Channel Chief Roundtable: Partner Profitability, Valuations Soaring

It's a good time to be a solution provider, according to some of the top channel chiefs in the IT industry.

During CRN's recent Channel Chief Roundtable at XChange Solution Provider, the channel executives discussed how partner profitability and valuations have greatly increased in recent years, thanks to a number of different factors.

"We do profitability surveys every year and kind of check on the health of the partners," said Edison Peres, senior vice president of worldwide channels at Cisco systems. "They're actually higher now than they've been in a long, long time. So I would say we're at a height, if you will, on the value."

[Related: Channel Chief Roundtable: Cloud And Managed Services Demand A New Partner Approach ]

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In addition, Peres said, valuations of solution providers are climbing, as many companies are seeing eight to 10 times EBITA (earnings before interest, taxes and amortization) instead of just two or three times EBITA 10 years ago.

So what's driving those profits and valuations upward? First, more solution providers are focusing on higher-margin professional services, Peres said. "I would say that even if you're born in the cloud or if you're not born in the cloud, I think, generally speaking, the economics of the partner community is actually doing well," he said.

Concentrating on services alone won't cut it, the channel chiefs said. Solution providers have to find the right kind of business model to deliver those services and earn higher profits. "I don't think [partners] are giving away their services the way they used to," said Jesse Chavez, vice president of worldwide channel strategy and operations at Hewlett-Packard. "They've learned that, in a lot of ways, they have to charge for their services. I think that is helping their profitability."

In general, the channel chiefs said partners that have adopted recurring revenue streams around cloud and managed services are the ones driving the profitability and valuation increases. For example, Cindy Bates, vice president of Microsoft's U.S. Small and Midsize Business division, said solution providers that have made the shift are reaping the benefits.

"If you look at the partners and our data, we say about 13 percent are fully cloud-transformed," Bates said. "Those guys have figured the model out, and they've got rockets on them."

But the channel chiefs said there is a divide between the old and the new. Solution providers that have embraced high-value services are thriving, while partners that are sticking with the traditional product reselling model aren't faring nearly as well.

"The good ones that differentiated themselves, where they've got some unique cloud-based offerings and some unique services, are approaching eight, nine, 10 times EBITA," said Frank Vitagliano, vice president of North America channels at Dell. "With the other guys that are running around still in the old model, it's significantly less."

As a result, the vendors themselves are putting more emphasis on various services opportunities -- and sometimes less on their products -- as way to strengthen their partner bases. Tami Duncan, IBM's vice president of global business partners for North America, said IBM's top services-focused partners may not be doing 70 percent or more of their revenue with IBM, but that those partners are usually the strongest companies from a financial perspective.

"The partners that are big enough that they've kind of gotten it and they've made the shift, they're doing fairly well," Duncan said. "I'd say that very low tier, maybe they're a vintage VAR, maybe they're a very lifestyle VAR, probably not as healthy as they were, and they will need to make a change relatively quickly if they want to move to the future."

The message from the roundtable was clear: Solution providers must adapt to the changing IT industry or become extinct. "There’s a lot of money in the channel right now. Valuations are great. There's a lot of cash. There's lots of opportunity," said Frank Rauch, vice president of VMware's Americas Partner Organization. "But [the lifestyle VARs] are probably not going to survive."

NEXT: Recurring Revenue Shifts

The channel chiefs agreed that the more recurring revenue and annuity streams a partner has, the stronger financially the company tends to be. "The recurring revenue piece to me is an indication of the health of that partner," Vitagliano said.

Plus, the channel executives said, recurring revenue streams raise the valuation of that solution provider; having long-term service contracts instead of a series of individual transactions makes a solution provider more financially attractive and secure.

The roundtable participants said most of their partners are moving toward services-based recurring revenue models on their own, but that hasn't stopped the channel chiefs from sounding the horn to their respective partner bases.

For example, Peres said Cisco is incentivizing its partners to embrace cloud and managed services. But he also said that, thankfully, many partners are taking the initiative and moving that way already.

"We do have a program that is a managed-services and cloud-based program that tries to motivate partners to move in that direction," Peres said. "But I think they're doing that naturally. Once they understand the value of managed services and the fact that it's more profitable and you lock your customers in a longer period of time, they want to go there."

And it's not just about incenting the partners, according to the channel chiefs. For example, Bates said Microsoft is incenting its own salespeople to drive more annuity-based business, whether it's enterprise software or cloud, through channel partners.

Chavez said HP is taking similar actions to develop go-to-market approaches that emphasize annuity streams, particularly around cloud services. "We're looking at models where, for service providers that are providing cloud offerings, we actually started paying some of our people on some of their recurring revenue so that we can incent that overall behavior," Chavez said.

Many solution providers are heeding the call from vendors to up their services play and boost their profitability.

Ben Johnson, founder and CEO of Liberty Technology, Griffin, Ga., said the company has shifted from product reselling to focusing more on its own OneSource brand of managed services for infrastructure, cloud and printing. He said the move to managed print services was particularly impactful for his business by increasing margins and deepening ties to clients.

"We became a managed print services provider because we got tired of just selling the hardware and doing all of the support and services for next to nothing," Johnson said.

Bob Goldstein, CEO of Single Digits, a networking solution provider based in Manchester, N.H., said the company's services allow it to reach more customers and solve more problems than just focusing on particular vendor products. Founded in 2003, Single Digits has grown its services portfolio with such offerings as wireless network management and its 1Cloud brand for business connectivity and voice/data services.

"Even though our customers have a lot of similar needs, they have different requirements when it comes to business and technology," Goldstein said. "As a solution provider, I think our services give us the ability to address more of those requirements."

Still, the shift from a transaction-based model to a recurring revenue model isn't easy. "These guys that have built their businesses in the last 15 years selling a big mainframe, they get a bunch of margin, and that's how you run your business," said Rauch. "Now all of a sudden it's coming in dribs and drabs."

That transition to smaller, incremental revenue instead of one big payday can be a painful adjustment, Rauch said, so VMware is helping to ease that transition by paying partners up front for the first year of a hybrid cloud deal instead of paying them on a monthly basis.

Still, many solution providers haven't made the jump to a services-led model or recurring revenue streams. As the demand for cloud and outsourced IT services grows, the channel will continue to evolve, according to the roundtable participants. And so will the vendors' approach to partners. Duncan said IBM, for example, is altering its channel revenue model around cloud and Software-as-a-Service.

"We're not in the endgame yet," Duncan said. "This is going to be a complete game-changer for how we compensate our channel and how our channel recognizes revenue."

In the end, the channel chiefs said it's incumbent on vendors to help solution providers change their business and encourage better financial health and higher valuations in their partner communities. "What we can do as vendors, not so much from an incentive standpoint, is more of a training [approach], more about helping them understand that new model, and providing them with some support and guidance relative to changing the business model," Vitagliano said. "It's all about changing the business model."

PUBLISHED APRIL 23, 2014