The Post-Pandemic Channel: A 'Boom Period' for M&A

Channel expert Mike Harvath says the pandemic has created a "perfect storm" for consolidation among partner companies -- especially for firms that have embraced remote work.

Mike Harvath, president and CEO of the Revenue Rocket Consulting Group, has been watching the IT industry from the inside for more than three decades. Before founding his company in 2001, he held high-profile positions at Apple and MicroAge Computer Center. In between, he started and sold several IT companies.

At Revenue Rocket, Harvath provides growth strategy consulting, with an emphasis on buy- and sell-side mergers and acquisitions, and growth strategies for IT service firms. He and his team have advised more than 500 companies to date.

The RCP team caught up with Mike recently to pick his brain about current trends and the impact of the pandemic on the channel.

RCP: How would you characterize the past year to year-and-a-half in terms of the pace of acquisition?
Harvath: Well, it's been amazing. Certainly, the pandemic contributed to an acceleration of consolidation in the space, in part, because it legitimized remote work, which has opened up opportunities for firms around the world to operate in ways they had not considered before. Most investment banks and M&A advisors, for example, didn't operate that way pre-pandemic. Of the 500 clients in 30 countries we work with, all have now implemented some level of remote work.

This has been an especially useful trend for most tech services companies. It has allowed them to scale and grow in ways they couldn't before and to attract customers in places they didn't feel they could before, because it changed their thinking about a geographic presence requirement. Pre-pandemic, many saw the world through more of a geographic lens. Not all, but more than you'd think. Now many more think in terms of a geographically neutral model, what we would call an optimized model. And it has sparked a kind of land grab for resources -- we need to expand our team, extend our reach, which means we need to acquire some businesses.

What non-pandemic-related trends are affecting the pace of M&A right now?
One trend we've noticed is related to the number of people approaching retirement age. A lot of business owners have kind of matured to the point where they're thinking of making an exit. They're simply planning for retirement, or they'd like to be part of something bigger on the way out, so to speak. You'd be surprised how many people we've had that conversation with. There's just a tons of them selling their companies, and many who hadn't thought about it until we approach them, but then think the timing is right.

What's the overall impact here?
All of these trends have created a kind of perfect storm for M&A that I think is going to continue for a while. They're going to drive consolidation, of course, and verticalization and more specialization. I also think they're going to drive valuations. Barring a major change to capital gains tax policy in the U.S., we're going to see a kind of boom period for consolidation that'll be with us for some time.

"Software development firms took a pretty big hit in 2020 if they were traditional project-based development shops. That was also true for app implementers. Any company that didn't have a recurring revenue strategy in place -- and a meaningful one -- got hit."

Mike Harvath, President and CEO, Revenue Rocket Consulting Group

Were there any types of firms whose opportunities contracted during the pandemic? Companies that weren't able to make the pivot and were really hurt by it?
Software development firms took a pretty big hit in 2020 if they were traditional project-based development shops. That was also true for app implementers. Any company that didn't have a recurring revenue strategy in place -- and a meaningful one -- got hit, because so many of their customers said, 'We're going to stop all spending until we see where the world is going to land.' That impacted them materially for three to four months.

Overall, we didn't see that impact on managed services companies, of course, because they had subscription-type, longer-term contracts. They did see some contract attrition, or a higher rate of attrition than they normally would have, particularly if they were exposed to the hospitality and travel industries. For the most part, though, this was just a blip on the radar for recurring-revenue companies

The companies that didn't have that recurring revenue and saw a substantial hit in 2020 recovered really well at the end of the year. They went into 2021 growing and meeting their 2019 numbers. That has been a common trend among IT services companies.

It's interesting to note that many of the smaller services companies with contracts with large enterprises were more materially impacted. Because they served bigger clients, and those clients were pulling back to see how the dust would settle and then took longer to come back into the market after the dust did settle. Some of them saw a six-to-nine-month drought that was pretty material.

But the good news is, everybody is now back in sort of a boom period.

What solutions or platforms are hot right now?
Anything cloud is on fire, as you can imagine. Anyone who does cloud infrastructure or enablement, lift-and-shift, or parking workloads in the cloud is super busy. We know that digital transformation is accelerating, and anyone who hasn't made cloud transformations is feeling some pain.

In the case of the Microsoft stack, we really don't see it. The cloud is causing an inflection point where vendors who are, say, putting in a new back-office infrastructure aren't just looking at Microsoft's line. They're looking at everybody.

In other words, if you can spell "cloud," you're doing well; if you're doing anything legacy, you're probably not.

Regarding the state of the workforce, a lot is being made of people exiting their industries and not returning. If that something you're seeing?
We're seeing people exiting their jobs, but staying in their industries as independent contractors so they can have more flexibility, drive up their incomes as much as 20 percent and have more control of their destinies. It's been hard to keep people inside the company, so we're seeing stratospheric compensation plans hitting the market. In general, it's because of the very tight labor market for specialized skills. When demand is high, labor rates go up, which makes it very challenging to manage hiring.

Firms that were smart about implementing employee-centric programs -- things like work-from-anywhere policies, unlimited PTO or tuition reimbursement -- are doing much better than the firms that didn't. These have been tough times for firms that didn't make the remote work transition very well. Some have lost as much as 50 percent to independent contractor status and other things because they couldn't adjust effectively.

Speaking of independent contractors, at the recent Inspire partner conference, Microsoft CEO Satya Nadella talked about there being 470,000 Microsoft partners. It has been a long time since Redmond talked about its partner numbers, and a lot of these people are becoming independent contractors. Do these numbers pass the smell test?
There are probably between 30,000 and 40,000 firms out there with annual revenues of more than $5 million. But there are hundreds of thousands of firms with revenues under a million bucks. If you assume that the U.S. accounts for about 60 percent of the market, that would mean there's under 100,000 firms globally that are of material size -- no more than 70,000 or 80,000. That's still a lot of companies.

You've been watching the Microsoft partner channel for a while. How would you characterize the health of that channel in terms of companies that are steering relatively close to Redmond, as well as their opportunities and the support they're getting? How do things look to you in that regard?
They look great! Microsoft has always been one of the top two -- along with Salesforce -- in terms of how they manage their channel. I think Microsoft partners do pretty well.