Telecom’s indirect channel has weathered one constant over the past three decades change. Since the U.S. telecommunications markets opened to competition in 1984, partners have witnessed the booms and busts and the inevitable expansions and consolidations of their supplier pools. Today, the channel may be headed for yet another inflection point. Three longtime switchless resellers TransNational Communications Inc. (TNCI), Lightyear Network Solutions and Ernest Communications Inc. left the playing field in 2013.
TNCI found itself millions of dollars in debt to operators including Verizon, Sprint, CenturyLink and AT&T. It declared bankruptcy in October 2011 and was purchased out of Chapter 11 by Blue Casa Telephone in May. Earlier this year, Lightyear confessed that there was no end in sight to losses, and that only liquidation or a sale would save the brand. Then Birch Communications Inc. announced it was buying Lightyear for $22 million. Shortly thereafter Birch also said it would purchase Ernest for an undisclosed amount, marking its 19th acquisition (see A Reseller Rollup Strategy following this article). What happened with privately held Ernest remains unclear, but it does not seem a stretch to say that Ernest could not withstand the headwinds that also felled its peers. While these are not the first resellers to go, they are three of the oldest, raising the question: What is the future of the switchless telecom reseller?
Opinions run the gamut among industry lawyers, analysts and master agents, and the resellers themselves. If there is any consensus, it is that the resellers that do more than rebill, that provide solutions to channel partners and their customers, stand a greater chance of outwitting the problem of declining margins even as the channel focuses on cloud, BYOD, apps, security, M2M and other next-generation solutions. After all, end users still require connectivity, and sometimes even the straight-up POTS products in which some resellers continue to specialize. But, sources say, the resellers that don’t grow beyond legacy approaches or secure their financial footing look likely to follow in the footsteps of TNCI, Lightyear and Ernest. And that has many partners re-evaluating their long-standing allegiances to these channel-friendly providers.
Perhaps a history lesson is in order. When the U.S. government in 1984 opened the telecom market to competition, up sprang the non-facilities-based reseller model. Also called switchless resellers, these companies provide service by reselling facilities of the major long distance companies first AT&T and later MCI, Sprint and others. In 1996, deregulation of local markets opened up a similar opportunity in local telephone services. These enterprising companies also began aggregating broadband services not only from geographically diverse telcos, but also cablecos. Accordingly, resellers thrived by offering:
Over the past decade, the sheen has worn off the reseller model. Market saturation can take part of the blame. Lured by the promise of big money in arbitrage, rivals crowded into markets across the country. To compete, everyone began cutting prices and, as a result, driving down margins across the board.
Second, service bundling a customer-loyalty tactic employed by telcos and cablecos continues to impact resellers’ top lines. “It’s tough to compete even with an integrated T1, when it’s competing against up to eight, 12, 20, 24-plus lines of voice bundled with up to 10/20/50/100-plus Mbps downstream speeds,” said Brian Washburn, service director, Global Business Network and IT Services, for Current Analysis.
And don’t forget regulation. Over the years, the FCC ended UNE-P and backed off special access, two Telecom Act mandates that had helped carry the competitive local market from 1996 through the dot-com boom and bust. But since the government stopped restricting the prices incumbents may charge, “It is increasingly difficult for resellers to secure a discount from carriers that maintains the requisite margins,” said Craig Clausen, executive vice president of New Paradigm Resources Group. The problem applies to both non-facilities- and facilities-based resellers, sources said; facilities-based resellers still rely to some extent on the larger operators.
To combat those challenges, some resellers tried deploying softswitches to create their own networks, or adding wireless services and platforms, such as telecom expense management to their portfolios. This has worked for some but not all. TNCI, for example, shifted to VoIP although it still needed access to Bell networks. Lightyear also turned facilities-based after its 2002 bankruptcy and branched out into wireless and some hosted services. Ernest tried the value-added TEM approach along with SIP trunking and other initiatives.
Expect reseller consolidation to continue, albeit at a slower pace. “Most of the attractive resellers have been taken,” said Mark Del Bianco, head of Law Office of Mark C. Del Bianco. Nonetheless, sources said, reseller M&A promises to remain a trend due to eroding margins, high competition and concentration on next-generation technologies. The buyers probably will be those aiming to consolidate markets and increase scale, said Washburn. Meantime, the resellers that remain independent will have to keep diversifying, said Clausen. This may mean they snap up companies outside of their traditional domains. To that point, reselling, on its own, “is probably not a long-term profitable growth strategy, but it is a way to build a customer base that can be converted to higher margin bundled and facilities-based services if you have the financing to acquire the necessary facilities,” Del Bianco said.
Along those lines, resellers that responded to a Channel Partners interview request by press time noted, without exception, and despite the opportunity for anonymous attribution, that they are flourishing.
