Death of the VAR in a SaaS World


In general, offline channels have not played a big role in SaaS GTM strategies. The early focus of business and infrastructure SaaS solutions has been on SMBs. SaaS delivery makes it economical to serve SMBs, and online channels make it economical to reach SMBs. As SaaS grows up though (see our earlier post), what role will offline sales channels, in particular VARs, be able to play?

We are very skeptical that VARs will be able to thrive and prosper in their current business model as SaaS adoption continues to gather momentum. The reason is that the TCO model that is promised by SaaS drastically reduces the revenue pool accessible to channel partners. (As we point out in our earlier post, the TCO model still needs to be proven in the long run.) In a June 2007 article, the McKinsey Quarterly compared the total cost of ownership (TCO) for a 200-seat CRM license as on-premise ($2.3m) vs. SaaS ($1.6m). More interesting though than the headline 28% reduction in TCO is the fact that the non-software revenue pool accessible to channel partners shrinks by 90%. Specifically, in this midmarket example, the $1.1m that is spend in the on-premise model for implementation, deployment and ongoing operations shrinks to a meager $106k in the SaaS world.

Faced with that bleak prospect, VAR channels can pursue one of three strategies:

Provide managed services. Become an MSP by offering management of the on-site IT infrastructure. Then shift as much as possible to offsite delivery. This is probably the most achievable and sustainable of the 3 strategies for a majority of VARs. In the infrastructure arena, this may be a way to escape the commoditization of storage and computing that drives margins relentless lower. The Holy Grail here is to price in a way that compares favorably with the high TCO of in-house operations. Let’s illustrate this with a numerical example from the world of data and systems management. Suppose you are a VAR that currently resells online backup for servers. Odds are the VAR’s customer may pay $0.50 per GB, so that’s $100 per month on 200 GB that are backed up from 1 server. Now suppose the VAR transitions to a managed services model by selling server management (i.e., provisioning, administration, system monitoring, maintenance, troubleshooting), including on-line backup. How would you price that? Let’s see. So one IT administrator (at $100k/year fully loaded cost) manages 20 servers, so that’s $5k/server/year of labor just for systems management (i.e., not including online backup). Assume an average server price of $4,000-5,000 with a 3 year life span, so that’s $1.5k/year, for a total cost of ownership of $6.5k per year per server, mostly in labor. Thus, the customer’s server TCO is ~$540/month. The MSP can promise a 30% TCO savings by selling a managed service at $380 per month, easily a much stickier business compared to just reselling products. Barriers to entry are pretty low though and are further reduced by emerging solution providers that cater specifically to MSPs, e.g., Digisense (“secure data management”) and Level Platforms (“managed services software”). While there are already an estimated 10,000 MSPs in the United States today, customer retention rates in this business are pretty high.

Extend the solution. Turn the one-size-fits-all SaaS offering into a customized solution by developing re-usable additional functionality related to vertical or niche horizontal requirements or integration with third party applications. A pre-requisite for this is a SaaS platform and marketplace provided by the vendor. This has limited applicability for infrastructure applications, while in the business apps space Salesforce is the leading example with Force and Appexchange. The platform ensures that VAR-developed solution extensions are compatible and reusable. The marketplace provides licensing and global distribution. And finally, the development environment lowers the barriers for the few channel partners with sufficientprogramming / scripting skills to pursue this strategy. Netsuite for instance encourages its VARs to pursue extensions. VAR deal sizes on Netsuite’s SaaS solution are $50-75k vs. $150-300 on a competing Great Plains on-premise solution. There is a belief that VARs/SIs who create vertical extensions can charge another $25K in high margin annually recurring subscription revenue, so not bad.

Ramp volume. Complement offline with online marketing and sales channels to reach new customers and increase share of wallet. Or acquire/partner with complementary VARs. This is the least sustainable of the 3 strategies given superior scale of vendors such as Dell or volume IT resellers such as Insight, CDW, or TigerDirect. Some larger and well managed infrastructure VARs will grow through acquisitions/partnerships and by extending their presence online. The volume strategy is debatable at best for infrastructure VARs (essentially amounts to running faster), and not really viable for business applications VARs given the consultative and industry-specific nature of the business.


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