CEOs know: the money is in the service

This article focuses on the financial imperative for CEOs of reselling organizations to profitably get their businesses into the service, support, training and consulting (SSTC) business.

Déja vu . . . all over again

Price points in the PC/Workstation industry have fallen

35 to 40 per cent in the past year, and the telecommunications industry is not far behind. At the same time, margin percentages have fallen in some cases one to two per cent per quarter. Each unit sold, or each transaction completed, will generate far fewer gross margin dollars in 2002 than it did in 2000 or 2001. Therefore the “yield” of each transaction processed by a reseller business has fallen. If transaction costs had fallen at the same, or even a faster rate than transaction yields, them more unit volume would mean higher profits. Unfortunately, transaction costs have stayed flat or gone up. Each incremental unit sold, in some cases, costs more in transaction costs than was yielded in gross margin dollars. Add to this problem the fact that overhead and fixed costs of operating reselling businesses have gone up over the past years and we have a recipe for a financial disaster.

The reselling industry is struggling hard to replace the gross margin dollars that have been lost forever. Some resellers have chosen to try to outrun the twin anchors of falling average selling price and falling margin percentages. The mathematics say that a 50 to 60 per cent annual increase in 2002 unit volume (and reduced transaction costs) are needed to generate as many gross margin dollars as was generated (and spent) by reselling businesses in 2001.

Unit volumes doubled but profit was reduced by over $300,000.

The solution to the disappearance of gross margin dollars in the reselling industry is to increase the blend of revenues generated by the sale of service, support, training and consulting. A sound “service” business offers margins 2 to 3 times that of the commodity hardware business, can be differentiated in the marketplace, leads to higher rates of customer retention and lower rates of customer loss, and does not require incremental investments in inventory.

On the other hand, a healthy service business needs different marketing and sales activities, different blends of staff, and different management approaches than typical reselling organizations.

2002 is a watershed year for many resellers. Those who are not clearly volume/price leaders in their markets will have to be clear leaders in service, support, training and consulting in their markets or they will not see 2003. No one can afford to double unit volume, and lose their shirt.

The decision to invest in building or expanding a business in service, support, training and consulting will have a major resource impact on many resellers. For this reason it is important to undertake an assessment of organizational strengths and weaknesses prior to making key commitments. In addition, an objective analysis of financial strength, client base strength, sales strength and marketing strength should be undertaken to determine if the current state of affairs should impact the service business decision. In a few words, it is best to look before you leap . . . perform an operations review.

Financial health — benchmarking is the fastest and most comprehensive method to determine the financial health of a reseller. The following is a list of metrics that should be calculated and then compared year-on-year for the previous three years. In addition, external comparisons should be sought with like businesses in order to establish how the reseller is doing in the context of the bigger market.

Revenue $/person — usually increases in revenue/person are desirable but reductions may be caused by increases in service revenues and therefore increases in margins levels.

Margin $/person — this metric should rise over time regardless of changes in Revenue $/ person.

Expense $/person — this metric should not rise faster than Revenue $/person rises.

Net profit $/person — metric should rise! If it falls, it indicates a business that is likely decreasing in value.

Cash flow $/person — this metric should remain stable or increase over time. Reduction in

Cash flow $/person needs explanation and should be treated very seriously

Revenue blend — percentages of sales generated by hardware, software, service, support, training and consulting. This metric should be within industry norms.

Drag — ratio of service revenues to non-service (product) revenues. This metric should be within industry norms.

Gross profit blend — percentages of gross profits generated in each category of the business.

This metric should be within industry norms.

Installed base blend — this metric measures the percentage of revenue that comes from clients that are more than one year old. The percentage of revenue from the base (in a mature reseller) should be 60—75 per cent

Average service billing rate — this metric is the average rate at which services are billed out at. This should be within competitive norms for similar services in like markets.

Utilization rate — This metric measures the percentage of service providers’ billable time that is actually billed to clients. It should be 80—90 per cent in a leverage model practice and 50— 60 per cent in a medical model practice

Productivity per person — This metric measures the amount of revenue generated by each service provider. It should be 2 to 3 times the service provider’s fully loaded salary.

It is critical to understand where money is being made in the reseller prior to jumping into service, support and consulting business. Financially, the critical issue is how much cash is being thrown off to invest in the new capabilities that will be required, and can operations be modified to improve the situation.

Customer base health — checking your customer base is like checking your bank account balance. With a strong customer base, it is very likely that the resources can be generated to make whatever transition you wish. If you wish to sell, merge or acquire, your customer base is your key asset. Get out into your customer base and do a customer audit. Talk to the 20—30 per cent of your clients that generate 70—80 per cent of your revenue and most of your profits. How satisfied are they? The best test of how satisfied they are is whether or not they purchase service, support, training and consulting from your operation. How much SSTC are they buying . . . how much are they buying from your organization? If you primarily sell them products, then what are their service consumption plans? Get heavily involved with your installed base.

Sales strength — lost sale analysis is the key method of understanding how well your sales organization is doing, and what it needs to improve upon. Go back 6 to 12 months. Select the top 25 per cent (by size) of deals that were bid, but lost.

Go back to the client and find out why the bid was unsuccessful. Was anyone successful? Did a product-driven solution win? Did an service-driven solution win? Why was the bid won — what did the winner do? It is important not to make any assumptions about what drove the sales loss. It is also important not to “punish” anyone as a result of what was learned. Let lost sale analysis tell you how strong your sales capabilities are.

Marketing strength — the ability to differentiate, or to make one’s business different in the eyes of clients, is the key test of marketing strength. Ask your employees what they believe makes your organization different in the marketplace. Have them point to examples of these messages being communicated to current and potential clients.

Ask your customers what they think makes your organization different. Have them point to examples of these messages being communicated to them. Are the perceptions of your employees consistent with the perceptions of your clients? Does your marketing program deliver the messages that you wish to deliver to your existing and new clients? Define the messages that you wish to deliver. Communicate them clearly and powerfully to clients and employees.

Implications for management

The Operations Review outlined in this article is designed to help reseller management assess the readiness of their people and their organization to make any transitions that may be required to participate in the service market. The data is clear . . . the future of value added reselling is in the service.

Bruce R. Stuart is the President of ChannelCorp. He is the author of the recently released books Reseller Management Handbook — 7th edition and Channels Handbook — 2nd edition. Both books can be perused at http:// www.channelcorp.com/products.htm.

Bruce Stuart is one of the world’s foremost experts on solution provider profitability, business model transformation and vendor channel strategy improvement. He has educated and consulted with channel and channel partner executives from more than 40 countries over the last 15 years. He is a frequent speaker at vendor events worldwide. He can be reached at info@channelcorp.com. The corporate Web site is www.channelcorp.com.

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