The Fall and Rise of the VAR Empire in the Age of Cloud

September 30, 2016

John Donnelly

Over the past thirty years, the North American VAR channel has succeeded in dominating the IT spend-scape. In many cases, VARs helped launch some of the most successful high tech companies ever created, including EMC, IBM, and VMWare to name a few. Owning a successful channel strategy was a prerequisite for success. In addition, the VAR channel offered significant economic advantages: building scale, speeding time to market and building strong long term customer relationships.

But times are changing. The evolution of the subscription pricing model and utility pricing are posing significant challenges for everyone in the spend-scape. SaaS companies haven’t really cracked the code on how to pull channel partners in. Sure, there is the services component, but this is a low margin, people driven business. There are some notable successes. For instance, Salesforce has developed a nice ecosystem of consulting partners, while Bluewolf has been one of the dominant players in cloud enablement. But these companies grew organically, and were focused from day one on cloud enablement.

The question becomes “How do I make money on cloud as a reseller?” In the past, a reseller would receive a margin of 15-40% on a product sale. In addition, they often would receive the same margin on first year maintenance. The reseller would typically see the cash net30. Great cash flow, great business, right? Now subscription pricing comes along, where a typical year one deal is somewhere between 30-50% of the total for a perpetual deal, with maintenance included. To compound the issue, many companies pay the subscription on a monthly basis. If we do some quick math, let’s say a perpetual deal is $100K. The year one subscription would be $40K. Further, the customer decides not to take an incentive to pay upfront, and instead go monthly. The reseller would receive a check for $3.3K for the first month. Great for long term revenue, bad for short term for cash flow.

The change to subscription has also caused significant pain with the sales people. How am I going to make my $200K W2 on subscription? Some resellers initially looked at a more favorable plan of paying reps upfront, but the math just doesn’t work. This model has to go away. The solution? CDW (Super VAR) has done a great job of building a cloud-only team, compensated on subscription, with no perpetual license baggage. In addition, they have significantly beefed up their cloud services team. They will be a dominant long term SaaS reseller. Another worthy mention is SHI. They invested early in cloud and in fact actually built their own cloud at one point. They just announced their emerging partners did over $400m in business in Q2. The business is there.

What about the rest of the 6000 North American resellers? Evolve or perish. If you look at the spend-scape for most resellers, storage represents a significant piece of their overall revenue. Has everyone seen AWS’ revenue numbers, Azure’s momentum? The storage business will be hit hard over the next three years. Folks like EMC and NetApp are going to struggle to keep their datacenter footprint, and the trickle down effect on VARs will be immense. When the legacy vendors start to struggle, the first thing they do is move away from the channel, which is just plain dumb! Not only are the AWS guys beating them with a better solution, they are also hiring their top sales people. Ouch!

Here’s a summary of the thoughts from resellers I have spoken with:

“I can make up the license fees in consulting.”  The math doesn’t work on several fronts. Sure, cash flow from the product sales will dwindle, but that isn’t the biggest challenge. Time is the biggest obstacle. CDW started this transformation 8+ years ago, and they started from scratch. They built a brand and identity around cloud, and they had the money and leadership to pull it off. The smaller VARs will need to accelerate this re-branding and restructuring to compete effectively. I was also told most smaller VARs generate 80% of their revenue from 2-3 customers. This makes it really difficult to move these top customers to Saas/Subscription model. Consequently, we’ll see a significant downsizing of these organizations. If you’re a VAR, don’t wait for the balloon to pop. Take a hard look at your forecast. Expect storage deals to shrink 10-50%. Whatever the bare minimum the customer needs to have is probably what they will buy. Then add 60 days to the sales cycle. AWS and Azure are targeting your customers with a great offerings and great people. They want to own your customer, so expect a fight in every deal.

I hope folks don’t think I am picking on storage. Networking, security…all aspects of infrastructure will be disrupted.

Most VARs are now beginning to sell SaaS and cloud based solutions. Burn your current compensation plan. Set a timeframe to close boxes and perpetual licenses, maybe through the end of the year. Pay the reps on monthly or quarterly accrual. Don’t make comp equal in the transition, but instead weight it over 75% on SaaS. Change the customer conversation to applications and not delivery. While the delivery platform is important, it is not the #1 driver. Focus on “rip and replace.” Go after the products you carried last year with the innovation you have today.

Here are my top recommendations for VAR success in today’s cloud-driven environment 

  • Get close to the leaders in SaaS
  • Have a clear understanding of how you are going to make money as a reseller
  • Ask for current partners that are successful
  • Go to the white board and figure out the revenue model with the SaaS provider in the room
  • Reach out and network with other VARs to get on the same page. What best practices are working for them?
  • Retain your best sales people by making it work compensation-wise through the transition.

In summary, expect a significant amount of consolidation. There will be several high profile failures but innovators like CDW and several of the “super” VARs will flourish. The opportunity for success is there.