Vendor Consolidation

With a few key strategies, partners can maximize profitability by leveraging the constant and sometimes disruptive force of vendor consolidation.

"Merger mania" is back, and partners had better be ready for it.

In the late 1990s, the dot-com boom was the setting for a frenzy of corporate mergers and acquisitions. In fact, the total volume in dollars of acquisitions in 2000 was higher than that of any other year in history -- until 2006. On Nov. 21, The Associated Press reported figures from Dealogic, a financial-software firm that tracks and analyzes capital markets. The numbers were clear: By November, the total value of announced acquisitions had reached $3.46 trillion for the year, eclipsing the record total of $3.33 trillion set in 2000. It seems that after taking a few years off to absorb the impact of the dot-com bust, corporations in a wide range of industries are once again hunting for deals.

The technology industry is no exception. New York-based analyst firm The 451 Group reported in March that merger and acquisition spending in the technology industry rose 67 percent in the first quarter of 2006 compared to that of the first quarter of 2005. And in 2005 as a whole, technology companies spent $339 billion on mergers and acquisitions -- 62 percent more than they spent in 2004. M&A fever in 2006 was perhaps most apparent in Google's much-discussed $1.65 billion purchase of the popular upstart video Web site, YouTube Inc. Other big deals dotted the landscape in 2006 as well, including Advanced Micro Devices Inc.'s $5.4 billion acquisition of ATI Technologies Inc.

Consolidation, of course, is normal in any industry and has certainly been a part of the technology community's history. "The software industry is maturing, and it's maturing a lot like consumer product goods or other industries," says Dawson Lane, past president of the Canadian branch of the International Association of Microsoft Certified Partners (IAMCP) and COO of Perth, Scotland-based Kit Software Ltd., a Gold Certified Partner and provider of software and services for commodities trade management.

"Consolidation really isn't anything new," says Stephen Graham, group vice president of global software business strategies at IDC, the Framingham, Mass.-based analyst firm. "There has been consolidation in the software industry. We had consolidation through different parts of systems management and collaboration. There will likely be some consolidation around content management providers, where there are a lot of smaller players in the market."

Large vendors such as Microsoft control the ebb and flow of M&A activity. Graham points out that Microsoft and three competitors, Oracle Corp., SAP AG and IBM Corp., have established themselves as the mainstays of the software industry. "If you're in the software business, it's likely that your business involves one of those four," he says.

Microsoft Munches on Minnows; Oracle Hooks the Big Fish

Microsoft has a reputation industry-wide for being an acquisition-hungry monolith, but, in fact, the company is more likely to snap up small firms rather than bigger competitors.

It was, after all, IBM Corp. that snagged Lotus Development Corp. for $3.5 billon back in 1995 and then, seven years later, bought PricewaterhouseCoopers LLP's consulting operation for the same price -- a figure IBM restated to $3.9 billion in 2003.

And Oracle Corp. made waves when it swallowed fellow enterprise resource planning vendor PeopleSoft Inc. for $10.5 billion in 2005. From then through November 2006, Oracle made 26 "strategic" acquisitions, according to the company's Web site. Over that same time period, IBM bought 18 companies.

Microsoft, for its part, made 17 acquisitions, none of which approached the volume of the Oracle-PeopleSoft buyout. The company's March 2005 purchase of Groove Networks Inc., which brought Bill Gates' replacement as chief software architect, Ray Ozzie, to Redmond, cost just $120 million. And Microsoft's 2000 purchase of ERP vendor Great Plains Software Inc. was a $1.1 billion deal, a small price tag compared to Oracle's PeopleSoft move.

In 2006 (through November), Microsoft bought Colloquis Inc., a provider of online business applications that feature natural language-processing technology; Azyxxi, a software package for the health-care industry; Winternals Software LP, a vendor of system recovery and data protection applications; Softricity Inc., a provider of virtualization technologies; Whale Communications Ltd., which makes firewalls for VPNs and Web applications; Massive Inc., creator of a network for video game advertising; Lionhead Studios, a video game developer; ProClarity Corp., a provider of BI applications; Apptimum Inc., which makes a utility that transfers applications to new computers; Onfolio Inc., an Internet research and information management company; and MotionBridge, a provider of search technology.

With mergers and acquisitions back on corporate agendas and a cadre of large vendors gobbling up smaller ones, partners need to know how to reshape their strategies to maximize profitability in a new era of consolidation. Developing a services business and targeting vertical industries are critical moves partners should make now. They should also take a hard look at focusing exclusively on selling Microsoft technology.

Follow the Shift to Services
Although the word can invoke fear for some industry observers, consolidation isn't necessarily a bad thing. Large vendors can use their marketing prowess to increase adoption of the technologies they buy in acquisitions, giving their partners greater opportunities to sell and service those technologies, says Albert S. Bitton, managing director of PartnerWise, a Montreal-based consultancy and Registered Member.

