Tech Data CEO On STG's Profitability, The HP Split And Why The Server 2003 Refresh Is A Dud

Windows Server 2003 Refresh Hasn't Lived Up to the Hype

Tech Data just recorded one of its best quarters in recent memory, increasing profits by 22.4 percent, to a record $52.5 million. The Clearwater, Fla.-based distribution giant has seen its stock price rise 13.2 percent, to $63.70, since its earnings were announced Aug. 20.

Tech Data CEO Bob Dutkowsky spoke with CRN after the earnings call about why the end of support for Windows Server 2003 hasn't resulted in additional server sales, which solution providers work closely with recently acquired services firm STG, and how Microsoft is putting the heat on Google through Windows 10 and its education initiatives.

Read on to learn what Dutkowsky thinks of the HP split, the notebook market and managing overhead.

How significant was the end of support for Windows Server 2003?

I don't think it was nearly as much of a lift as what all of the vendors were anticipating. You saw all the vendors talking about how there were tens of thousands of Server 2003 servers installed that needed to be upgraded. I think that didn't cause that big wave everybody was expecting. Instead, it was more of a well-planned out transition that has happened over time. Some of those servers got virtualized up into bigger servers, some of that workload moved into the cloud, some of that workload was switched to mobile apps, and in some cases, some of those apps were just shut down.

What did that mean for server sales?

It wasn't like every one of those servers needed to be replaced with a new one. It was more of a transition that I think businesses large and small thought through logically and reacted to. When end of life came on Windows XP, you had to either get a different PC or you had to get a Mac -- you had to make a move. This time around, you didn't necessarily have to run out and buy a new server. So I think that's how it unfolded.

Do you expect a bump in server sales as stragglers refresh?

I think it's just going to continue at the pace it's at right now. As businesses make the choice to either replace or virtualize or move it to the cloud or push it out as a mobile app, that process is underway. It's hard to say, with some of the success we had in the data center -- was that actually Windows 2003 that was moving to virtualization? For example, we had a very strong VMware quarter. Was that businesses that were licensing VMware and shutting down Server 2003 servers and consolidating it onto a bigger, virtualized server? We don't necessarily know exactly how it played out.

What drove the growth in your data center business?

You have to turn back the clock first. Remember, last year, the PC just kind of overachieved everybody's expectations. Consequently, budget dollars were moved from the data center to the desktop. And now, this year, the budget dollars have moved back into the data center. In our portfolio of products, storage did really well, software did well, security products did well, some of our server product lines did exceptionally well, and that's just this pendulum of budget dollars moving from the desktop to the data center. … If the product can go with you, whether it's a notebook or a cellphone or a tablet, those areas were stronger.

To what extent was this tied to the Server 2003 refresh?

We could see the pieces of the puzzle on the table. Virtualization was up, which could say bigger servers. Storage and networking were up, which could be more smaller servers or more medium-sized servers. By the way, the average selling price for our server business was up, so the servers that businesses did buy were bigger. Bigger servers with more virtualization. That would tell me that some of the 2003 workload moved there. Mobility products were up, so did businesses change the applications into mobile apps as opposed to being centralized apps? We don't necessarily see that end-user action. We see it through the eyes of our resellers.

Where and how have you leveraged STG since it's become part of Tech Data?

It's been a really positive addition to the line card, to the products we take out to our partners. There were cases where our partners were not able to compete for business because they didn't have all of the skills necessary in the data center. They might have 75 percent of the skills, but if you don't have all of them, they couldn't actually bid on the deal. By adding STG, in some cases, that allows our partners to bid on the complete project that their customers want.

What solution providers does STG work with?

Their biggest customers are companies like SHI and Insight and CDW. They know how to work very effectively to make the partner look better and be able to serve their customer better. It's early, but we already see where our partner's pipelines are getting bigger because they're able to add STG, and that was the whole strategic reason why we wanted to acquire it.

What has the acquisition meant for partners with robust services practices?

Nothing at all. If they have the skills, they don't need STG. [But] very few partners have all the skills. It's just a question of whether they want to go out and hire the skills on their own, or if they want to "rent" them from STG. If a partner sees where they can have a really viable, long-term business, then they're going to go hire that skill. It's just makes good business sense for them. But if they have a one-time-only opportunity at one of their customers, then it doesn't make any sense for them to skill up -- then they use STG.

