The recurring revenue model has become a sort of Shangri-la for the channel, a mythical promised land that will almost magically extend the life of many solution provider businesses.
And while many top vendors are encouraging their solution provider partners to make the journey and charting a course for them, the transition is slow and sometimes painful, with plenty of pitfalls to avoid along the way.
In a wide-ranging roundtable discussion, CRN recently spoke with some of the top channel chiefs in the industry about the state of the IT channel. Specifically, we asked these channel executives about recurring services-based revenue and if their partners are making the transition to managed services and cloud services.
While all the channel chiefs agreed the recurring revenue models are gaining momentum, they reported mixed results from their respective partner bases. Some partners have successfully made the jump and are reaping the benefits, while others have not.
"The bottom line is I think the idea of moving to a new consumption model [with] a by-the-drink approach is definitely growing," said Edison Peres, senior vice president of worldwide channels at Cisco Systems, San Jose, Calif.
Peres said the transition to services-based recurring revenue models will encompass the entire industry, but there will be some solution providers that simply can't make the leap. "Most partners will make the transition," he said, "but you are going to get a number of them that are not going to be able to because of cash flow, which is going to stimulate a lot more acquisitions and consolidation in the industry."
Frank Vitagliano, vice president of channel sales at Dell, Round Rock, Texas, said the vast majority of Dell partners have some kind of recurring revenue model. But not all services models are created equal; the services can range from sophisticated -- and high-margin -- managed services to lower-value break/fix services for older legacy systems, he said.
"So when you ask, 'Do our partners have it?' Yes, the vast majority of them have it," Vitagliano said. "But are they really doing what we would draw up as real sophisticated managed services? Not sure yet."
Scott Dunsire, vice president and general manager of the Printing and Personal Systems Group and Americas Channels at Hewlett-Packard, Palo Alto, Calif., believes a strong services-led model is the hallmark of HP's best solution providers. "I would tell you that the good partners out there have all transitioned their business," Dunsire said. "Especially in the second tier of the VAR community, they all have some sort of managed services business [because] they couldn't live on product margins alone."
But like Peres, Dunsire believes the move to a more recurring revenue model will leave some solution providers on the outside looking in.
"There will be probably a significant amount of acquisitions in the channel to really obtain that expertise that is needed to move this in our direction," he said.
Frank Rauch, vice president of the Americas Partner Organization at VMware, Palo Alto, said the services-based recurring revenue model is maturing with the advent of the cloud. "We saw a lot of people stick their toe in the water and kind of build their own services out -- maybe small clouds -- and play around as an aggregator, try to pick up maybe five or six and then really settle on one or two," he said. "It's maturing."
Rauch also said VMware is working hard to make it easier for partners to adopt recurring revenue models by federating pieces of the data center that solution providers can build a service around, a la VMware's new vCloud Hybrid Service.
Chris Frey, vice president of North American channels and SMB at Lenovo, Morrisville, N.C., has a different view on recurring revenue from the client device end of the market. Specifically, he suggested solution providers should look at coupling trends such as BYOD and PC hardware refreshes with building their own cloud and managed services to control not just the data center, but the end-user devices as well.
"I think it is an opportunity for them sometime between now and the April time frame when [Windows] XP actually is not getting the support anymore to start to build this cloud infrastructure and to address the opex savings to their customer," he said. "At the same time, they can start recommending devices during a time of device confusion."
THE CLOUD CONUNDRUM
The channel chiefs all agree that solution providers should explore some kind of cloud services business, but they say not enough partners are addressing the cloud. Peres, for example, found that Cisco partners aren't moving fast enough on public cloud opportunities.
"I think there's a lot of work being done as it relates to building out private clouds, and I think that is a lot of the opportunity today, and for a lot of our infrastructure partners it plays right up their alley, but when you ask them what are they doing around public clouds, they are just not yet clear," Peres said. "Do they do it themselves? Do they white-label it? Do they resell and become agents? They are struggling with that because that economic impact is very different to their overall business."
Peres said he's encouraging partners to make calls to Cisco and other potential cloud partners to at least start a conversation because customers will be looking for solution providers that are an authority on the technology. "If you cannot be in that [cloud] conversation because you don't carry it, white-label it or support it," Peres said, "then you might not have the same credibility that the customers might need from partners going forward."
CRN asked the roundtable participants what percentage of their partner base was addressing the cloud, which produced a range of responses.
For example, Rauch said the majority of VMware partners were addressing the cloud, but that's to be expected because those solution providers already were deep into virtualization and data center.
Still, Rauch said there's a difference between "addressing" the cloud and actually planning or building a revenue model around it. "They've addressed it in their own minds," he said.
Dunsire said solution providers need to do more than just address the cloud -- they need to monetize it. Vitagliano seconded that notion and said there just aren't enough solution providers taking an active role in transforming their businesses.
"I think they know the cloud is there, and they know they've got to do something," Vitagliano said. "But are they really doing something meaningful? And figuring out how to monetize it? It's a 75/25 percent split in the wrong direction."
So while the channel chiefs said the majority of partners are addressing the cloud, only about a quarter of them are truly making money from it. And that's a concern.
SLA HEADACHES AND CAPITAL CRUNCHES
A lack of motivation to move to the cloud isn't the only obstacle for solution providers, the channel chiefs said. Even actively planning a cloud or managed services business means solution providers have to contend with major challenges as they trek toward the prize of recurring revenue.