"[Consolidation] is a good thing because it enables technology to be mass-marketed by a great sales and marketing company," Bitton says. "Much like a lot of businesses, ideas are a dime a dozen. It's different when you put them in the hands of an Oracle, a Microsoft, an SAP that can deliver them to the masses."

For some traditional resellers, though, consolidation leads to big problems. For those VARs and resellers that derive revenue less from providing services and more from margins earned on straight software sales, fewer vendors with applications in the market means fewer products to offer customers. That leads to commoditization of the applications partners are selling, experts say. And commoditization leads to lower prices, which leads to shrinking margins and lower profits.

"The reseller model is definitely going to have problems," says Ted Dinsmore, partner at New Haven, Conn.-based consultancy Exertus Partners LLC, and co-author (with Edward O'Connor) of Partnering with Microsoft: How to Make Money in Trusted Partnership with the Global Software Powerhouse (CMP Books, 2005).

"I would not like to work for [a traditional reseller], for sure," says Petri Salonen, president of the Dallas chapter of the IAMCP and founder and CEO of Tellus International Inc., a consultancy and Registered Member based in Trophy Club, Texas. "The only thing that you can [use to] separate yourself from each other is the price."

And it's critical for partners to differentiate themselves based on more than just price, Dinsmore says. Traditional resellers have to forge relationships with vendors and customers that go beyond the classic sales relationships of the past, Dinsmore says. That means putting people in place -- sometimes at considerable cost -- to develop one-on-one relationships with key contacts.

"Relationship-based reselling seems to be the only way to meet margin," Dinsmore says. "Put people in place on the ground so that [you] have relationships with customers and relationships with vendors. The resellers that seem to be surviving are the ones that have feet on the street and still keep a good margin."

More and more VARs and resellers, experts say, are reacting to consolidation by transforming their businesses to focus not just on pure software sales, but also on providing services -- such as implementations, maintenance or even application hosting -- for their clients. Service providers, experts agree, can differentiate their offerings and demonstrate value to clients more easily than traditional resellers can. And for service providers, consolidation can actually lower costs and lead to increased profitability, Dinsmore says.

"I have to certify my people in each of those ISVs' [certification programs]," he says. "If I have fewer products to deal with, I have fewer hurdles in getting my people billable. It's an advantage to a Microsoft partner to have this consolidation happen."

"The barrier to entry for service providers is considerably lower vs. [that of] traditional VARs," echoes Mike Harvath, president and CEO of Bloomington, Minn.-based consultancy Revenue Rocket Consulting Group, a Registered Member. "Service providers will get a lift from [consolidation] and the traditional VARs will be hurt by [it]. The small solution providers, if a big portion of their revenue comes from reselling, are going away. Most of those companies have been successful in reinventing their businesses as service providers."

Microsoft and Micro-Verticals: The ePartners Strategy

In February 2006, ePartners Inc., a Gold Certified Partner and service provider based in Irving, Texas, unveiled a new strategy. The company shifted from a generalist approach to a vertical approach, focusing on "micro-verticals" in the health-care, government and manufacturing sectors. In doing so, it became a living example of a partner company going vertical to maximize profitability. So far, the new strategy is working.

"Financially, we're adding some very nice numbers," says Bill Anderson, ePartners' vice president of product marketing.

But there's more to ePartners' vertical strategy than just the customized services and applications it provides to partners in its three targeted industries. First of all, the company didn't ditch clients that weren't part of its new target audience.

"We haven't gotten out of the business of selling and servicing clients that come to us," Anderson says. "They still make up most of our business. It wasn't about saying 100 percent of our new sales will be from just a couple of verticals."

But, he says, it was about developing a portfolio of services and applications based on the Microsoft Dynamics ERP platform that ePartners, which deals exclusively with Microsoft technology, could use again and again with companies in the same vertical niches. Having that "repeatability" with its offerings, Anderson says, has allowed it to improve sales cycles, lower costs and perform implementations faster.

Those niches are micro-verticals, much more specific than simply "manufacturing" or "health care." The company has, for instance, experienced success with its semiconductor and industrial-equipment offerings, and with a program for community hospitals, Anderson says.

"The buying patterns of a community hospital are very different from that of managed care," he says, adding that the manufacturing industry offers similar stratification. "It's very difficult to differentiate yourself as a provider based on the fact that you sell to manufacturing companies. Anybody who knows something about manufacturing knows that there's a difference between process manufacturers and discreet manufacturers. Some people think that's a big enough delineation, but it's not. You don't want to go so tight that you've only got 12 clients to serve nationally, but you don't want to be so loose that you're not relevant to that market."

Anderson says that ePartners' strategy has allowed the company to focus its marketing on its chosen micro-verticals and make a name for itself quickly in those markets. He also says that the company is using its success in some micro-verticals to move into others.

