Little margin for error

The tight margins on commodity hardware and software show no signs of recovering. We look at ways in which resellers can help their profits to recover.

The dictionary defines 'margin' as "the amount allowed beyond what is absolutely necessary". But those that make and buy IT products obviously do not read the dictionary, since nobody could possibly claim that the margins on most core hardware and software extend beyond the "absolutely necessary".

And when the dictionary suggests 'brink' as a possible synonym for margin, it is being positively prophetic, because that is precisely where many resellers will be heading if things don't improve.

If margins change, it will not be in the right way. Having got used to low prices, it is unlikely that the market will allow margins to rise again. Alex Tatham, commercial director at distributor Ideal Hardware, said: "Margins are bad, and I don't see any sign of improvement. Our average margin is 7.8 per cent. That is unheard of for us, but I can't see the trend of ever-decreasing margins stopping in the foreseeable future."

Commodities - products which the average IT manager or end user can install and manage for themselves, and which the average large distributor believes it can shift without a big investment in technical skills - are unlikely to bring the reseller more than five per cent. That includes desktop PCs and applications software. Monitors fare little better, at about eight per cent, perhaps because they are big, bulky things and customers realise that they cost money to store and ship.

The concept of inflated 'list prices' is virtually dead, because nobody is fooled by a PC which is 'discounted' to £1000 from a list price of £3000. Now that so many PC vendors sell direct, everybody knows what hardware really costs.

The biggest brands seem to bring the lowest margins. But this simply reflects the basic economics of market forces, and there seems to be relatively little overall variation in margins.

Mark Wilkin, product marketing manager at hardware vendor Hitachi Information Media Group, said: "The market is so competitive, it tends to harmonise margins, especially for products which are heavily advertised through mail order."

Components are not doing too well, either, according to David Flack, marketing manager at vendor Memory Plus. "Take memory, for example. The margin achieved by the dealer or reseller was traditionally about 25 per cent," he said. "However, the quick commoditisation of the memory market has forced margins below 15 per cent on solutions and below five per cent on volume. We have experienced a three per cent margin erosion during this year alone."

Resellers' best bet is to fit components themselves, and make money by providing the service. Clive Longbottom, service director at market researcher Quocirca, believes resellers that install a memory chip or hard disk can charge the customer almost double what was paid for it. "There is opportunity for good margins, as long as you can work fast and not mess it up," he said.

And the higher up the scale you climb, the better the outlook. According to George Fletcher, sales and marketing director at Xbidit, an online electronic marketplace for the IT channel, enterprise products such as servers and storage bring double-figure margins because price is seldom the customer's prime concern.

"Because of the importance of servers, corporates are less likely to accept an unfamiliar brand, so there is some brand loyalty," said Fletcher. "The fact that servers use state-of-the-art processors and the biggest hard disk means that the vendor can command a high price."

Think small
Specialised hardware commands better margins, although resellers are obviously unlikely to sell in high volumes. A low-priced projector for presentations, for example, would be lucky to make 10 per cent, but a high-end model from a prestige brand can make 20 per cent or more. A single projector can earn the reseller as much profit as 10 notebook PCs. Developing markets such as network attached storage boxes also attract good returns.

But the best margins on hardware are for throw-away items. Although PCs are becoming so cheap that some maintenance firms find it cheaper to replace rather than repair them, it is consumables such as paper, ink and toner cartridges that make money. Printer vendors often generate more return on consumables than on the actual printers, and a margin for the reseller of more than 50 per cent is not an unreasonable target.

Extended warranties are another lucrative sideline, especially now that hardware is more reliable than most end users seem to realise. Resellers with their own service engineers can really profit in this sector, otherwise the warranty must be underwritten by a third party.

Commodity software fetches rock-bottom margins, but this is hardly surprising, given that even distributors are installing operating systems and basic personal productivity software.

However, margins on specialised software remain buoyant, especially when it is relatively new and seen as bringing a competitive advantage to its users. Ecommerce, business intelligence and content management software can easily attract margins of 20 to 30 per cent, as can the more 'glamourous' end of the market, such as encryption and virtual private networks. But antivirus and firewall products have become commoditised and margins have slipped.

Customer relationship management software may do even better. Interact Commerce, publisher of SalesLogix, offers its reseller partners a standard 40 per cent margin, with even more on additional volumes.

Gary Holland, sales director at Interact, said: "The margin has remained consistent since the company was founded, and we don't anticipate changes in the future. We will occasionally increase the margin for our business partners when they are in a highly competitive situation for a major tender which has forced them to offer a price significantly below list."

But resellers cannot always specialise in high-margin products. Customers still want to buy desktop PCs and basic applications such as Microsoft Office - ideals that earn resellers mere peanuts. As each field of technology becomes more mainstream, so margins inevitably plummet.

Jonathan Wagstaffe, managing director at networking reseller Connectology, said: "In the last year or so it has become very interesting. There has been real competitive pressure and a real crunch in margins. Any hope of making money from shifting tin has completely evaporated."

Resellers that switch to newer, more lucrative technologies find that their margins increase for a while, but eventually slide again as the new technology starts to become commoditised.

Techtonik switched from being a general network reseller to specialising in security two years ago. Peter Johnson, managing director, said: "Networking was becoming very box-shifty and we wanted to add value. Last year, we commanded margins of 30 per cent or more on security, but now we are down to 20 per cent."

Road to riches
The recommended route to maintaining prosperity is to increase your services business - everything from pre-sales consultancy, specification, configuration, installation and user training, to ongoing maintenance and support. Margins for services are routinely quoted as being 20 to 30 per cent and above.