Of course, it makes sense that resellers, given the chance to talk about their companies to the channel, would send nothing but optimistic messages and, as most did in interviews with Channel Partners, tout their debt-free, profitable financials. So, for a reality check, Channel Partners also asked master agents, the key partners brokering many resellers’ services, for their thoughts on the future of the reseller market. These frank responses, shared under condition of anonymity, indicate a somewhat tepid confidence.
To wit, the traditional reseller model “is all but dead,” said one master, with another echoing that statement almost word for word. Another said resellers are not defunct but added only those that bring more value and accountability to partners remain worthwhile. Even then, the master noted, there are stumbling blocks. “We have to sell past the fact that they have less brand.” Another master agent told Channel Partners, “Resellers were always a race to zero and there are very few who are efficient enough to succeed there.” Finally, one observer did dub the reseller model “alive and well,” but said this refers to providers that serve as more than rebillers, offering products such as hosted voice and BC/DR.
It appears resellers have some hesitant partners on their hands. Indeed, one master pulled away from reseller sales five years ago. “We started selling more for the best quality channel carriers and that paid off. It paid off even more when the resellers went away, as we had little to no business with them,” the agent said. Two others also have cut back. “Our reseller business makes up less than 2 percent of our revenue,” said one master agent. “At one time, it represented more than 30 percent.”
One factor in the move away from resellers, said one master agent, is “stickiness” or lack thereof. “Selling a commodity became less rewarding when you were constantly repricing or moving from one reseller to the next,” the agent said. “Dealing with the type of subagents that traded in reseller traffic was exhausting. These are the least loyal customers, and the least loyal subagents.”
Another issue is shifting priorities. “Given the enormous opportunities in hosted voice, cloud, big bandwidth, wireless management, SIP, collaboration and colo, the niche addressed by resellers is not worth our attention,” said one partner.
Still, other masters voice support for their reseller suppliers. “We sell many resellers and they are a vital part of our portfolio,” said one. “These companies have continued to expand their product set and keep up with technology evolution,” said another.
The takeaway is that the future of the reseller market remains an unknown. Sources agree that resellers refusing to branch out or specialize in a niche face trouble. “The straight reseller model is unsustainable,” said Ben Bronston, head of Bronston Legal PLLC. But companies that offer POTS lines as an add-on service, rather than as the core product, might do fine, he said. And, Fedor Smith, president of research firm ATLANTIC-ACM, said resellers that focus on vertical markets such as the financial services sector, which requires ultra low-latency networking, are finding success. “There really is a long tail,” he said, noting it’s just a matter of grabbing on and figuring out what works. As Smith put it, “Telecom is no easy ride.”
The purchase of Ernest Communications Inc. marked Birch Communications Inc.’s 19th acquisition since 2005 as the 17-year-old company has moved to transform from a competitive provider of legacy services into an IP and managed services provider for SMBs. With Ernest and fellow reseller Lightyear Network Solutions, which it also acquired this year, Birch will own network in 10 states and 290 central offices; all told, it serves 46 states and Washington, D.C.
“You can’t just be a reseller anymore,” said Brad Smith, Birch’s senior director of channel sales. “It’s imperative that you have your own network going forward.”
Over the past eight years, Birch has carried out that directive through M&A and, this year, attracted even more support from banks (for a total of more than $100 million) for that inorganic growth. Along the way, Birch appears to have paid reasonable prices and, if it can streamline its products and departments to keep overhead costs down, the strategy “will ultimately prove profitable,” said industry analyst Craig Clausen, executive vice president of New Paradigm Resources Group.
Attorney Ben Bronston agreed, calling Birch’s M&A game plan “very clever” because the company appears to have a knack for keeping the economics in its favor. Even if there’s significant customer attrition, “each acquisition probably pays for itself in relatively short order,” Bronston said. One way Birch seems able to make that happen is by not assuming agent agreements, sources said. Indeed, the company confirmed that it negotiates with acquired companies’ partners on a case-by-base basis. Lawyers and analysts calculated that this plan adds 15-20 percent back into Birch’s bottom line, contributing to the positive economics of its consolidation efforts.
Meanwhile agents expressed confusion over Birch’s treatment of Lightyear and Ernest agents’ contracts. Some agents said terms are not being honored while others said they had not yet heard how Birch planned to handle their agreements. Birch’s Smith told Channel Partners that the company buys assets contracts are considered liabilities. “So even though we’re not technically acquiring the contracts, they’re all being worked out,” he said. Smith added that he cannot give specifics, but “for [partners] to sign up with us the terms have to be as good or better or they wouldn’t do it.”*
Interestingly, several of the master agents Channel Partners interviewed said they won’t sign new contracts with Birch; but more than half remain undecided.
*Sept. 05 update: Birch Communications has informed Channel Partners that 90 percent of Ernest dealers now have signed agreements with Birch.
Birch Communications Consolidation: November 2005-June 2013