Value-Added Services: Bottoms Up

Solution providers are anticipating a good year in 2007, and it's definitely not because they're expecting bigger discounts from hardware and software vendors.

Channel partners are projecting increased profitability and revenue growth approaching 25 percent this year as services make up a bigger portion of solution sales and boost average selling prices, or ASPs. That's according to the results of the 2007 VARBusiness State of the Market survey of 477 solution providers in North America. Services accounted for 50 percent of VARs' revenue stream in 2006, the survey found, and 60 percent of their net profit.

Among the other findings: The average tenure of a VAR's customer relationship is almost nine years. Nearly half of VARs' revenue comes from selling to vertical markets. And wireless, security and storage are high on VARs' lists of technology to add to their portfolios in 2007.

The State of the Market results reflect several long-range trends among solution providers: VARs are putting more emphasis on professional/consulting, technical break-fix and managed services today than on pushing hardware and software; and sales and marketing skills, not just superior technical capabilities, are increasingly important in winning and keeping customers.

No longer do VARs' fortunes rise and fall with the level of discounts offered by hardware manufacturers and software developers. "More solution providers recognize that their destiny is in their own hands and isn't dictated by the vendors," says Ryan Morris, channel intelligence director at CMP's Institute for Partner Education and Development. (IPED is a part of the CMP Channel Group, which publishes VARBusiness.) "There's no way to stem the tide of commoditization if all you do is resell. The way to turn that around is effective differentiation at a branding or real competition level and the ability to generate proactive demand."

That's born out by the percentage of VARs that, when asked what enabled them to continue doing business with customers for multiple years, cited first and foremost their relationships with their clients (94 percent) and offering them the best service (75 percent). That far outweighed more transaction-oriented factors such as best product (28 percent) and best pricing (21 percent).

NavigateStorage provides businesses with a range of data protection, archiving and disaster-recovery solutions. Much of the company's revenue still comes from storage hardware and software, but president and CEO Jim Addlesberger says the value his company provides is the expertise it offers in data-protection systems and processes, and its experience working with technologies from multiple vendors.

Premise, a VAR in Clearwater, Fla., earns roughly 50 percent of its revenue through hardware sales, with services and software accounting for 35 percent and 15 percent of sales, respectively. But that's changing.

"The trend is definitely toward more services," says president Robert Nowels. Premise's forte is deep expertise with the IBM iSeries servers that the company resells and experience implementing high-availability and disaster-recovery systems.

NEXT: Services paying off for average selling prices, too

There's evidence that the increased emphasis on service and customer relationships is paying off in higher ASPs too. Of those surveyed, 33 percent said the average selling price of their typical IT solution had increased in the past 12 months, while 50 percent said it held steady. Only 17 percent said the ASP had declined.

VARs that reported higher ASPs cited increased demand from customers (66 percent), the ability to offer more services (47 percent), and better sales strategy and sales management (43 percent) as factors. For those reporting lower ASPs, competitive market pressure was far and away the leading culprit.

Server and storage hardware prices continue to drop, but Nowels says that means customers have more to spend on new or upgraded applications and more sophisticated high-availability systems. "We try to avoid 'commodity' situations," he says.

Establishing and managing sales goals is the top sales and marketing priority cited by respondents, followed by greater management focus on sales.

Surveyed VARs said they did business with a typical customer for an average of 8.7 years. That number was lower for smaller VARs with annual sales of less than $1 million (8.3 years), higher for midsize VARs with sales of $1 million to $9.9 million (9.3 years) and higher also for large VARs with sales of more than $10 million (11 years).

Solution providers attributed nearly half (48 percent) of their overall revenue to sales into vertical markets. Of those sales, survey respondents classified 54 percent as industry-specific vertical solutions and 44 percent as general horizontal solutions to similar businesses.

North Carolina Software Support, Wake Forest, N.C., is one VAR that relies on its vertical-market expertise to grow the bottom line. The company, which provides services to the banking industry, enjoyed "a little bit of an uptick" in 2006, says Jay Yovanovich, senior vice president of operations. He expects things to hold steady this year, or even to grow a little.

On the whole, surveyed VARs said that 50 percent of their revenue in 2006 was generated by consulting, break-fix and managed services, while only 26 percent of their revenue came from software sales and 24 percent from hardware sales. Small VARs reported generating 52 percent of their revenue from services, compared to midsize and large VARs (45 percent and 42 percent, respectively).

Services are also more profitable: Solution providers said 60 percent of their net profit was derived from their service offerings. For small VARs, that figure was 63 percent.

Professional and consulting services, on the average, account for 51 percent of all services-generated revenue, followed by technical break-fix services (33 percent) and managed services (16 percent). The latter, which include monitoring, managing and servicing a customer's IT system, account for a bigger chunk of service-related sales for midsize and large VARs.

Surveyed VARs said that, on the average, 45 percent of the revenue they derived from software came from shrink-wrapped products, 33 percent came from custom-built software, and 22 percent came from vendor software that they customized.

VARs' great expectations for 2007

Solution providers have high expectations for 2007. Nearly 34 percent project sales growth of more than 15 percent, while 47 percent expect growth in the range of 5 percent to 15 percent.

Although things got off to a slower start in 2006 than they did in 2005, business has been booming since September, says NavigateStorage's Addlesberger. "The activity level and opportunities we're working on are as high as I've ever seen," he says, noting that his company has almost $1 million of contract proposals outstanding. He can't say for sure what's driving the sudden demand, but he's hoping it continues into 2007.

Solution providers are a little less confident, though, about their 2007 profit margins. Only 19 percent anticipate net profit gains of more than 15 percent, while 46 percent expect gains of 5 percent to 15 percent. Almost 31 percent expect little change in their bottom line, and 4 percent expect reduced profits.

That isn't stopping VARs from thinking about expanding their businesses with new products and technologies. Asked what technologies are high on their list of things to add to their product lineups, 45 percent of survey respondents pointed to wireless technologies. Security software was cited by 35 percent, while 33 percent listed the old standby of desktop and laptop PCs.