilization rates slumped with the economy, the company mistakenly kept many engineers on its payroll because it had steep investments in them. Big mistake, Miceli says. "But what do we know?" he says half jokingly. "We've only been around since 1955." For the record, Des Plaines is still serving greater Chicagoland.

Industry veteran Jeff McKeever, one of the founders of MicroAge, once one of the world's largest reseller organizations, says companies began collapsing after suppliers changed the way they did business with the channel (for an interview with McKeever, see page 70). His company, for example, found itself in the unenviable position of having to sell PCs below cost in order to qualify for back-end rebates from suppliers. These arrangements, known as "special pricing letters," added overhead to his cost structure and strained his cash flow. "When you have to wait six months or more for your money, the time-value of money alone destroys your profits," he says.

Additional problems befell MicroAge when these same suppliers reduced by 15 days the terms provided to MicroAge and companies like it. "In MicroAge's case, we went from virtually no debt to having nearly $300 million worth of debt in a matter of 90 days," he adds. "That puts leverage on a business that wasn't otherwise there."

Debt, it turns out, has done in a significant number of VARs, despite the relative low cost of capital today. Take Aztec Technology Partners, for example. A Braintree, Mass.-based roll-up company, Aztec Technology spent tens of millions of dollars trying to combine 10 IT solutions companies. It wound up with none. Like many, Aztec Technology didn't go down without a fight. The company significantly restructured its business in 2000, selling several subsidiaries and shutting down another in an attempt to repay its debt. Try as it might, however, the company never got a handle on its finances.

Newer companies that came of age at the height of the Internet bubble of 1999 and 2000 turned out to be more susceptible to the vagaries of financing in 2001. Unlike more established companies, these organizations typically had no longstanding customers or creditors to fall back on when the market tanked. Debt nearly destroyed fledgling ASP USinternetworking, which filed for Chapter 11 bankruptcy on Jan. 7 of this year. That same day, the Nasdaq exchange stopped trading on USIX shares, which, two years ago, were worth $53.63 each, but then fell to around $0.20 each. As bleak as things are there, CEO Andrew Stern notes that his company remains standing,something few other ASPs can boast. Rival Breakaway Solutions, for example, never made it out of bankruptcy, although Totality, a San Francisco-based solution provider, eventually bought some of the failed company's assets.

You may recall that Breakaway once rented a billboard outside Boston's Logan Airport at the height of the dot-com market with a message designed to attract travel-weary consultants from rival companies. The pitch: "If you worked at Breakaway, you'd be home now." Turns out the pledge was truer than anyone could have imagined.

Experts who follow IT consulting and the solution- provider channel say 2001 was indeed a particularly rough year. It saw the demise of many once high-flying Web integrators, including Scient, and, most notably, MarchFirst, which went belly up after its first birthday on March 1, 2001. Like Aztec, those roll-up companies never got a handle on their debt loads. But the demise of these companies doesn't explain why older companies, including ComputersAmerica or DIS Research, withered. Fessenden's company, for one, withstood several economic downturns during its 17-year history. But it never saw a slump quite like 2001. Combined with the meltdown in the Web-integration services market, Fessenden says the one-two combination punch proved fatal to his company.

In addition to selling to too few customers, selling to the wrong ones upended many VARs last year. Independent consultant Hank Haddad, author of VARometer and other guides for channel companies, knows of one VAR who failed after selling to customers that had no way of paying their bills. When their financial problems became his, the VAR naturally ran into a collections problem. In general, Haddad advises VARs to develop a high value-added ratio. VARs, thus, should pay particularly close attention to the selling price of their solutions minus the cost of purchased goods and materials. Some successful VARs, he notes, maintain a ratio of 3-to-1.

Longtime market-watcher and IDC analyst Janet Waxman says VARs who fail never seem to get right the one thing they need to do to survive: building a business model that fits customers' needs and showcases the talents of the solution provider. In contrast, she adds, successful companies never stop fine-tuning. "The companies that are successful over a prolonged period of time," she says, "refresh their business models almost minute by minute."

That may explain why USinternetworking is still standing. Faced with mounting losses, tightening credit markets and mounting customer concerns, Stern took drastic action late last year to save the company. He persuaded widely respected Bain Capital to pump more than $100 million into the company, but he and other executives had to give up rights to all of the company's equity. The move gave USinternetworking breathing room from its creditors, but effectively meant the end of the company as its executives knew it. Ironically, Stern says, bankruptcy has turned out to be more a feeling of relief than a sense of failure. The breathing room, he notes, is giving him time to take a hard look at some preconceived notions.

Too bad more companies don't do that, says Ken Wasmer, president and CEO of The Wasmer Group, one of several business consultants that specializes in helping solution-provider companies strengthen their businesses. After studying more than 400 solution-provider companies, Wasmer discovered that only 20 percent were actually making money from services, although almost all thought they were.

His Alexandria, La., company is on a mission to help VARs (for a fee) get a handle on their services businesses. In the following, Wasmer and other business advisors offer advice

Kenneth Wasmer: Service Business Woes

Peter Meyer: Lack of Differentiation

Jim Kidd: Lack of Sales Focus

Janet Ruhl: Misreading Trends In Pricing

Amy D. Wohl: Getting a Head Start On Opportunities

Bruce Stuart: Management Shortcomings

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