"We've got different markets that we're selling into reactively. Success in one segment brings opportunity in other segments. The strategy has worked very well for us."

Carve Out a Niche
Just focusing on providing services, though, isn't enough to ensure a boost in profitability. Another critical strategic move that partners should make is to focus on serving vertical or even micro-vertical markets, partners and analysts agree. The approach has worked for companies in other markets, PartnerWise's Bitton says.

"If you take a look at the hardware industry, it's a bit more advanced than the software industry," he says. "The same thing that occurred in the hardware industry is happening in software. Those who do well provide a solution stack around a specific problem that one of their industry customers has. Focus on a niche market because Microsoft does not focus on niche markets. They build general software and they rely on partners to build industry solutions around it."

"We're in an economy of niches today; that's supported economy-wide," Harvath says. "If you're going to be a regional generalist, the market will put pressure on your ability to run that business successfully."

Deciding which vertical markets to attack can be as simple as a partner focusing on the industries in which it tends to have the most internal expertise and success with customers. But the process of making the transition from generalist to vertical specialist isn't always so simple, Harvath says.

Partners need to ask themselves, "'How do we transform what we do into product-type services -- packaging services in a fixed-fee, fixed-scope way?' It's very important that resellers do that," he says. "Otherwise, they can't translate that into something their sales force can sell." That process, Harvath says, usually takes at least two years and involves major shifts in marketing strategy as well as staff changes to adjust for industry expertise.

Ponder the All-Microsoft Model
Developing a services component and zeroing in on vertical markets are virtually ironclad tactics that partners should follow in order to maximize profitability in reaction to consolidation. A third component of consolidation strategy, though -- dealing exclusively with Microsoft technology and deriving all or almost all revenue from Microsoft-related sales and services -- might be less of a sure thing for some partners. But, as Microsoft continues to grow and strengthen its market positions through acquisitions, partners should consider scaling down or ending relationships with third-party vendors.

"We think partners can be more profitable if they're more committed to a vendor," says Sherle Webb-Robins, general manager of the Microsoft Partner Program. "Partners are getting very focused on what they do very well. Customers are not looking for everything being completely separate -- they're now wanting integrated solutions. Partners are realizing they cannot maximize their profitability or their opportunities if they're doing too many things."

On that point, there is little disagreement. Partners that spread themselves too thin working with too many vendors will eventually put a dent in their profitability, IDC's Graham says.

"If you hedge your bets with lots of third-party products and you try to spread the wealth, there's a basic overhead that's needed to maintain several partnerships, and at some point it's going to cost you," he says.

Tellus's Salonen adds that Microsoft rewards those partners that it considers committed to the company, meaning Microsoft-focused partners are likely to be more profitable than those that work with Microsoft and a host of third-party vendors.

"I would be tempted to say definitely [that partners] are more profitable if they are dedicated Microsoft partners," Salonen says. "Microsoft people are all humans. When they see that [partners] live and die with the product that they have, they are more tempted to give [partners] leads, to help them out."

Some experts recommend that partners focus not only on Microsoft technologies but also on subsets of Microsoft's offerings, such as unified communications or the Dynamics suite of business applications.

"If a company focuses on a narrow enough sliver of the Microsoft suite, that's a pretty good strategy," Harvath says. "If you take it to the extreme, and you've got a guy that only focuses on one toolset and only a limited set of markets where [he's] an expert, that's the guy who makes the most money."

However, Graham warns, "You can become extremely focused to your detriment."

A February 2006 IDC study co-authored by Graham and titled "Microsoft Competencies: Partner Pathway to Business Performance," reported that "companies that build and base their business on one vertical industry, one solution offering and one technology tend to perform worse than companies that support more than one of each." (See "The Myths of Profitability." in Scott Bekker's cover story this month.)

And, ultimately, partners should base their decisions of whether to go all-Microsoft and how many products to support on the most important factor of all -- what their customers want. While the all-Microsoft model might be best for some partners, it might not work for others, Bitton says.

"I come across many companies that focus on accounting solutions," he says. "Each of their partners wants them to focus exclusively on its products. [The partners] tell me that's not what their customers want. Vendors want [partners] to focus on one vendor, but clients aren't letting them do that. That's what the market dictates, and I don't think that'll go away."

Keep Up with the Pace of Change
Consolidation can be unpredictable. New companies with new technologies are constantly entering the market, making themselves attractive targets for larger vendors. And, every now and then, an acquisition such as Oracle's 2005 buyout of PeopleSoft Inc. or Hewlett-Packard Co.'s 2002 purchase of Compaq Computer Corp. shakes up the industry.

As such, while partners should focus on the basics of providing services and targeting vertical markets, they should also keep their business strategies flexible.
"If you're a prospering and growing services company, you need to be reinventing your business model every 18 months," Harvath says. "If you haven't changed your model, you'll go out of business. The challenge is really to have enough focus and insight to reinvent your business."