The day of reckoning is here for product-centric resellers. If you want to thrive as an integrator in the new millennium, the time to grow service revenue is now. Our resident expert points the wayAdmit it: for years you've talked about kicking the product-sales habit, but you've been either unwilling or unable to do so. And why bother, especially when an 85 to 90 per cent product-revenue model has made lots of companies rich -- on paper at least. Indeed, if you become really good at moving boxes, then you eventually get to live like the founders of billion-dollar distribution firms.
Problem is, there's little room in today's market for midsize distributors, even those with a unique technical niche. And if demand for IT products in your speciality should slack off long and deeply enough, you're toast. In fact, it's my estimation that if you stay with the 15 per cent service-revenue model typical of so many resellers, you're headed for a fall anyway.
At a recent event where I was speaking to integrator partners of a large midrange distributor, most attendees agreed with this statement: "The IT world is rapidly diverging into two distinctly different business models: a volume model and a value model." One integrator posited that to succeed with a volume model, a company would probably be required to do at least $30 million in product sales by 2000.
Quality or quantity?
The numbers might be off, but the thinking is right on. By 2000, smaller integrators that aren't generating 20 to 30 per cent of their total revenue from services will be struggling to survive.
Like you, the integrators at the above-mentioned meeting have long been fighting the pressure of declining product margins. Like you, they've cut costs and become more efficient, always with the hope that the margin slide will stabilise.
Okay, repeat after me: "Product margins will continue dropping, and they'll never stop dropping."
And unless you have one of the few companies that's prepared to risk it all to become a very large volume reseller, you'd better start thinking about where your "value-add" lies besides fulfilment.
Of course you've heard all the messages about migrating your company to a more service-centric model, but you've also learned that it's hard -- very hard. Is it any consolation that you have lots of companies in the integration community?
I didn't think so. Especially when the main problem with becoming more service-centric is building the ever-elusive "critical mass" of business.
So what exactly is that critical mass?
Well, Norm Shockley, president of Acclaim Technology, a $US50 million Sun integrator in the US, defined it as "a size where you have a project-based rather than a task-based model.
"This lets you solve complete customer problems like call-centre tracking or supply-chain management."
Then there's the problem of funding. "Margins on hardware are so slim, there's little profit left to finance growth of the higher-margin service business," added Shockley. Indeed, a business model of 80 per cent hardware revenue, 2 to 3 per cent software revenue, and 17 to 18 per cent services allows a mere 20 per cent overall gross margin.
But of course there are ways of getting to that service sweet spot of 25 to 40 per cent (which nets you an overall gross margin of 35 per cent or better), as the history of Corstar Business Consulting clearly shows. Over the past six years, this $US15 million integrator has grown its service revenue from about 15 per cent of its total to 60 per cent today, while maintaining an average profit margin of 40 per cent.
The secret? "We sell into vertical markets, financial services and advertising, where we understand the customer's business and real IT needs," said MD John Sitar. "If you don't intimately know a prospective customer's business, they won't buy your services."
With fewer than 50 employees, Corstar is careful to limit the projects and service tasks it takes on. When the project is too large for existing staff to handle or the service is outside Corstar's core competencies -- network cabling, for example -- then the integrator will subcontract the work but manage the project.
Rick Gordon, president of $US55 million AE Business Solutions, agrees with Sitar's philosophy of focusing on vertically-oriented services and strongly recommends that integrators mine their installed base.
"It's a big advantage doing business with clients who know you and have faith in you," said Gordon. "By selling in vertical markets you get to know the client's business and that makes them trust you all the more."
Walking the talk
Many leading hardware and software manufacturers, too, advocate a vertical focus. Companies such as Hewlett-Packard and Microsoft point out that higher-margin service opportunities are thus easier to come by.
Not exactly a new message, but lately there's a sense of urgency in the vendors' voices. In fact, more vendors are walking the talk by actually turning over large portions of their own service business to integrators, and showing companies new to the game exactly how to play.
HP, for example, now offers integrator training and certification on its Virtual Vault (high availability) and Systems Utilisation Analysis products -- opening the door to several different pre- and post-sale service opportunities. "In a very real sense, we're offering integrators much of the business previously delivered by our professional services organisation," noted Mike McDonnell, HP's program manager.
McDonnell has also initiated another program that seeks to match hardware-centric integrators with ISVs that have a high service-content solution. "Again, the goal is to create more service opportunities for integrators," he said.
Software vendors are also guiding integrators to higher-margin service ground. Microsoft, for instance, has shifted the focus of its Microsoft Consulting Services business unit from advising end-user customers on selecting and implementing Microsoft-based technology to help Microsoft Certified Solution Providers (MCSPs) do the advising.
For a hefty fee which Bill Henningsgard, general manager of Microsoft's MCSP program, declined to reveal, certified integrators may engage a Partner Program Manager (PPM) for instruction on how to package and sell services. Apparently the high cost of these PPMs is not a deterrent. Henningsgard reports that the 40 PPMs Microsoft currently employs are booked solid, and the company is busy adding more PPMs.
