Both Ends Against the Middle?
IBM has lanched a direct ship fulfillment program that may threaten its distributors' sales margins. Meanwhile, it's also expanding worldwide service efforts, which may encroach on its VARs' integration business. In redefining its channel relationships, will IBM emphasize cooperation or competition? And in adapting to the change, will the channel stress volume or value?
Things are changing in the IT channel. You might say the emergence of a new fulfillmentmodel is playing both ends against the middle. The pioneers of "build to order"and "direct ship" fulfillment like Dell have been so successful thattheyve incented competitors like IBM and Compaq to follow suit. In this model,product is typically configured to customer specs by the vendor and directly shipped tocustomers. By diminishing channel involvement, vendors reap higher margins and createcloser customer relationships, while customers get orders quicker and cheaper. But wheredoes this leave the distributors who traditionally were clearing houses for shippingproduct and VARs who focused on low-level configuration and assembly, as well as on-siteintegration?
Some resellers see their one-time supply partners as new competition for a fixed poolof customers the more customers buy direct from vendors, the less they buyindirectly through the channel. And as vendors do more configuration, assembly andintegration, some resellers are trying, at best, to redefine their roles and, at worst, tojustify their existence. Vendors tend to cast what looks like a paradigm shift in a morepositive light. If they assume more of the lower level activities and expenses of thechannel shipping, assembly/configuration, inventory they free resellers toserve more customers by improving value-added vertical market, application and integrationexpertise.
By developing more "complete products," direct ship OEMs are forcingresellers to create more "complete solutions." But thats only part of theproblem. Hardware OEMs, like IBM and Compaq, are also getting into the solutions business with the dramatic growth in vendors worldwide service organizations likeIBMs Global Services, resellers are competing for integration projects with eachother, as well as with their OEMs.
So how will the channel redefine its role in relation to IBM, in particular. Willdistributors evolve director ship fulfillment to compete with IBM, the OEM? Will VARsdiversify and/or specialize to compete with IBM, the worldwide integrator? Or will IBMredress its more competitive posture to keep from alienating its indirect sales network?
IBMs Big Corporate Picture
Tom Bittman, Vice President/Research Director, Server Strategies, Gartner Group,monitors changes at IBM that affect its corporate constitution. He observes that "IBMis changing rapidly from a hardware and direct sales company to a services company andtrying to, at the same time, grow their software business because services whileits growing at a 25 percent to 28 percent rate and the revenue is already somethinglike 30 percent of IBM revenues [have] margins [that] are pretty slim compared tothe rest of IBM business." Software margins are high because you create code once andsell it millions of times.
Services, by contrast, depends on people who are not duplicable, which drives up cost.IBMs service revenues will continue to grow rapidly as those activities expand. Butmost of IBMs profit will derive from the high margins on its software sales which should redouble as IBM shifts from creating software for mainframe and AS400products to "layered" software (any software above the operating system) with across-platform focus. But to succeed in layered software, Bittman says IBM first must getpast Microsoft.
IBM wants to consolidate a mid- to high-end desktop based on an open cross-platformEnterprise Java Beans server layer and an overall CORBA architecture. Microsoft wants toinvade the mid- to high-end with its proprietary brand of Java and its COM and DCOMarchitecture. If IBM loses the layered software war, Bittman says Microsoft will controlthe application interface and middleware layer. With the increasing success and robustnessof NT, soon Microsoft will also own the entire computing platform. In that case,IBMs best play would be to grow its service business, which will drastically changeIBMs entire organization.
Bittman believes neither Microsoft nor IBM will win the layered software marketoutright. Instead, IBM will control the enterprise segment where heterogeneous andlarge-scale computing is important and cede the lower-end NT segment to Microsoftand hardware dominance to companies like HP for whom thats a core competence. Inthis scenario, IBM remains more of a software and services company.
Between a Rock and a Hard Place
Marilyn Trugilio, Senior Research Analyst, Equipment Asset Management Service, GartnerGroup, follows the desktop hardware, software and services reseller market. In heropinion, more large vendors will adopt and refine the direct ship model by 2002more than 70 percent of U.S. enterprise PC shipments will be directly fulfilled by systemmanufacturers. But she says that wont stop OEMs from also expanding their servicebusiness. As a result, some resellers will be stuck between a product rock and a servicehard place.
