Climbing to the Higher Cloud

**Editor’s Note: You can download the three-part Digital Issue series that explores the shift to the Higher Cloud from the Higher Cloud Immersion Center.

Cloud computing is undoubtedly the consumption model of the future. Customers — from small businesses to enterprises — are shifting IT resources and applications to the cloud to capitalize on cost savings, scalability, flexibility and expanded capabilities. The channel is critical to the future success of cloud computing, but many channel partners are struggling to make money through the resale of cloud products and services. The answer, some say, is that channel partners need to focus beyond common cloud services and develop Higher Cloud practices.The 2112 Group's Lawrence M. Walsh

Channel Partners asked Lawrence M. Walsh, CEO and chief analyst of The 2112 Group, about Higher Cloud services, what they mean to channel partners and what it will take for partners to develop these advanced capabilities. Walsh will expand on the Higher Cloud trends during his keynote address, “Delivering the Higher Cloud: Channel Partners’ Road Map,” at Cloud Partners, a Channel Partners event, Sept. 8-10, in New Orleans.

Channel Partners: When you think about the Higher Cloud, what does it mean and how does it translate to channel partner practices?

Larry Walsh: In the channel, complexity has always been our friend. The more complex a technology or system, the less likely an end user will be able to do it on their own without the assistance of a technically qualified professional or organization. The cloud is no different.

Cloud computing has tremendous potential for delivering complex systems and applications with greater scale and efficiency. Creating those systems isn’t easy; especially those that amplify business value and open new opportunities. They require higher levels of integration, customization and enablement.

Higher Cloud is the product of channel partners that invest in advanced integration, business consultation and professional services. Channel partners that invest in building or acquiring higher levels of application and cloud expertise will not just differentiate from their peers, they will command higher prices and margins, and enjoy accelerated growth.

CP: What do channel partners have to do to reach for the Higher Cloud? What are the market trends that require them to strive for complexity?

LW: The channel has two cloud problems. First, few channel partners have achieved critical mass for cloud performance. Second, many cloud solutions sold through the channel are already commoditized.

By the end of 2014, the average channel partner will earn less than 25 percent of its revenue on the sale of cloud products and related services. Profitability will fall in the same range. However, the profitability of the most common cloud products through the channel is falling rapidly. In 2013, cloud profitability fell by as much as one-third. This is happening even as channel partners are increasing cloud sales as a percentage of their gross revenue and profits. The translation is they’re competing on price and shifting to a volume over value sales model. While this may seem reasonable, it ultimately means more stress on the sales process that will increasingly put more pressure on price cuts.

By dealing in complex cloud solutions, channel partners have the opportunity to focus on a value proposition in which they can command higher prices and profit margins. In the value model, customers are paying for true solutions and the expertise of their channel partners. Value models are more sustainable than volume, since it’s less reliant on price as a competitive differentiator.

CP: When you say cloud has already commoditized, what specifically does that mean in terms of the products and services being offered? Isn’t the subscription and recurring revenue model of cloud computing a revenue generator?

LW: The general presumption that the recurring revenue model associated with many cloud services is a good thing for channel partners is true. The theory goes that recurring revenue compounds over time. As more accounts are added, more revenue is generated, and that revenue is predictable. If you sign a customer to a two-year contract that pays $100 per month, the total value of the contract is $2,400. If you sign 10 customers to the same contract, the total revenue over two years is $24,000.

The problem isn’t in the recurring revenue model as much as the types of cloud products and services being offered through the channel. The most popular and best-selling cloud products are backup, telephone services, hosted email and business productivity apps such as Microsoft’s Office 365 and Google Apps. While channel partners are earning good money through these products, there’s increasing pressure on price and margins due to oversupply. These are relatively simple offerings that are widely available in the channel. As a result, customers have options to shop for the best price, which causes vendors and channel partners to lower what they charge.

If you want an example of this, look no further than the cloud pricing war between Amazon, Google and Microsoft. These three cloud giants continue to drop prices on hosted storage and compute. While Amazon saw a 90 percent increase in cloud subscribers over the last year, its profitability increase was negligible. Amazon and other cloud vendors are betting that lowering prices will capture customers that they will retain over time. They’re sacrificing short-term profits for long-term revenue.

The same thing is happening in the backup and email segments. Channel partners are lowering prices on these services as they either compete for business against peers or perceive customers’ tolerance for true value decreases. More complex services, where there is lower supply and more valuable outcomes, translate into greater price integrity and returns on channel partners’ investments.

CP: OK, let’s get down to specifics. What precisely is a Higher Cloud service?

LW: That’s a bit nebulous. It sounds contradictory to say, “but commodity cloud services can be Higher Cloud offerings.” More so, more complex applications and associated services are also higher level. The defining difference isn’t so much what the cloud service is, but rather what it does.

Let’s start with commodities. If a channel partner is selling cloud-based backup or hosted servers in isolation — the classic one-off sale — they’re not going to do well. However, if they bundle multiple services integrated to interoperate seamlessly, they stand a much better chance of aggregating the overall value of the package. Add on consulting, management and maintenance services to ensure the integrity and reliability of the package, and you have a more complete solution with a higher overall value to the customer. In this scenario, the value doesn’t so much come from the products, but rather the attached services and expertise delivered by the channel partner.

The greater opportunity is in the cloud white spaces, which are typically more advance applications such as CRM, ERP, accounting, logistics management, machine-to-machine operations and higher level security services. A small number of channel partners are plying the waters of advanced cloud applications, where they’re taking legacy enterprise and midmarket applications and porting them to hosted services. More sophisticated channel partners are even performing business functions on behalf of their customers.

The thing to remember is few customers wake up in the morning thinking about or wanting to do IT functions. They have their own business functions and objectives that require and deserve their attention. If a channel partner can relieve the IT burden so a customer can focus on their core competencies, they win.

CP: What does it take for a channel partner to engage at the Higher Cloud level?

LW: In a word, “vision.” As the Latin proverb says, “Fortune favors the bold.” Channel partners need to define not just what they do in the cloud, but what they’re solving for and how that’s different from competitors. Being a reseller of a carrier, IT vendor or cloud provider simply isn’t enough. They need to define a solution, tell a story about the benefits and what makes them unique. That’s where they’ll create and maintain value.

Once channel partners define their vision, they need to determine what it will take to make their vision a reality. This means translating vision into a strategic and operational plan, making investments in technical and sales capabilities, setting objectives and executing. Evolving capabilities will keep channel partners not just ahead of competition, but relevant with customers. And channel partners with high customer relevancy will ultimately win the cloud race. Not every channel partner will follow this path, but those that do will reap the highest rewards.

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