Do you expect STG to be material to earnings down the road?

It's a small piece in a very big company. We reported $6.6 billion in sales -- STG is tiny relative to that. STG is strategic. The revenue contribution is a long ways away from making a difference at Tech Data. It's the value that we bring to our customers that makes our customers want to do business with Tech Data. … Over time, I think that STG stands to get bigger. Clearly it's one of the most profitable things that we do. But it's small, so we have a real desire to get it to be bigger. But it will only get bigger as our customers need that kind of resource.

Is STG operating as a standalone business unit?

Yeah, it really is. It's integrated into our Advanced Infrastructure Solution [AIS] business and managed by the executive that runs AIS, but we've left it kind of alone so that it's unique. They don't sell products. Our main business is to sell products, and they sell services. And it's a different mentality. So , rather than try and hammer it into the Tech Data business, put a square peg in a round hole, we've kept it separate on purpose. … Charles Layne [pictured], who was the CEO of STG, now reports to Chuck Bartlett, who's the [executive vice president] of our data center practice in the Americas. But really, they're like teammates.

How specifically does STG enhance partner offerings?

There's no two of those that are alike. One partner will have operating system and storage skills but not networking, and STG can fill in the networking. The next customer might have networking and operating systems, but not servers, and STG can fill in the servers. So it's not like one size fits everyone. Each one is unique, and that's one of the things we really liked about STG -- because it's a partner-driven model, they know how to make the partner look better in the eyes of the customer.

What's the long-term vision for how partners interface with STG?

A few partners have come to us and said, "Hey, this is great. This means I don't have to hire a person and get them certified in that platform when I don't even know where the next sales opportunity is going to be in my territory." … Others have said, "Oh, that's great. We'll use STG and we'll learn from them, and then we'll have our own talent that will backfill that." … We have 115,000 customers that, at some point and time, are going to need STG's talents. We're not looking for lifetime dancing lessons with our resellers. … It's not our model to fight with our customers.

Did you cut overhead to remain in the lower-margin PC business?

We didn't consciously cut SG&A [sales, general and administrative expenses]. One of our competitors has announced restructuring programs where they're literally cutting structure [Ingram Micro said in July that it is slashing up to 540 jobs as part of a $100 million cost-cutting program]; in our case, we're just optimizing our structure and growing into it. So if you have a lot more sales, then the percentage of your SG&A goes down relative to your sales. In our case, we're growing our sales and keeping our SG&A consistent or slightly down because of the efficiencies we can get from our IT systems and our logistics capabilities and things like that.

Is Microsoft gaining market share from Google in K-12?

I think it went through a cycle where, for a long time, it was a Windows world. Then Chromebook came up and took a position there. And Windows 10 now is taking a new position. So K-12 is becoming some kind of hybrid between Windows and Chromebooks. The beauty is, we sell all of that, so we don't really care what direction a particular school district goes. We have all of the products. We don't have a dog in the race. We like Windows and we like Chromebooks.

Has the release of Windows 10 put Microsoft on more equal footing with Google?

Oh yeah. I think Windows 10 is a very competitive product, certainly in the enterprise space. That permeates all the way down to state and local [government markets], and K-12, and all the way to the home. When there's more competition in the market, that's a good thing. More competitive platforms, more competitive operating systems, more competitive networking, security and server products. Competition is good, and the secret of the Tech Data model is, we carry all of those products. So we're a big fan of the competition.

What's driving your notebook sales growth?

Last year, there was a lot of desktop growth. Now this year, I think the age of fleet of the laptop business is causing replacement. Laptops and notebooks take a much bigger beating than does a desktop. Somebody's briefcase thrown in the overhead of an airport, dropped in a cab. Those things get beat up over time, so they just have to get replaced. So last year, businesses were replacing the desktop and were just saying to their users, "Keep that notebook another year. I realize that it's big and tired and heavy and slow, but keep it another year." And now, a year fast-forward, they're replacing the old ones.

What's the outlook for notebook sales looking forward?

That's a never-ending cycle. Those products, they wear out. They have to be replaced. I don't happen to believe that the PC and the notebook are dead. They've become very purpose-built products. The desktop does more heavy computing, the notebook does mobile computing, the tablet does content delivery, and the cellphone/phablet is a hybrid of all of that that goes with you everywhere. None of those die -- they just find their own position in people's lives, and people might decide that they need all four of them, ultimately.