Hugh Jones, Enterprise Services Manager at Microsoft Australia, said the company is encouraging its partners to engage PPMs to help build their services business around the Microsoft product set, while at the same time maintaining customer consulting services to end users. He added: "we want to transfer and leverage our skills through the service providers community."
Likewise, Autodesk, the number-one vendor of computer-aided design (CAD) solutions, is giving better margins on vertically-focused sales of its AutoCAD product and encouraging integrators to pursue incremental service opportunities -- in its accounts.
Vince Cavell, manager of HP's solutions reselling organisation, said: "Customers want complete solutions and will pay integrators to mitigate the risk of implementing those solutions." Pay, yes, but first you need to solve a few problems unique to running a service business:
Technical staff requirements. The labour-intensive services business requires that you hire more people, and the shortage of skilled IT workers means you'll be paying high salaries when the people you hired have more marketable experience. Therefore, it takes a lot of money to build a service business, and you should know precisely where those funds are going to come from.
Cyclical business. Another challenge is trying to sustain a constant revenue stream as projects come and go.
Becoming established. There's little difference to a buyer whether he purchases a name-brand server from you or from your competitor, because the product is already well known. It takes time to build the reference accounts and the reputation your company needs in order to lessen the perceived risk.
Seven steps to service success
Rome wasn't built in a day, and neither was any IT service business. But here are a few bricks to get you started.
Use your home-ground advantage. Start by evaluating the opportunities within your installed base. Your success rate in closing business should be high and your cost of sales less when selling to companies with whom you have established your credibility.
Go vertical -- at least for a segment of your business. Become expert in a specific industry's IT needs and in the solutions that specific customers require. You'll gain more credibility, and if your core business stays healthy, migrating to a more vertical model can be done gradually without disruption.
Create a profit-and-loss centre for your service operation. This will help you monitor the associated costs and profits. It will also form a close-knit team of employees with a service mindset and, eventually, a service culture.
Create a strong, positive perception of your company. Invest in training and certifications for your people, seek and document testimonials, build on your referrals, and establish reference sites.
Establish partnerships, especially with ISVs in whose products you acquire expertise. Such partnerships enhance your value to the ISV, as well as to the manufacturer whose hardware sales will benefit from the alliance. As a result, expect increased sales leads from both vendors.
Hire proactively. The time to start looking for a Unix/NT integration expert is before -- not after -- you've sold the project. If you anticipate having cyclical project business, at least subcontract with service professionals in the areas where you intend to build critical mass.
Be patient. If your company is currently successful, make changes to your business model carefully, in a nondisruptive manner. You don't want to disturb your core revenue sources.
Financial signposts to service prosperityAs you remould your business model to service-centric, chart your progress with the following operating parameters.
Margin: The service component of integrator businesses averages a margin of more than 40 per cent. Considering that even the most efficient volume-oriented companies require nearly a 20 per cent margin to be profitable, your combined service/product margins should be well over 20 per cent.
Per cent billable hours: The good margins you make on service only happen while your people are billing out their time. A good goal for billable hours per employee is 80 per cent of their time.
Sales per employee: As you increase the service content of your business, the amount of revenue you generate per employee should decrease.
Collection periods: It's very likely that as your service business increases (as a percentage), your collection period will also increase. Service projects can run for long periods, and often there's a misunderstanding about when a job is completed. That's why you should insist on progress payments and define clearly what constitutes project completion.
Financial leverage: Volume integrators tend to carry large debt because of large accounts-payable balances. Service-oriented companies purchase fewer products and tend to have much less short-term debt. However, as you mould a service model, your investment in new people, coupled with a potentially slower DSO, could put a strain on your borrowing. A good target for your debt-to-equity ratio is 1:1.
Employee compensation: Depending on the type of worker you currently employ, your salary per employee might increase as you hire more billable-hour-type workers.
Service work in progress
Considering that AE's service business has doubled each of the past three years, the company appears on track to hit the 30 per cent mark this year. Hardware sales, too, have been growing rapidly, so it has been a challenge getting the services ratio up -- a problem many integrators would welcome.
Here's how Ae Business Solutions is growing its service revenue to 30 per cent of its total.
Dedicated P&L centre
The secret of AE's success with services is really no secret: nurturing its installed base.
Another strategy that has worked for this integrator is having a sales force that special-ises by technology. Each sales team has the responsibility for selling both products and services. But success is never without problems. "It's been a challenge changing the mindset of our employees," admitted Gordon.
A guiding field-management structure
Beyond these obvious moves, however, are a few more subtle success strategies that AE uses:
Field management. Make sure you have the right field-management structure in place to guide your people and support their efforts.
Vertical focus. Having an industry-specific focus helps you to better understand customers' IT problems, provide more targeted solutions, and increase the perception that your company can be relied upon to deliver important services.
Accepting business. Have the courage to turn down business where you don't think you can succeed.