Cloud Computing Economics 101
The Channels’ Financial Guide to Cloud Computing is a multi-part series discussing the financial impact of cloud computing within the channel. Topics include the economic impact of cloud computing, changing the portfolio of products / services and designing sales compensation plans to change behavior. This is the first blog post in the series.
If you are a business operating in the channel- be it a Value Added Reseller, Distributor, Systems Integrator, Telecom Agent or a Managed Service Provider- then you understand the monumental shift to cloud solutions happening in the industry today. It is no longer a question of “if” you are going to transform your business; you already have plans or are in the midst of this move to cloud.
The challenge is that one cannot simply say ‘today we are going to change our business model and focus exclusively on cloud.’ History has shown that very few companies have been successful in wholesale transformations, however, understanding the critical transformational components can significantly increase the chances of success.
One of the fundamental components that is always acknowledged but never fully understood, is the financial impact cloud has on the bottom line of a business. Let’s take a look at this financial impact and difference between one-time product transactions versus recurring services subscription transactions.
Product-based solutions have the characteristics that they are sold once, deployed/implemented, managed by the customer and then refreshed every 3-5 years repeating the cycle. Upgrades and support are typically an additional pre-paid annual cost (either upfront or through an assurance/warranty/support plan). The customer cash outlay for a product-based solution looks as follows:
Subscription services based transactions:
Cloud solutions are subscription based with an ongoing monthly service bill that is an alternative to a product-based solution. This monthly bill includes upgrades. Depending on the provider, there could be an initial set-up fee, but the core cost for the solution is spread out over multiple months. In this model, the cash outlay for a cloud-based solution is spread out over many years versus requiring customers to pay a higher initial purchase cost upfront, with a much lower recurring monthly service cost.
Now that we’ve covered the basics, here are where things really get interesting. Both the one-time product sales model and the subscription service sales model will be successful for partners as long as new customers are acquired every month. Once the monthly new customer acquisition slows down or stops, the one-time product sales model isn’t as profitable since the incoming revenue drops significantly.
However, the truth is that, on a month-to-month basis, most channel partners spend a lot of time nurturing existing relationships and not enough time acquiring new customers. Over time, a subscription-based business will grow and compound, while a business based on a one-time transaction will never be able to gain that leverage.
The vast majority of channel partners are used to selling one-time product transactions and getting paid upfront – instant gratification. Compensation plans for channel sellers are front-loaded and built on the one-time payment model. This forces everyone to keep selling to pay the bills and keep the lights on. If you stop selling, you quickly go out of business. It’s a feast or famine model that has been around for decades. In addition, customers can easily switch their procurement source if they are only buying product-based solutions hence this model does not help create stickiness.
If channel business owners want to even out monthly cash flow and reduce their dependency on large customers leaving and/or individual sellers leaving, one way to do that is by selling subscription services such as cloud computing. The goal is to build up enough subscription business to start the month with enough revenue to automatically cover costs and even produce a healthy profit.
With a subscription model, a channel partner will start every month with an automatic customer base that is paying for service month-in and month-out, regardless if any more new customers are acquired.
On the other hand, with a one-time product model, channel partners start the month with no automatic revenue or sales since every new deal is paid out one time and then the customer transaction is done. Thus the goal with a subscription service is to build up enough revenue to automatically start a month and cover the operating costs of the business. How quickly the business can get to this operating break-even point is the key, since growth beyond this point starts to turn into profitability.
Cloud services also create stickiness and tie customers with their channel partner and cloud service provider.
However, it’s important that channel partners jump to cloud with both feet. But, as you can see from the charts above, selling only one cloud subscription deal won’t materially impact the business’ bottom line. Each transaction is too small to individually be material. This is why many channel partners get discouraged in the transformation to cloud.
The net-net is that cloud computing solutions is where the industry is headed. Customers want the benefits of cloud computing such as increased business agility, optimized cost, reduced deployment time and more. The financial model is different from what has been done in the past, but is more advantageous in the long run and when properly understood and executed. Channel partners need to make the right investments and take the plunge to reap the benefits.
Stay tuned for the next blog post in this series: How does a channel business owner transform their business from a product-based business to a cloud-based business?