Resellers must quickly shift their revenues more towards service or theyre at themercy of the direct ship product vendors. "If VARs dont increase their servicerevenues ... pretty substantially," says Trugilio, "theyre going to be outof business or theyre going to be acquired." In her estimate, "through2002, 40 percent of the resellers competing in the desktop marketplace for equipment andservices will change ownership." Mega-mergers, like that between largeintegrator/distributors Inacom Corp. and Vanstar Corp., and acquisitions by big horizontalproduct resellers like Compucom of others like CIC, will become more commonplace. Channelconsolidation will continue as direct ship vendors buy struggling resellers for theirunique geographic coverage and market or application expertise.
But, even after reinventing themselves, some large resellers will be hard-pressed tocompete at the high end with super-service providers like IBMs Global Services.Trugilio says they lack the majors international scope, simpler sell-throughprocess, economies of scale and ancillary services.
Global corporations tend to prefer global support partners with worldwideinfrastructures for delivering product and services. And, to control administrativeoverhead and clarify accountability, they want to reduce the number of vendors andintegrators they deal with for procurement and installation. But, while they prefer that aservice organization like IBMs Global Services fulfill a contract, says Trugilio,they want to negotiate lower PC pricing terms and conditions through a product arm likeIBMs Personal Systems Group. The big OEMs have also developed finance organizationslike IBM Credit Corporation with the huge coffers to carry large, long-term loans oftenrequired by the Fortune 500.
Large resellers and some distributors lack this level of full-servicecapabilities. Trugilio says they are mostly North American-based and conduct internationalbusiness through geographic partners. And, though multiple organizations complicate thelogistics of sell-through and drive up price through inventory/shipping costs, theirfragmented credit arms cant compensate customers with better financing than directship OEMs.
Trugilio says these convulsions are precipitating a reseller identity crisis: "Thechannel in general is concerned about whats theyre role going to be,whats their value proposition, what can they do to get companies to do business withthem..."
Go Down-Market and Specialize, Specialize
With its full-service portfolio, Trugilio thinks "IBM is going to milk thehigh-end and the global deals." Mid-market companies have fewer in-house ITresources, so they tend to outsource complex integration and support services.
These more granular service requirements are hard to satisfy with a direct ship model.So Trugilio sees mid-market accounts of up to 5,000 seats or so with more complexintegration needs as a promising frontier for resellers.
Once down-market, VARs, especially, will differentiate themselves by improving theirmarketing and sales generation and specializing in different combinations of verticalmarket and technology expertise. A reseller concentrating in one-off installs of, say,Lotus Notes in the newly deregulated and booming markets like utilities andtelecommunications can quickly develop a very marketable brand identity. Those who take across-market approach, says Trugilio, might develop a technology focus like doingUNIX-to-NT migration in many verticals, while others adopting a cross-platform strategymight focus on integration of heterogeneous systems in fewer verticals. And a certainpercent will still team with the big vendors on projects. IBMs Global Services mightmanage product fulfillment on a project, Trugilio speculates, employ resellers to dovarious degrees of assembly, delivery and installation of product, then assume after-salesonsite technical support.
Distributors Steel Sharpens Steel
Direct ship pressure and increased competition from new VAR players like Internetspecialists is forcing many distributors to improve their core operational efficiencies.Brooke Powers, Vice President/General Manager, Systems Product Marketing, Tech Data Corp.,says, "manufacturers ours and resellers core competenciesare all different three years ago we kind of all had some sort of overlap ... andmaybe were in some areas that werent our core competencies." Now, he says,distributors arent reinventing their role as much as re-embracing it andPowers thinks this is a positive development. Tech Data, he says, uses its Factory Directdirect ship, Channel Assembly and Private Label fulfillment programs, for example, tobetter assemble, configure and ship product so, with fewer logistical headaches, VARs canfocus on sales.
