How best to boost margins - and inflate the value of a potential exit - is an issue facing every VAR boss as the returns from reselling IT kit continue to shrink.
Many are now turning not to services but to developing their own intellectual property as a means to avoid the race to the bottom.
Often, the failure of vendor partners to address a specific customer need provides the impetus for a VAR to take up the slack and move into software development. But what may begin as a ploy to add value can quickly gather speed.
In many cases, resellers are now going on to spin off their widgets into separate companies as they prepare the ground for a hopefully lucrative exit.
While it's a risk-laden strategy, the rewards on offer are potentially staggering. UK application migration consultancy Camwood flogged its ISV arm AppDNA to Citrix for $92m (£58m) in 2011.
Webscreen, a DDoS mitigation technology that grew out of security VAR Boxing Orange, was sold to Juniper for $10m last year by new owner Accumuli.
And the UK channel is bursting with examples of traditional VARs branching out to become mini-vendors.
Storage integrator Proact launched an enterprise-class online file storage and sharing service, Probox, last year while education reseller Gaia Technologies has spent the past 12 months developing a 3D Visual Learning platform business it claims is a key strand of its long-term growth plans.
Symantec PGP partner Intellect Security is building out its Cryptosoft venture as a vendor in its own right, complete with its own channel, after securing £500,000 in seed funding last month.
Intellect and Cryptosoft chief executive Jon Penney says the move was necessary to build maximum value for its intended exit in 2016.
"Most owner-managers of VARs my size will have an eye on an exit," he says. "The typical VAR is looking to attract one to two times gross margin.
If you have a piece of IP in the mix, in the right part of the market, you could be looking at more like six to 10 times gross margin. The risks are greater but the rewards are equally high."
Intellect first hired two software developers to create the product five years ago after identifying a gap in the offerings of the major encryption vendors. Cryptosoft is designed to simplify the deployment of PGP's software development toolkit (SDK) to the corporate enterprise.
"What would have taken six months with a SDK, we can now do in a day," he says. "Initially, it was a value-add to our business that gave us an edge in an increasingly competitive security market. Now we are going further and creating a full-blown vendor ourselves that can stand up on its own."
The stakes are high. Developing IP eats up time and money. For the uninitiated, registering patents and creating IP audit trails can be a cruel maze. And different skills and routes to market - as well as extra funding - may be needed to even get the venture off the ground, let alone ensure a return on investment.
Any VAR boss splitting their time between two ventures risks spreading himself or herself too thinly, as NTS managing director Jonathan Lassman discovered to his cost.
Lassman sold his backup appliance making company, Tadasoft, to a business partner in a paper deal in 2011 but says he nearly lost his £500,000 investment in the technology altogether.
"At the time, [launching my own IP] was the right thing to do, as the theoretical exit from a manufacturer is 10 times turnover, whereas for a reseller it's six times net profit," Lassman says. "The problem is that one or both of the firms will suffer with the diversification you are trying to achieve. I haven't seen many resellers create a product and make it seriously successful."
Lassman claims the fortunes of Tadasoft - which he says reached a turnover of £450,000 before plateauing - was thrown off course by two stumbling blocks.
Firstly, Lassman admits that registering patents for his software was not as straightforward as he anticipated. It was subsequently cloned by a partner it had recruited to carry its technology in Israel.
"Because software is so easy to copy just by changing a comma, you cannot really patent the technology, you can only really patent a way of doing something," he says.
Channel conflict is also a potential issue for any reseller assembling a partner ecosystem to build critical mass for their product, Lassman warns, even if - as with Tadasoft - it is hived off as a completely separate firm with no ownership ties.
"You can put up all the divides you want but you'll have a level of distrust from every reseller in the market," he warned.
Cris Pikes, chief executive of security reseller Sysec, sidestepped this issue altogether by opting to pursue an OEM channel model for his vendor venture.
Pikes launched his illicit-image analysis technology, Image Analyzer, in 2005 after concluding that the real money lies in owning IP rather than selling someone else's. With offices in the UK, US, New Zealand and India,
Three patents gained
Image Analyzer now owns three patents relating to video throttling, video content analysis and curvature analysis and its technology is used by 43 OEM partners including McAfee, Websense, Trustwave and Guidance Software.
But Pikes admits the transition from reseller to vendor is not an easy one. "Do not underestimate what is involved - a lot of blood, sweat and tears have gone into this," he says, adding that he had invested £3.7m in the venture, which is an entirely separate entity from Sysec with a separate shareholding structure.
"Because it is a different route to market and a different set of skills, our approach was to segregate it," he says. "You need development resources, a strong management team, product engineering and road map guys - which many resellers do not have - and a corporate development guy to raise funds."
VARs eyeing IP glory should plan meticulously for their potential exit, Pikes advises. If the desired buyer is a US vendor, it is important to apply for patents across the pond as well as in the UK, for instance.
Intellect's Penney admits he had overestimated the goodwill of vendor partners when Cryptosoft first started out.
"My original plan was predicated largely on support from the [encryption] vendors as we were adding value to their portfolio and making their product much simpler," he says. "In reality this did not happen. If [the vendors'] salespeople don't earn money from it, they won't buy into it. Part of the reason we are standing Cryptosoft up on its own is because of their lack of appreciation of its value and their reluctance to get behind it."
Lassman says Tadasoft would have been more successful if he had been able to dedicate his full time to the venture, but adds he had no regrets.
"My advice would not be don't do it. But do not take your eye off the ball," he counsels.
Antony Young, founder of channel consultancy Demuto (pictured, above right) says: "Every reseller should be looking at how to increase the value of their company. Five years ago, it was services and now it's all about IP because of the advent of SaaS. The whole industry is becoming software led so it makes sense for VARs to develop their own software."
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