Channel Chiefs: How To Do The Math On Recurring Revenue

Solution providers should be looking to transition their businesses to include more recurring revenue, but many don't fully comprehend the model or how to compensate employees for sales that are billed over a prolonged contract, say top channel executives.

Recurring revenue is still a minority of the total percentage of sales for most solution providers, said Frank Rauch, vice president of VMware's Americas Partner Organization. The mix of recurring revenue is "very, very slim," but the number of people starting to embrace that model is becoming a bigger story, Rauch said.

"I don't think you have a lot of maturity right now in our base in terms of the recurring revenue. A lot of them are selling more toward traditional models. The SMB guys seem to be picking it up a little bit faster just simply because they're selling software to service and they have those types of offerings that are scalable. The large guys are getting there," Rauch said.

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Rauch's comments came during the CRN Channel Chief Roundtable, held at the XChange Solution Provider 2013 conference in Orlando, Fla., in March. In addition to VMware's Rausch, the roundtable featured top channel executives from Cisco, Comcast, Hewlett-Packard, SAP and Verizon.

Solution providers may need to make big changes to accommodate a recurring revenue model, but they are necessary to position themselves for the future and for what customers want in the cloud, the executives said.

Tony Anderson, director of indirect marketing for HP's Enterprise Group Americas, estimated that 20 percent of solution providers understand recurring revenue and are successful.

"I think there is a very small amount that really is occurring. I think there's some education that needs to happen and then they need to try to get the offerings that we've got out there, and engage with us to make sure that they can take it to the next level," Anderson said. "I think that transition is happening. And there are a few leaders out there for sure, and I think we want to try to get the broader base a little more engaged and moved up the stack."

Anderson added that HP isn't forcing solution providers into more services -- partners are pushing that way on their own.

"I think we're providing a vision, and it's up to them. They've got to engage, right? They have to get their business model aligned," he said.

Verizon's Janet Schijns and Comcast's Craig Schlagbaum work for companies that make their living off recurring services revenue and agreed that some solution providers struggle to get to that model.

"When I talk to the VARs, they [have] a couple things they need to work on. Most VARs, even the billion-dollar ones, don't have a pricing expert in their business," said Schijns, vice president of medium business and channels at Verizon Enterprise Solutions. "They don't have someone in their business that understands how to do real pricing strategies ... gross margin-plus as opposed to discount off hardware."

NEXT: Managing Sales Force Compensation

Roundtable participants acknowledged a big issue solution providers face while transitioning to a recurring model: compensation. Because solution provider sales forces traditionally got paid up front when a big sale was made, changing that to getting paid a smaller amount up front but more over time is a difficult one for many companies to swallow from a cash-flow perspective.

Verizon has programs in place to help solution providers make that transition, Schijns said.

"We can help them to get their customers used to recurrence while they still get a cash flow," Schijns said. "I think you've got to make a fundamental decision with your sales force. So your sales force either has to be paid on volume or they've got to be paid on margin. As a business, you have to make that decision first."

A model that pays 50 percent up front and 50 percent over time should work for most companies, she added.

In addition, solution providers should look to compensate based on margin, not on revenue, Schijns said.

"If your salespeople are paid on volume, there's a totally different model because that's transactional versus they're paid on margin and maybe walking away from specific deals. Then they should be paid a percent of margin versus a percent of revenue," Schijns said.

Schlagbaum, vice president of indirect channel sales at Comcast Business Class, said every solution provider should be educated on the Rule of 78s, a term used to calculate annual interest or revenue based on aggregated monthly payments.

"I [recently] asked that question to a bunch of VARs in the room and not a single one raised their hand. They have no clue. That's how you have to build a business model around this," Schlagbaum said.

Schlagbaum explained it this way: If you sell a monthly $1,000 contract on Jan. 1, another on Feb. 1 and every month for the rest of the year, you would have accrued $78,000 in revenue.

"A lot of people would say $12,000 and that's completely wrong. Now, you have $12,000 as a jump-off point for the next year, but you actually build within the calendar year $78,000. That's the magic of recurring revenue. That fundamental premise is missed by virtually everyone," Schlagbaum said.

"So you have to build your business model around that accounting principle. You can look it up online, but it's something that's fundamental to a recurring revenue model," he added. "You've got to have the patience to endure what it takes in order to drive that kind of revenue over time. If you're building your own service, it's essentially in my opinion a three-year endeavor to build your own cloud offerings."

NEXT: The Cloud Changes The Customer Game

Mike Kozel, vice president of partner management at SAP America, added that solution providers should be looking to grow recurring revenue because it's what customers increasingly want.

"I believe over time it will be a blend. I don't think it's going to be one way or the other, you know, turn a switch and you're going from an on-premise to a cloud solution. I think there will be a mix," Kozel said. "We're really seeing .. what I call the focused reseller, someone who has a unique skill, whether it's an industry skill or a solution skill or geographic capabilities that's focused, that's bringing a unique set of solutions, whether it's IP or a unique set of wrap-around offerings to the customer. We're very focused in the marketplace and we're working very closely with those partners."

Ideally, partners will become self-sufficient in terms of offering more services, he said.

"[For] things like demand gen and pre-sale sales -- we're not going to be that crutch. We are going to work with them. We're going to enable them. We're going to go with programs to make them successful. But the ideal partner over time is self-sufficient," he said.

Richard McLeod, senior director of worldwide collaboration channels at Cisco, added that solution providers don't need to transition their entire business to the cloud by tomorrow. A gradual development in line with market demand should work for most.

"We're not going to go to 100 percent cloud tomorrow. The question is, is it 10 percent of the volume or 20 or 30 or how much this year, next year, and the year after? And I think each VAR has to plan what's right for them," McLeod said. "That is a key in terms of how they change this to what is the proper mix of recurring revenue to up-front revenue. How much investment do they want to make to get that greater margin that comes from value-added.?"

How quickly or deliberately VARs make that investment should also drive how they change their compensation programs, McLeod added.

"If you change the compensation program too quickly, to rewarding recurring, then suddenly you don't get the up-front money that you need to pay the bills. So it's a very careful trick in terms of how you plan it. ... Do you have a financial person that's also driving that compensation lever to know how much when and how? At Cisco, we're starting to turn that dial with our internal sales team as well and we're actually compensating our direct salespeople 30 percent greater when they drive channel-oriented cloud solutions."

The real key is working with customers who are looking for partners to help them plan the transition to the cloud too, McLeod added.

"Customers are confused. [They're asking] 'What is this cloud? What do I need to do? When do I need to do it?' And to have a VAR that can provide that architectural and road map planning as well as the transition approximately to the cloud [is good]. Which apps go to the cloud? Which ones not? When, how, and with who? To package that all up under a white-label offering and to provide also the professional consulting of transition and integration, and make the cloud and the old premise work together, that's an amazing opportunity," he said.

PUBLISHED APRIL 15, 2013