Electronic commerce techniques are critical for expanding core competencies. Asproducts "keep changing faster and faster," says Powers, "people want moreand more power, and prices are going down, so the [sales] life cycle is three or fourmonths for a product." To be profitable, distributors must sell product faster beforethe next wave of products when prices fall. And they must know how much manufacturesproduct is "in process," rather than in stock, to accurately forecast how muchproduct OEMs can deliver within a VARs delivery window. "We talk aboutarrivability rather than availability," says Powers ... now"were actually right at the end of the manufacturers assembly line, so wecan ship [product] directly to even the end user."
Powers concedes that post- and pre-sales technical support will become more importantas outsourcing by customers becomes even more popular. So eventually distributors may haveto compete with OEMs in these areas. But he claims that what VARs most want fromdistributors now is adequate product at the right time and price. Distributors, not OEMs,excel here. And, he adds, "its rare these days for a company to use aone-vendor solution." So, even if it provides most of the technology and integrationon a project, a large OEM will still need distributors for one-stop shopping for differentvendors products.
Powers believes, a bit contrarily, that the recent churn in the channel is actuallygrowing business "were seeing more VARs coming into the marketplace thanever before." The proliferation of new technologies presents new opportunities, andstart-up and success are easier because VARs can virtually take orders and pass them todistributors over the Internet, who then direct ship product under the VAR label. So,while some distributors might suffer reversals in trying to compete with OEMs, IngramMicro, for instance, attributed its $500 million revenue shortfall in Q4 1998 toCompaqs aggressive PC pricing, others are cashing in with new customers. The lessonhere might be, as the big guys force channel consolidation, first, do what you do bestbetter and, second, diversify with more partners.
Lets Work This Thing Out
Despite its aggressive move into high-end integration and direct ship fulfillment, IBMseems largely committed to its resellers. Susan Whitney, Vice President, Server Marketing,IBM, says about 45 percent of IBMs server revenue comes from the channel, and itstill relies on partners for specialized market access, solutions and applicationexpertise which IBM lacks or lacks enough of. And, though IBMs direct ship focus isvertically oriented, that doesnt hurt vertical resellers. Rather, says Whitney, IBMoften introduces them to account situations, collaborates on campaign generation, andshares leads.
Still, she emphasizes, that leaves lots of opportunity for IBM services. "Theservices market is almost infinitely large [and, though] we are a market leader, ... ourshare is still very, very small." So shes convinced the services market cansupport all kinds of reseller/integrators, as well as large OEM organizations. She doesconfirm, however, that IBM is inclined to focus on global and high-end accounts "Global Services can deal on very competitive economies of scale and leverage itstechnology infrastructure, [which] tends to be what the larger accounts need."
But, she maintains that the direct ship model provides just one element of value in thechannel value chain product fulfillment and adds, "when you fulfill asystem, you still need skills and expertise for the installation, ... implementation,integration, ... and market access capabilities." These are VAR, not OEM,competencies. And she sees evidence that some direct ship programs work to VARsadvantage. With IBMs Quick Ship program customers or resellers order IBM productsover the Web and get a response within two minutes telling them when the product will beshipped and delivered (the objective is within 48 hours). But IBM business partners, notcustomers, predominantly use Quick Ship. "As IBM enhances the fulfillment process,business partners are the largest consumer of products fulfilled that way," shecontends. "It reduces their inventory carrying costs, their operational expenses andallows them to invest their expense dollars in areas where they can differentiatethemselves."
Whitney does agree that the roles of channel members are in flux and that value andinfluence seem to be migrating back up the food chain towards direct ship OEMs. But shefeels the value that resellers provide in the future will not be less, just different."I believe business partners realize their value-add is much stronger when itsabove and beyond the fulfillment portion. "For example," she says, "part ofthe value chain distributors provide is the whole technology infrastructure, salessupport, systems support... and we dont have the capability to provide this with thesame depth and breadth." So she sees the value shift as one of quantitative, notqualitative, degree.
Finally, like its business partners, IBM is doing more business virtually to drivetime, distance and complexity out of the fulfillment process. For example, she says, inaddition to its Quick Ship program, IBM offers its U.S. business partners "theability to run configurators for our products over the Web and then place an order forthose products." It also offers its Web-based Partner Info service which helpsresellers locate product information and contact appropriate IBM reps.
About the Author:
John Harney is a freelance writer based in Washington, D.C., who specializes in