How much adoption of Windows 10 have you seen among enterprise customers?

It's starting. … We're not looking in the eyes of the CIO and saying "how fast are you going to deploy Windows 10?" But I think it's beginning to get some footing. The reviews that are out on it are all really strong. It looks like a very solid product. I think it's going to gain traction. Where we see it the most, clearly, is the adoption of Surface. Surface is Windows 10, and if it's not Windows 10, it gets upgraded to Windows 10 very quickly. Our closest view we have is the momentum that Surface has, and I think that's partly driven by Windows 10.

How has the release of Windows 10 affected the tablet market?

Our Surface business was up over 20 percent in the quarter. That tells me that form factor of a very portable tablet with a real keyboard and Windows 10 is a winning form factor. That used to be an iPad or a notebook or an Airbook. And we saw all of that stuff. But the Surface has captured a space there that is very attractive. And we're all in on Surface in all of our geographies. We're a big player with Surface.

What impact has the HP split had on you and your partners?

They're done a marvelous job of a [project] that no one has ever attempted to do before. To split a Fortune 5 company into two distinct companies is a massive undertaking. … HP did a ton of work internally, but they relied very heavily on input from companies like Tech Data. We worked hand in hand with them for the last year and a half to help them go through the process of the separation through the eyes of the channel. It sounds like kind of a simple thing. … But behind the scenes, there's a tremendous amount of work on the IT systems that make that volume flow every day.

How did Tech Data assist HP with the split?

We were in collaboration mode with HP from the beginning to make sure that their systems and our systems were communicating correctly, and the pricing schemes, and the catalogs were right. … From our point of view, we've done everything they've asked us to do. In terms of IT projects, in terms of inventory so that we're prepared to support the partners that buy HP products. … When November comes and the split actually happens, I think it's going to be a relatively smooth process. … This is like putting a man on the moon. It's really hard stuff that they're doing, and they're doing it very well.

What changes can HP partners expect to see come November?

At the end of the day, I think one plus one is going to equal three when it comes to HP. The idea that these business have got to be more competitive on their own should cause research and development and in investment in innovation. Both sides of the new HP, I think, are going to be better. They'll have more competitive products, they'll have a more competitive coverage model. Both sides of HP are totally committed to the channel, and I would suspect that not being encumbered by the other side of HP, each side is going to have more finely tuned channel programs that we'll get to work with.

What has driven your state and local government sales success?

It's been across the board. It's been everything from the desktop and notebooks all the way up through the data center products. Networking, security, a broad array of products that support enterprises like state and local governments and municipalities. They're just like a business -- they have to have scalable computing, they have to be secure, they have to have networking capabilities to tie the remote units of the business together. A town and a business are not that far apart. It's the same set of products. Again, the breadth of our product line is what really helps us there.

How is this year's federal buying season shaping up?

Our business is big in federal governments, but not that big in the U.S. federal government. So, for example, we're very big with the Canadian government, we're very big with several of the federal governments in European countries. We're not that big in the U.S. We're more state and local, K-12, municipalities in the U.S. We have a federal business, but it's not that large. We do business in 100 countries, so federal means 100 countries' federal businesses. The U.S. just happens to be one of those 100, and we're not that big here, but we're much larger in some other countries. Therefore, the global federal business has been pretty healthy.

How is Tech Data planning to capitalize on the payment card industry liability shift?

I honestly don't know the answer to that question. I'm sure that we have people looking at it, but it's not at the top of my radar screen. … Those kinds of initiatives eventually find their way to distribution, but distribution seldom leads the way in that stuff. I'm sure that we have a bunch of people in our finance and accounting side that are looking at the impact that's going to have, whether there's different kinds of products we might be able to offer into the market, but it's not on the top of my radar screen.

What should Tech Data partners be watching for in the next quarter?

The beauty of our model, and the fact that we have so many customers, is that when one product might be down, another product area is up. Part of our job as a distributor is to point out to the partner where those hot areas are, and make sure that they're focused on those. If they need skills, we help them get certified, we help bring market opportunities to them, we do demand generation programs for them. All of it wrapped together is why they do business with someone like Tech Data. We're constantly expanding those sets of values that we bring to our customers to help them grow.