"If you're not making 20 per cent on services, you're doing something wrong, and you can easily make 40 to 60 per cent," said Longbottom. "You have to look at how crucial the service is to the customer. Web page design is very hot at present and is well formatted. You can make serious money from tailored training courses."

An average systems engineer can earn up to £700 a day in fees, while a good business consultant or highly skilled network support engineer can charge above £1000. Consultancy and small technical jobs are likely to be billed by the day, and there is a growing trend towards per call or per user charges for helpdesk services.

But larger projects, as well as some basic services such as installation, are increasingly done on a fixed-price basis. Fixed-price is easier to sell because customers know exactly what they are paying and getting in return. But it also means that resellers must have good project management skills to avoid over-runs, and a watertight contract in case the user moves the goal posts.

Services-based business may be more lucrative than flogging white boxes, but resellers must be aware of the overheads involved: account management, staff training, pre- and post-sales work, and so on. Many resellers fail to account for these, and find that their expected 30 per cent profit margin on services is swallowed up by extraneous costs.

The cost of selling products must be pared to the bone, too. There is no point lavishing effort on unknown prospects or small customers who never buy services, so a request for a quote may be met by the reseller with no more than a price list and a mission statement. Anything else will be charged for.

"We are absolutely adamant that, if we do a lot of services work, we will charge for it, and we recommend that resellers do the same," said Ideal's Tatham.

He believes that resellers should "detach" value-added services from their product sales to increase the value of the services. "Too many reseller salespeople still go in and ask: 'How many PCs do you want?' and then try to sell services on the back of that," he explained. "They have to make the change from a product sale to a services solution."

Renewable turnover
What resellers need if they are to beat the margin drought is repeat business. "There is a need for a total change in the way the channel makes its money," said Longbottom. "A turnover model is needed, not a capital model, with renewable turnover and the ability to up-sell with additional applications and rented hardware."

Managed services, where the reseller sells a service that is actually provided by a third party, can be lucrative and relatively low-risk. The biggest opportunities are in the corporate and small to medium sized enterprise markets, according to Caroline Quirke, sales and marketing director at ATL Networks, which provides managed security services.

"On managed services, margins are typically about 30 per cent on the initial sale," she said. "Most managed services contracts last for two or three years, and the reseller also gets a percentage when the customer renews. Managed services represent clean profit for resellers because there is no need to handle products, finance credit or make up-front investment."

In the same bracket come application service provider (ASP) deals, where clients rent software over online links. Such services are generally billed per user or seat per month. Contracts typically run for two or three years, with the first year's payment sometimes being made up-front, otherwise the ASP has to finance the up-front cost of the software. However, software vendors are coming round to the idea that ASPs should also pay on a monthly basis, like their clients. Sometimes a set-up charge of five to 10 per cent is also levied by the ASP.

Graham Crich, senior vice president of sales and strategic alliances at business services aggregator 7 Global, believes the charging model will become more sophisticated. "An ASP model in 12 months' time may comprise a monthly or quarterly standing charge, complemented by the number of times customers have accessed the application or service," he explained.

ASPs are keen to sell through the channel, using resellers to access existing customers, while resellers are equally keen to sell ASP services, because overheads are low.

However, commissions on ASP contracts are paid in instalments, so few resellers have taken the plunge for fear that, in the short term, their sales staff will migrate to conventional, commission-paying rivals. It will be interesting to see how much lower margins will have to fall before more resellers are willing to follow suit.

Conclusions:

• Margins on commodity hardware and software are in single figures. They are unlikely to rise and may fall even further.
• Specialised hardware and software can make up to 30 per cent, while margins on consumables can be more than 50 per cent.
• Margins on services are difficult to calculate, and many resellers forget about the overheads involved, although 30 per cent is a good target.
• Turnover-based sales, such as rental, ASP and other managed services, are becoming more lucrative than capital sales and one-off services.
• Resellers faced with low margins must learn to cut their sales costs, and change their sales philosophy to become more services and turnover focused and less reliant on one-off commissions to salespeople.

(box 1)Case Study: IB Business DevelopmentBased in Cardiff, IB Business Development is typical of smaller resellers which are moving away from hardware to make ends meet.

"I would much rather sell time than products," said Ian Brooks, managing director. "If I never sold another PC, I would not cry over it."

However, Brooks believes the ideal is to sell both, because it is still possible to make a profit on products - albeit a small one - and to add value by configuring servers on-site. It just requires a different focus.

"We are a hybrid consultant and reseller," he said. "Our pitch to small businesses is that we would like to be their bolt-on IT department. So we try to specialise in the products that an IT department has to have, such as PCs, accounting software and so on."

Brooks thinks resellers should make a stand against ever-declining margins, instead of cutting each other's throats. "People who complain about appalling margins are still the first to cut prices," he said.

With margins on standard hardware down to between three and eight per cent, IB always sells at recommended retail price. "If people try to negotiate, we just say: 'No, we don't do that'," he said. "Small businesses still think £5000 to £10,000 is a lot to spend on equipment, and assume we are making a lot of money on it. We do all we can to shatter their illusions about that."

There are fewer problems when it comes to service. "People are much more likely to quibble over hardware costs than labour costs," said Brooks. "I can't remember the last time anyone queried a labour bill."

IB usually charges £45 to £60 an hour for one-off business, with discounts for its "bolt-on IT department" customers. "We try to keep the charging simple because it makes it easier for small businesses," he explained.

Overheads are deliberately kept as low as possible. Brooks has no salespeople, preferring to let his technical consultants do the selling. He charges for pre-sales work such as specifying systems, whether or not the customer eventually buys from IB.

He also tries to avoid fixed-price contracts, because he believes they encourage resellers to cut corners, especially if they run into problems. Clients are then dissatisfied and everybody loses out.