Analyst: Smaller Solution Providers ‘Will Be Left Footing The Bill’ Amid Memory Crunch

‘The larger, national kind of partners that have scale, that have large customer bases, that have buying power and selling power, I think will be in a better position to weather the storm and find pockets of positive, profitable opportunity,’ said longtime channel analyst Alex Smith.

Longtime channel analyst Alex Smith said he is optimistic that solution providers will ultimately succeed in the face of supply chain volatility caused by the global memory shortage, but he admitted that smaller companies will likely face greater margin challenges.

“A lot of partners who are smaller—midmarket partners, specialist partners—will be left footing the bill in some of these things,” said Smith, a former Canalys analyst who is now vice president and leader of the ecosystems, channels and marketplaces at Austin, Texas-based research firm The Futurum Group.

Smith spoke to CRN last week about the impact of ongoing price increases and fluctuating availability of servers, PCs and other products in the channel. These dynamics, caused by a shortage of DRAM and NAND chips, have prompted OEMs to shorten price quote windows and change other ordering terms for channel partners.

In some cases, vendors have warned that product prices can go up after orders are placed but before they are shipped. And some have suspended certain incentive programs.

All these ripple effects are putting unprecedented margin pressure on solution providers as deals become more complicated and customers ask partners to absorb some of the extra costs—but Smith said larger solution providers are likely better equipped to handle the blows.

“The larger, national kind of partners that have scale, that have large customer bases, that have buying power and selling power, I think will be in a better position to weather the storm and find pockets of positive, profitable opportunity,” said Smith, who is also general manager of the firm’s Futurum Research division.

Smith said he believes some customers will be amenable to price increases, which could help solution providers increase margins on hardware deals.

“On one hand, there is going to be a natural inability to hit [the] top line just on the basis of getting access to product, hence the ‘shortage’ being the key term there,” he said. “But on the other hand, those that have the kind of customers that are really willing to go above and beyond to get access to infrastructure will see a benefit from the increase in price.”

The analyst said he thinks “it will be somewhat reminiscent of” what happened during the COVID-19 pandemic in the early 2020s when “channel partners, especially volume partners that are doing big hardware sales” performed “really well.”

But even then, the analyst said, uncertainty still looms.

“A lot of those similar traits remain where it absolutely is hard to get that answer as to, ‘Am I going to have a product available? If I have a customer, what is the price going to be of that product? How long is it going to take to get here?’” Smith said.

“And so it does take a lot more work and effort to get answers to that and to get confidence to land product in a customer environment,” he added.

Here is more of CRN’s interview with Smith, who talked about why he is optimistic about how the channel will fare during the memory shortage, why OEMs are shifting ordering terms and suspending incentive programs, and the need for such vendors to be as transparent as possible about changing conditions.

To what extent do these component shortages and their ripple effects pose threats to profitability for solution providers?

I’d start by saying that this was not an unexpected thing. I was first hearing about expected shortages landing in the market as early as the October time frame last year. And obviously it takes time for that communication and the actual effects to land in the market.

But I think this—unlike events that you don’t see coming, like COVID—is one that was pretty visible and obviously stems from the amount of capacity that hyperscalers are hoovering up [for AI data centers]. So the OEMs started communicating. Partners started trying to get in line and position themselves to be in the best position possible to mitigate this.

And I think anytime that there are these kinds of shortages, it’s a double-edged sword. On one hand, there is going to be a natural inability to hit [the] top line just on the basis of getting access to product, hence the ‘shortage’ being the key term there. But on the other hand, those that have the kind of customers that are really willing to go above and beyond to get access to infrastructure will see a benefit from the increase in the price and an improved ability to make slightly better margin on that.

So I think in some respects, it will be somewhat reminiscent to the COVID period where channel partners, especially volume partners that are doing big hardware sales—they really did well. Granted, there were still some of the big buyers at that stage. I think there’ll be more of a question as to can they even get access to product.

So you were saying that with the increases in prices, that actually could improve the ability for solution providers to increase margins?

Yes, just by virtue of having higher-price products, more premium products. And then you have to look at the price elasticity: What’s the point where customers will say, ‘No, we’ll just sweat our assets’ versus pulling the trigger? If the prices are going up, there’s just more room in the margin stack to eke out a couple more percentage points. Now, granted, the cost goes up as well. So [when] prices go up 10 percent it doesn’t mean their margin goes up 10 percent, but they have more room in that price profile to extract a little bit more margin from the product. So as it blends out for the business, I think there will be some that will see some positive tailwinds on the back of this.

Some of the partners we’ve spoken to—these are more midsize partners, not super small but not big either—from what they’re telling us, they’re grappling with customers who really don’t have headroom in the budget for higher prices. These partners are taking a margin hit because, in some cases, they’re trying to not pass on the extra cost to customers. There was one system integrator in the Washington, D.C., area who told us that government customers were pretty close to dictating how much margin would be acceptable for this partner to make.

I don’t want to ignore that side of the equation. And I think you’re also seeing the OEMs changing their terms, shortening the quote validity windows, preserving the right to cancel shipments or even change pricing right up until the point of shipment occurs. And I think everywhere along the value chain is trying to strike that balancing act of where can they win the best deal versus not having anything at all.

So if you just flow through that value chain, starting right at the beginning, where the crux of this is happening at the memory level, if on one end, you see some of these big hyperscalers that are doing long-term commitments, big deal cycles, etc., that’s clearly why there’s the lion’s share of attention and [a lot of] product going [in] that direction.

