Analyst Report: How the cloud is disrupting the software-distribution channel

On Cloud

To sell and market its hardware and software products, the IT industry has historically leveraged an indirect sales channel made up of distributors, resellers and systems integrators. But the continued popularity of the cloud in enterprises, governments and small and medium businesses is changing this market, and in the process it is disrupting the business model of the channel. Much hype surrounds this sector, which now must find new ways of capturing opportunity in the cloud.

Advantages of the channel

In the past, the channel would buy from the distributor and then resell to a client at a higher price. It could leverage volume in its buying by setting its own prices in competitive scenarios. And it could consolidate the costs of the license in the overall service, much like outsourcing companies do.

The advantages of this channel process are easy to understand: It offers software companies a route to market with unbeatable local reach at a much lower cost than if an in-house sales force had to be hired.

The channel itself is a huge business: According to market researcher DataMonitor, the size of the global software market is forecast to have a value of $299.1 billion by 2014, which is an increase of 32.6 percent since 2009. I estimate that more than half of this revenue runs through the channel.

The challenges of integrating the cloud

The cloud changes the dynamics of this market. Cloud solutions are mostly deployed with a local consulting practice involved in the delivery and migration. Enterprise software solutions require a local partner that knows the end-user client and is able to do on-site consulting. Therefore, on-site support is needed, along with partners that have access to a local ecosystem. This is key to the success of any software publisher.

Currently resellers selling cloud solutions receive a fee from the publisher, mostly a small percentage of the overall revenue (the fee is larger the first year and lower the following years). This structure looks remarkably similar to the insurance broker market: The revenue sits with the vendor, and the partner gets a commission. Most partner agreements are vendor-confidential, but a hypothetical example of this would be a software corporation rewarding its partners 10 percent of revenue for new business one year, with renewals in the following years dropping to 4 percent.

As a consequence, the channel is losing revenue, not to mention a grip on the relationship with its client and on pricing flexibility in many scenarios.

Recommendations

The solution to this challenge doesn’t lie in increasing the margins for the resellers. Rather, aligning sales and revenues with an increased interest in cloud adoption is needed. Some ways to achieve that are:

Talent development. Software vendors need to encourage the IT channel talent to develop cloud-focused businesses. Change is always more difficult than creation, and assisting young talent can accelerate the process. Right now vendors don’t readily enable channel startups. But “born in the cloud” partners are the ones that will thrive the most. Occasionally vendors fund startups on a case-by-case basis, a practice that should be expanded.

Cross-border partnering. Support models for the new cloud channel need to evolve to better enable customers to migrate and find partners across country borders. This will help drive the borderless benefits of the cloud. Currently most partner programs are nationally or regionally executed. For example, if I go to Microsoft’s website from the Netherlands, I land on Microsoft’s .nl page. If I look for a partner in dynamics, I get an overview of partners that are based in the Netherlands, though I might be better off with a partner that is more experienced in my field or has support capabilities in other worldwide locations.

Consolidation. Since margins for the channel are lower and reseller services around cloud software are less labor-intensive, the software channel needs to consolidate and, over time, shrink. This will enable the ecosystem to rebuild on a new base profitably. In combination with the cross-border partnering, cross-border consolidation will help the partner community leverage its investments over an ever-smaller world.

Specialization. The channel should build a partner community based on competence in technology and a specific focus on an industry or vertical. Microsoft, for example, offers “industry solution maps” that define industry-specific best practices and product combinations. A vertical approach like this will enable specialization and thus efficiencies required to have a profitable business.

Segmentation. Reward partners for the role they play. Some partners are more suited to influence (strategy consultants, for example), while others are more-trusted advisors because they have a technical capability like hosting. Technology partners can trial new solutions on the early-adopter market. Rewarding partners for developer activity is another segmentation. The developer partners can develop stickier, localized and specialized solutions. These are key differentiators for the partner as well as the vendor. Last but not least is the segment on growth potential, and this is where a key to unlocking the full potential of the cloud sits. The partners that should be treated as more important today are the ones that focus 100 percent on helping drive key initiatives.

All points above are related. For example the tech workers and engineers employed at the SMBs or enterprises or within the channel are sometimes inhibitors to change. This group of influencers could lose importance as the cloud gains momentum. No longer will there be requirements for reinstalls, rebuilds and so on. Infrastructure work will remain in some form, but the desktop applications will run somewhere else where resources are shared. So this community could perceive the cloud as a threat. And this is the case at the channel and at the client site. I believe this group of professionals has a key role to play as the market for information technology keeps growing. Market drivers like mobility and social media will continue to drive growth. With the proliferation of web-enabled devices a new generation is here that is unaware of not being online. By encouraging new startups and consolidation as well as specialization, there will be ample incentive for this group to help enable change.

There are already many success stories in the cloud channel. Resellers like Spot ICT in the Netherlands are an example of success in the cloud. This Microsoft partner started as a new venture focusing on the cloud. Spot ICT had no past history or client base with direct revenues from selling hardware and the associated software licenses. The company is now one of the leading Office 365 partners of Microsoft in the Netherlands today. However, it still faces challenges. Fees from vendors are low, and the services and consulting fees are relatively small, too. In order to be successful, Spot ICT will need a large client base and, with that, a large sales force.

Recognizing the challenges the partner community has is where it all starts, and results will also only come from well-defined plans. Finally, though this switch to the cloud may hurt revenues in the short time, in the long run the opportunity of the cloud is up for grabs and promising.

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