With profit margins on both hardware and software sales shrinking all the time, where can resellers go to boost their profitability? The usual advice is to move into services as a way of adding value ? for you, as much as for the customer ? to your product portfolio; and with good reason.
In his review of 1996 share performance, consultant Richard Holway notes that during a year when share prices of computing companies generally rose by 19 per cent, IT services companies outperformed all others with a 60 per cent rise, whereas distribution companies? stock fell by 13 per cent and internet companies? by 43 per cent, while software products companies? rose by a mere two per cent.
?The situation would have been even worse had we not included such companies as Sage and Misys in the products category,? Holway points out. ?Both companies recorded significant price increases in 1996, but both companies make a majority of their revenues from services rather than product sales.?
But contrary to popular belief, IT services aren?t an automatic formula for success ? as is apparent from the Computing Services & Software Association (CSSA) annual survey of its membership, published last February. The service and software companies that make up the CSSA?s members ended the year full of optimism about the business situation ? optimism that didn?t seem to be borne out by the figures. Revenues and operating profits were below expectations for all companies, apart from those in the #11 to #20 million revenue range, where they rose only slightly; growth rates for contract staff dropped and there was a slowdown in the number of full-time employees too.
One of the companies that features in the FT London Share Service?s list of top gainers is Misys, which sells financial software and services. Over the past year, Misys has managed to nearly double its turnover and profit, and its share price is currently a very heal-thy 1212.5p. But another services company, MDIS ? also in financial software and services ? isn?t faring so well. Its share price has dropped from 260p at its flotation in March 1994 to 42p in April this year, and it announced a 1995 loss of #58 million. How can two companies operating in the same sector get it so right and so wrong?
MDIS fell into several of the classic traps that lie in wait for IT service companies, according to Dave Bradshaw, senior consultant at Ovum. ?A significant number of companies run into problems soon after a flotation,? he says. ?The members of the management team focus all their attention on the flotation. They get carried away by their own hype and stop concentrating on the customer.?
Early 1994, MDIS seemed to be on a roll. It had just reported its third consecutive year of profit growth, and its flotation on the London Stock Exchange was reportedly the largest ever for a UK IT company. In interviews, chief executive Jerry Causley spoke bullishly of his plans to transform MDIS into a major force in European information systems.
Yet later that year the company already seemed to be not floating, but drowning. Its 1994 profit was below expectations, causing its share price to plummet, and wiping #100 million off its value at a stroke. In January 1995, a second profit warning followed, the company?s value fell yet again, and finance director Ian Knox resigned. By the end of the 1995 financial year, MDIS had turned in a loss, on turnover down on the previous year.
A number of things went wrong for MDIS. Some of them were arguably sheer bad luck, for example, some major sales it had expected failed to materialise. But some of them unmistakably suggested that in the year leading up to the flotation, the management team had been spending too much time dreaming of the future, and not enough concentrating on its customers? needs in the present. The release of its IBS banking software product was delayed, because halfway through updating it, the company had suddenly decided that what it actually needed was a complete rewrite, in order to offer an open systems version.
The delay alienated some customers, and meant that in its first year as a public company MDIS was trying to sell a new, untried, and incomplete product into the ultra-cautious banking sector.
And with hindsight, it seemed that MDIS?s profit growth, achieved while its revenues were falling, had been achieved at least partly by steadily cutting its headcount ? a risky move for a company intending to move further into a people-intensive area like services. But once the company had floated, pressure from the City to show a profit made it harder still for the company to invest in people.
?The lesson is to keep focused on what customers want,? says Bradshaw. ?It?s a good idea for companies to have a special management team taking care of a flotation, so that it doesn?t take attention away from the day-to-day running of the company.?
Holway agrees that keeping a strong customer focus is essential for resellers that want to make money out of services. ?The service companies that have the most success, whether they?re small or large, are the ones that have long-term customer relationships that go on for years. Those that do least well are those that have to sell all their contracts the hard way,? he says.