And then as flow-through, likewise, the OEMs, the reason why they are changing their terms is because as they are getting price increases, they want to manage the sell-out on their side, and so they want to be able to ensure that they don’t take a hit and that they can sell it to the customer that’s willing to pay the most.

And then you get down to the channel partner, and unfortunately for them, their stage in the value chain might mean that if they are a local [Washington,] D.C., partner servicing the government—and that is a huge portion of their business—then they don’t really have many levers. It’s either they lose the business or they win it but with maybe a less attractive margin profile.

So for sure, I definitely don’t want to discount that scenario. And a lot of partners who are smaller—midmarket partners, specialist partners—will be left footing the bill in in some of these things. I think on the flip side, the larger, national kind of partners that have scale, that have large customer bases, that have buying power and selling power, will be in a better position to weather the storm and, again, find pockets of positive, profitable opportunity.

We spoke to an executive at one of the larger solution providers in the U.S. who gave us the sense that large companies could potentially be better equipped to handle the volatility in the market.

That’s for sure, true, but I think partners, even the smaller channel partners, shouldn’t be afraid to let their customers know the reality. I think everyone, in any walk of life, when there are additional cost line items that go into a product—whether it’s due to economic factors, i.e. shortages, whether it’s due to political factors like tariffs—it changes the cost profile of a product, and in some cases, you will see the sellers doing what they can to absorb those costs, and especially in a blended portfolio environment.

If as a company you’re budgeting to 10 percent gross margin and then you’re seeing one part of your business fall to 5 percent, maybe there’s another part of the business that is going to [increase to] 15 percent and then you land in where you want to be. So I do believe that companies will try to do what they can to mitigate these costs.

But the sellers themselves are the ones at the front line, and oftentimes they are targeted on gross margin. They will be seeing these increased costs coming from their price books, and so they’re not going to be super incentivized to take a hit because that comes out of their pocket.

So ultimately, I do think that where possible sellers will try to pass this on to customers. And if anything, we’re in a transition window where if you have that negotiation and conversation [that] was happening over here and now the prices are coming, that transitionary window is always more complicated. But then you gradually get to a place where this is a new reality now, at least for the time being.

I’m optimistic that in the net-net, partners will do well. And again, I just turn back to the pandemic as a recent case study on this. Different circumstances, but I think most would agree that partners selling hardware did really well in the pandemic.

One thing that we’ve noted among the various solution providers we’ve talked to is just the significant increase in man-hours for getting deals through to the finish line because of the shifting ordering policies, shorter price quote windows and fluctuations in availability. And so it seems like there’s a lot more going back and forth between the vendor and the customer. One CEO said this is definitely an extra cost for them. And it seems that the OEMs don’t really have a choice with these fluid pricing and ordering policies. But this does seem like an extra administrative cost for the solution providers. Are you seeing that in the channel at all?

Those kinds of costs are harder to fully pinpoint because they are time-sunk costs for salaried employees. It just makes for a much more challenging environment and, again, I keep bringing this up, but it’s very similar to the pandemic times where there were some vendors whose supply chain visibility, transparency [and] systems they had around were just not equipped to deal with that type of event.

So it was very similar in the sense of trying to understand what the inventory levels were like, understanding ship times [and] understanding where products were in in any given state of time. And a lot of those similar traits remain where it absolutely is hard to get that answer as to, ‘Am I going to have a product available? If I have a customer, what is the price going to be of that product? How long is it going to take to get here?’ And so it does take a lot more work and effort to get answers to that and to get confidence to land product in a customer environment.

It just all stems from these critical componentry points. We are still hyper-reliant on a few choke points in the world. The causes are different, but the characteristics and one of the ways in which things manifest are similar. I think channel partners in hardware have their work cut out for them this year. I think these are always good reminders of any time the role of the channel is questioned or being put in doubt. I think it’s moments like these that show it can be difficult to get product to the right customer at the price point, so it’s a good thing there’s still a channel to help do that.

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We’ve reported on some OEMs canceling or pausing certain incentive programs. For example, Cisco ended compute promotions and discount incentives, including deal registration, because of the rising memory prices. And then Lenovo paused new customer bonus nominations for partners winning data center product deals with new customers. Have you seen any activity like this?

I haven’t heard those specifics, but if I were to assume, the [OEMs] would have budgeted for incentives at a certain price point, and they’re seeing that the price points are changing quite, quite dramatically, and these incentives probably don’t match with the kind margin profile that they are looking to get from their channel business.

So again, I haven’t heard about specific changes, but I would just say I’m not surprised given everything that we've discussed so far. When you’re planning for this, you plan for a certain budget and when you have things like this that are dramatically changing the profile of the business, then you have to revisit some of that.

Is there anything else you would like to add for solution providers facing these issues?

I would reiterate a tone of optimism, and just again for everything I said, yes, it will be hard work, [with] more complexities, lots of communication [and] friction.

Visibility is probably something that carries a lot more weight in this kind of environment. And that’s also a note to the OEM vendors who are working with partners. I remember during the pandemic—I won’t say which vendor—but there was one vendor whose supply chain system was just a mess, and their ability to get information out to partners was awful. I think the best ammo that [partners] have as the front line to customers is being able to provide those soft-factor touches around, ‘This is what’s happening, this is the state of play right now, this is what we think the best course of action is,’ and being able to navigate those waters. But if they don’t have that information or if the information changes on them, then they’re the ones that are going back to the customer and look bad and have egg on their face. So I think transparency and communication are the winning tools in supply-constrained environments like this.