How Do You Measure Up?

Some solution providers dream of the days when their businesses generated 65 percent gross margins. For the Best in Class solution providers surveyed as part of CMP Technology's Institute for Partner EducationDevelopment's ongoing profitability research, that dream is a reality.

Best in Class (BIC) solution providers average 65 percent blended gross margins—a combination of hardware, software and services—compared with an industry average of 35 percent. What's more striking is that those eye-popping margins weren't the result of any one-time deal or unusually strong quarters but came about because of consistent patterns of behavior and business models geared toward maximum profitability, said Ryan Morris, director of channel intelligence at IPED, a sister organization to CRN.

And Morris said virtually any solution provider can emulate BIC qualities to improve profitability within his or her own business. "What we are looking for are patterns of behavior that any company can implement and sustain over time," he said.

IPED's focus on solution provider profitability comes at a time when the channel isperhaps undergoing its most dramatic metamorphosis yet. Solution providers that entered the channel some 20 years ago were often businesspeople who saw an opportunity in technology. Many younger solution providers, by contrast, are technologists who saw an opportunity in business. As such, they must learn basic business skills such as marketing, cash flow management, hiring and retaining employees to hit the profitability bars of BIC solution providers.

"We have a business here that's doing its thing and everyone goes home with a paycheck, but we haven't seen that type of business opportunity [BIC gross margin numbers]," said Michael Demars, president of Competitive Computers, a Claremont, N.H.-based solution provider that specializes in small businesses and has annual revenue of about $2 million.

Demars said he started the company when he was 15 years old because he loved technology, but acknowledged he lacks some basic business skills that could lead to more profits. "I'm not convinced that I'll ever quite get to those numbers, but I also feel like that I need to know more [about the IPED study]. I've gotten the technical education over the years through many certifications and training, but I can't really write a business plan."

Next: Slicing and dicing the Profitability Study results

IPED's BIC numbers were derived by taking results for the top 20 percent of solution providers measured in 155 different categories and averaging their numbers.

A maniacal focus on the bottom line helped the BIC solution providers hit a gross margin number close to double that of the typical solution provider, the IPED data show. Product margins for the BIC group averaged 47.6 percent vs. 25.8 percent for the rest of the channel universe. BIC consulting margins were 37.8 percent vs. the industry average of 27.5 percent. And managed services margins for the BIC reached 30.2 percent vs. 23.7 percent for the other VARs.

The average deal size for BIC partners was almost 20 percent higher than for non-BIC solution providers: the average transaction for a BIC solution provider totaled $43,000 vs. the industry average of $36,000. Customers handled by BIC solution providers, as measured by annual revenue, also tended to be larger than those managed by average VARs, IPED finds.

For example, 27 percent of total revenue for the BIC group came from customers with annual sales of more than $250 million, compared with 22 percent for the industry average. Likewise, while 50 percent of the average solution provider's revenue came from companies with annual sales of less than $10 million, the BIC group derived 46 percent of its sales from this client group.

BIC solution providers, too, kept a tight rein on cash flow. Their net working capital, the length of time receivables are outstanding, totaled 7.8 days for the BIC group vs. 26.8 for the average solution provider.

Not surprisingly, the BIC solution providers embraced business models that tilt more heavily toward services and away from product sales than did the average solution provider. BIC solution providers derived 25 percent of their revenue from consulting services vs. 19 percent recorded by the average VAR. Conversely, the BIC solution providers generated 40 percent of their sales from products vs. 45 percent for the average solution provider.

BIC solution providers also supported a higher percentage of billable hours during which employees can fuel their services-oriented business models.

Next: A look at billing, marketing and training

Seventy-five percent of the time logged by BIC solution provider employees was classified as billable hours. Among the industry-average VARs, approximately 58 percent of the hours logged by employees was considered billable.

The BIC group also invested heavily in keeping their employees highly trained. BIC VARs averaged 9.2 days per quarter in training for each technical engineer and 6 days per quarter for technical sales people vs. 7.6 days and 4.7 days, respectively, for the average VAR.

BIC solution providers spent more on marketing, training and infrastructure than did the average solution provider. "Success in business is not free; you have to put money on the table to get invited to the game," Morris said.

Not only did BIC solution providers spend substantially more on marketing than the industry average -- 11 percent for BICs vs. 7 percent for the average solution provider -- but they also spent it more effectively.

Of the marketing development funds received from vendors, BIC solution providers spend 15 percent more on actual marketing activities such as demand generation than the average solution provider. While both BIC and the average solution provider spent MDF in virtually equal percentages on demo equipment, personnel, training and certification, and research, the way MDF dollars were spent on premiums was markedly different between the two groups.

Don't expect to get a pen or a T-shirt from a BIC solution provider: They spent only 4 percent of their MDF on trinkets, while the average solution provider spent two and a half times that, or 10 percent, of their MDF on premiums.

BIC VARs, too, didn't leave as much money on the table as other solution providers. BIC left 12.9 percent of MDF unclaimed, while the average solution provider left 15.4 percent of his or her MDF allocation on the table.

Solution providers who attended a presentation on the IPED study at CMP's recent XChange Solution Provider in San Diego said some of the results were surprising.

"It makes sense to me, but I've never really thought about how much gets reinvested back into the business," said Tracy Butler, president of Acropolis Technology Group, a Wood River, Ill.-based solution provider. "When I came back and sat down and looked [at my business] I learned that we really do spend quite a bit of money reinvesting in new technologies. When we look at what we have going on in the areas of virtualization, we are talking about spending $30,000 to $40,000 in the base virtualization equipment we need before we sign up a client. It's something we have to get ready for to handle the next generation of managed services."

Butler, too, said he is trying to follow the lead of BIC solution providers in improving his cash flow by reducing his days outstanding receivables. "The last year and a half we have been running 15 to 20 days, and we look at that quarterly," he said.

Butler said the old ways of customer billing aren't sustainable in today's market and can be a drain on solution provider profitability. "The way we used to do it was get the P.O., do the work, then bill the customer, and wait 30 days beyond that," he said. "From the time you placed the order until the time you got paid could be 60, 90 even 120 days for a decent-size project."

So, Butler has taken pains in recent months to get paid up front on projects he undertakes—establishing some best-in-class practices of his own.

His policy is to pre-bill 75 percent of the total project or the hardware cost, whichever is greater. As a result, his company has seen a dramatic improvement in cash flow.

"We pre-bill a lot of our projects," Butler said. "We try to get our clients to pre-pay if not the whole thing at least a good portion of the deal up front. That will make the days sales outstanding really go down, which leads to better cash flow. We just tell customers that hardware is really expensive and we are going to be on the hook for it. Last quarter, we were down to 5.4 days because we really pre-billed a lot."

Results like those give even BIC solution providers a run for their money and are just one example of why no VAR, even those at the top of their game, can afford to daydream for long.