One of the biggest obstacles are byzantine service-level agreements, which are becoming more and more complicated, according to Peres, as clients offload every bit of IT function -- and risk.
"Customers are really starting to want to not take any risk at all," Peres said. "Then the question becomes how much risk do they put onto the vendor versus the resellers? When you are doing a managed services contract, I think a lot of the challenge is figuring out how much of an SLA they actually can give the customer. They have to be careful because they can take on more risk than they can actually afford to."
Peres said Cisco is working with partners to help them develop sound SLAs that don't leave them on the hook for too much, but customers are still pushing the threshold. "When you take a look at the value chain, customers want to move it all off their balance sheet, and I don't know that everybody is ready for that in the marketplace either," he said. "I think this is just an area of maturing that is going to happen between the customer or the channel as well as the vendors in figuring out who can tolerate what and finding the right balance."
An even bigger issue for aspiring managed and cloud services providers is finding the capital to actually build a new practice. Not only do solution providers need to invest in training and certification and hiring new talent, but they also need to build a financial plan to allows them to stay afloat as they transition from big, million-dollar integration jobs to smaller, incremental services fees spread out over time.
Dell's Vitagliano said he sees some of the larger national solution providers making the jump to the cloud through careful financial planning, but those companies are a small percentage of the overall channel.
"They do it like we would do it: they build an investment plan, they build it into their beginning-of-the-year budget, and they do it as an opportunity investment," Vitagliano said. "But a lot of the smaller partners struggle with it, and that is why we are starting to see roll-ups happen and a lot of these small to midtier solution providers are getting gobbled up into bigger companies."
Peres agreed and said cash flow is key for solution providers looking to transform their businesses. "There is definitely a cash flow implication to partners and how fast they can transition their business model from a project-based to a recurring-based model," Peres said. "So it's something that they need to do in the proper timing to be able to manage the cash flow aspects of it. Some partners are growing faster than their balance sheet would allow them to, and they are going to be a lot more challenged."
Meanwhile, HP's Dunsire said larger solution providers have a big advantage in making the jump to a services model because they already have the infrastructure in place to support building a new practice, whether it's managed services or private or public clouds.
"If you look at the major nationals, the CompuComs, the Pomeroys and the SHIs of the world, they have built that infrastructure to support that," Dunsire said. "When you work down into more the SMB reseller, I think it is a challenge, and I think it will continue to be a challenge."
In addition, Dunsire said finding the necessary capital to fund that new business can be a challenge for SMB resellers. "There is a major investment that needs to happen, and vendors can't afford to invest in every single partner out there, right?" he said. "So you have to work with your distribution partners. You've got to leverage some of the infrastructure they put in place and really try to piggyback that to a larger community, to the masses, and really spend time working with the partners that have built out that infrastructure."
THE GOOD NEWS
Despite the considerable challenges in building a recurring revenue model, the channel chiefs said there's plenty of reason for optimism for solution providers looking to make the leap to a services model.
For example, Lenovo's Frey said there is plenty of opportunity in the SMB space to bring more services-led solutions to customers. "In the SMB market, there's room," he said. "There's lots of room, and I think that there are a lot of customers that want to buy from a local VAR."
Cisco's Peres agreed, saying solution providers can still deliver IT services to small and midsize businesses without having to compete against some of the larger national integrators. "I don't see a huge SMB push from some of the major nationals when it comes to a services perspective. I think there will always be opportunities for partners to grow in the SMB space," Peres said.
Another critical element is support from vendor and distribution partners. The channel executives described how they're endeavoring to help solution providers change their business models with more targeted, solution-specific training.
"We need to train VARs," Frey said. "We need to be on the streets training these SMB resellers in how to bring value to the customer and how to bring a service that is affordable to them versus trying to force a solution on them that they don't have the credit lines to be able to support."
And on the financial side, HP's Dunsire said major IT distributors are stepping up to offer more creative financing options to help partners grow their business and transition to recurring revenue models. "I've seen the distributors become pretty creative in making sure that these partners are healthy. I think that plays a pretty pivotal role," he said.
And, Dell's Vitagliano said, a significant number of legacy solution providers have already been changing their business models, moving away from transactional product reselling to more services-led businesses. So vendors can demonstrate to other partners that the transition, although at times complicated and painful, can be done.
"We've all been here for quite some time, and we've seen these guys morph," Vitagliano said. "They have morphed their business through a lot of different cycles, and they are still around."
Plus, the channel chiefs said, the solution provider business will be worth a lot more with a recurring revenue model than without one.
"The valuations of the partners are much higher than they used to be," Peres said. "Why? Because of the services that they have and the value that they are bringing are higher versus just being a box-mover. You are seeing eight, nine, 10 times EBITDA [earnings before interest, taxes, depreciation and amortization] as far as value of a company where before if you got four you were doing great."
Overall, as slow as the process has been for many partners, the channel chiefs were optimistic more solution providers will make the jump to healthier, services-led businesses in the future – but that the vendors themselves need to continuing encouraging the move as they transform their own businesses.
"I think your channel kind of evolves and grows with you. When you look at VMware even three years ago, it's a very different company than it is today," Rauch said. "It challenges your legacy partners to be able to accept, to be able to morph, to be able to become more agile, and to be able to develop some of the new characteristics of your company."
PUBLISHED OCT. 14, 2013