Service Charge: How Recurring Revenue Models Are Changing The Channel Financing Game

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While one of the top benefits touted about cloud and managed services is its affordability, traditional VARs looking to move to recurring revenue models often find that transformation to be expensive.

When his company first broke into managed services, Tim Burke, CEO of Quest, said he had to make significant investments in infrastructure, training and software. While some other companies see the move to managed services and cloud as an inexpensive one, he said, those companies are often just skimming the surface of the services market through third-party systems instead of building a full practice from the ground up.

The problem with making big investments in services, Burke said, becomes finding a financing company that understands cloud and managed services and is willing to invest in that model, or at least believe in the underlying balance sheets of the established reseller business.

[Related: Channel Financing Week]

"The challenge in the managed services space and the cloud space is you invest in infrastructure and capacity and obviously finance that unless you have deep pockets and can do it yourself," Burke said. "But how do the financial people look at that model?"

Dan Ransdell, general manager of IBM Global Financing in North America, said that, in his experience, many solution providers start off thinking they can do it themselves but ultimately find out that the transition is not that simple -- or inexpensive. Solution providers frequently view the transition as flipping a light switch, he said, when there is usually a longer transition period for services and resources, resulting in duplicate costs.

Many different parts of the market had to re-evaluate as the cloud transformation changed how customers and companies think about their IT assets, according to Susan Middleton, research director for IDC's Technology Financing Strategies and Technology Valuation Services programs.

"The whole industry is going through this seismic change, so regardless of where you play you're undergoing this big change. Change is good, but it can be difficult," Middleton said. "At the end of the day, there are many different parts of the market that had to change."

The problem is, not all financing options are evolving quickly enough to mirror the market's move to a recurring revenue model, solution providers and financing companies told CRN. There are plenty of options, from traditional banks, to vendor or distributor programs, to venture capital, but the real trick is finding a financing company that understands the new business model, Quest's Burke said. That can be harder than one might think, he said.

In fact, Burke estimated that 70 percent of the traditional financial community doesn't understand the cloud and the new recurring revenue models. In his own search for financing, Burke said he has tried to explain it to many banks as similar to a real estate model, such as how a business might buy an apartment building to lease out apartments. He said some banks, such as the Silicon Valley Bank, have worked to understand the model, but others have had a hard time or are completely disinterested.

"You have to zero in very quickly with financial organizations. Do they really get it?" Burke said. "You have to really zero in on someone who gets the concept of what you're doing and understands."

IDC's Middleton agreed, saying that banks are working to adjust to the newer models and often rely on a company's previous history and credit as a basis for financing, instead of looking the evolved business model, which might be unfamiliar to them.

"[Understanding it is] something that everyone's capable of, it's just a different sort of mind-set," Middleton said. "I think banks are adjusting but [the business] needs to be a known entity and you have to have a track record. It's more of a loan or project-based financing, now it's just a different model and sometimes change is hard."

The cloud and managed services models are difficult for banks in particular because they lack that collateral on which traditional hardware reselling financing was based, said Robert Wagner, managing director of business development for Wells Fargo's Supply Chain Finance Group. Banks such as Wells Fargo are collateralized lenders, he said, with the reseller's hardware product acting usually as the collateral.

"The landscape has changed a lot," Wagner said. "The channel is moving more toward managed services and the cloud-based recurring revenue models. Those are new models for us to finance, but we're used to product financing."

With cloud and managed services where the value is tied to long-term service contracts, banks have to adapt their model and find unfamiliar kinds of collateral, whether it is liquidity or additional assets. One way for banks to offset that risk, Wagner said, is to use the OEM partner behind the deal, which can serve as a "backstop" to make sure the solution provider stays on track with its business and services.

NEXT: Financing Based On Numbers, Not Technology​

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