?It?s better to lose a customer than having to sell a service anew each time. There?s no doubt in my mind that the key is making sure you deal with customers long term, so that they?re in a position of having to decide to get rid of you rather than deciding to use you.?
Holway believes that many resellers make the mistake of trying to build up their services business simply by taking out ads and pulling in as many new customers as possible, without thinking about how to retain those customers afterwards. ?Going for the hard sell may seem to be a good idea, but it?s time-consuming and expensive,? he argues.
And how do you keep customers? Quite simply, Holway says, by ?providing a high quality service at a reasonable price. I know the word partnership is grossly overused, but it?s true ? you need to be prepared to share the risks as well as the rewards to be a true partner. Take Sage ? it has over 100,000 customers on its Sage Cover contract, and keeps them year after year. Similarly, Computacenter has achieved good results from services because it?s built up long-term relationships with blue-chip customers.?
Another common mistake, says Bradshaw, is to ?be a complete me-too; to go into any service area just because other companies seem to be doing well in it. Occasionally, you?ll get away with it and land on your feet, but often it ends badly. You need to understand the market, and you need to have something to add.?
Holway agrees that ?service companies should be making sure what they sell doesn?t become a commodity item. So you don?t sell a vanilla introduction to Windows course, which they could get from 100 other companies. You provide a course that?s tailored to their requirements, run in on their site ? and you can charge twice as much for it, because they can?t compare prices. If you?re dealing with an engineering company, make sure the course covers scientific calculations in Excel. If you can, find a market niche and stick to it.?
One of the biggest commodity services is third-party maintenance (TPM) ? possibly the only IT business area that delivers lower margins than selling hardware. At the low end of the market, price-cutting is fierce, and yet the investment needed to run a successful TPM service is considerable; basically, it?s an area to avoid at all costs. Even Granada Computer Services, one of Europe?s biggest third-party maintainers, has had a long struggle with falling revenues and flat profits, and consequently has been trying to move upmarket into ?enterprise? services such as running corporate help desks. Over-reliance on third-party maintenance income was another weak point for MDIS; pre-flotation, TPM accounted for about half of its services revenues. Yet with its roots in hardware sales ? it started life as a hardware supplier, before moving into reselling Sun and Motorola Unix boxes, and Causley began his career selling and installing hardware ? TPM was a natural progression for MDIS, and it has clearly been hard for the company to change its culture in order to successfully sell corporate services such as outsourcing.
Lack of focus is one of the few problems MDIS has not had, but it?s apparent in many other service companies that run into difficulties. ACT Group, for example, morphed into a bewildering number of different shapes before finally being swallowed up by Misys in February 1995. It started life as a computer bureau, diversified into computer stationery, maintenance and software, acquired the UK distribution rights for Victor Sirius PCs, then moved into making PCs under the Apricot name in 1985. (?Changing your name all the time ? that?s another common mistake companies make,? comments Bradshaw.)
Five years later, it sold off its hardware manufacturing arm and moved back into software and services, once more calling itself ACT. It bought companies in the banking, medical, and financial services areas, and in 1993 acquired services company BIS Group from Nynex. In October 1994 it sold off its services arm to concentrate on financial software. Throughout all these changes, ACT?s revenues and profits continued, miraculously, to rise. But in 1994 ACT issued two profit warnings in the space of seven months, and as its share price dipped, was ripe for acquisition.
Spreading itself too thin was a problem for Sherwood International, which sells insurance and assurance software plus associated services such as facilities and applications management, which accounted for nearly a quarter of its 1996 turnover. Sherwood was struggling with falling profits until it pared down its business, phasing out its investment management, housing management and local government activities in order to focus on services and sales of its Amarta life and pension product. The company now says it will only be looking to acquire companies that fit in with its focus on the insurance market. It?s also bolstering its plans to build up its services business by investing in people.
Moving into services seems a good way for resellers to bolster their profit margins, and for some it undoubtedly is. But the lessons of stock market history show it isn?t always easy. The change of culture needed to move from a product-focused to a service-focused business shouldn?t be underestimated ? nor should the investment in people, skills and time spent cultivating the customer.
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