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The hunt for higher margins

It's not exactly headline news that product margins have dropped significantly over the past few years, which is why smart VARs are re-evaluating their business models and trying to sell more high-margin products.

“Justifying purchases based on a 10- or 15-year-old relationship doesn’t always hold water anymore [with customers], given the level of scrutiny that most IT people and their budgets are under these days,” said Darren Hamilton, partner business manager for ProCurve Networking at HP Canada.While many argue there are no high-margin products left, VARs are finding ways to boost profits by turning products into solutions or wrapping professional services around hardware and software sales.

Here are a few areas where VARs can bump up those margins:

Attaching add-ons, peripherals and up-selling

The industry is like grocery stores, said Jim Estill, CEO of distributor Synnex Canada. People know the price of eggs and milk, but they don’t necessarily know how much avocados should cost – so the avocados are where you make all your money.

“Resellers will sell a notebook computer and make the same amount on the bag they sell for the notebook,” he said. He also points to higher-margin point-of-sale peripherals such as bar-code readers, receipt printers and portable ticket printers, and to some extent ergonomic equipment.

The more a person pays for a computer, the more willing he or she is to pay for peripherals, he added. Microsoft’s Windows Vista OS increases the average selling price of a computer by a few hundred dollars, and since people pay more for Vista machines, there’s an increased tolerance for add-ons. If you buy a $2,000 notebook, for example, you’re more receptive to buying a remote pointer for PowerPoint slides for $49.

“Sales are inversely proportional to margin,” he said. “That’s why specialty products are higher margin.” When resellers are competing directly with retailers, they tend to make lower margins. “The strategy for a small reseller should be avoidance, not going head-on. You can always sell a specialty because people will pay more to a specialist.”

Selling solutions

Commodity products have margins ranging from five to 12 per cent, said Greg Rokos, president and CEO of ESI Technologies in Montreal. But as you get more specific in terms of solutions such as business continuity, disaster recovery, security or compliance, margins increase. “If you can create a solution around a product or set of products, then the margins become more interesting and go in the 15 to 25 per cent range,” he said. Professional services can range anywhere from 25 to 40 per cent.

“I don’t think it’s just one product,” he said. “You have products in security where there’s very little margin, and there’s point products in storage that’s the same thing.” The trick, he said, is to take these products and turn them into an overall solution.

Owning the intellectual property

When you own the intellectual property, margins jump up to 45 or 50 per cent – possibly even higher, said Rokos. At the same time there are huge R&D investments to be made, and you don’t know whether the market will actually buy your product.

ESI owns the intellectual property for several solutions which were either developed in-house or acquired. “These are the areas that we feel are needed to differentiate our offering and maintain the levels of gross margin to be able to reinvest and grow,” he said.

This includes Octopus, an on-demand IT services management tool designed by its technical team. “It ties in very well with everything else we do,” he said. “It can hook into our managed services and can be supplemented by our specific solutions.”

Selling services
For Ottawa-based TeraMach, complementing a product sale with professional services helps to increase its overall margin. “It would be tough to compete against a price-only competitor,” said Christian Nguyen, its director of marketing.Another Ottawa VAR, Nitro Microsystems, provides outsourced network management by bundling hardware and software with professional services. “When we can take the part numbers out of the equation, when our client has handed us the responsibility to manage their hardware, yes, we have higher margins,” said Larry Poirier, the company’s CEO.

Nitro migrated toward services because of customer demand, he added. “Customers can purchase their technology anywhere, but it takes a knowledgeable IT firm to integrate it all,” he said.

Working with specialty distributors and niche manufacturers

TeraMach has had some success working with specialty distributor Arrow. “It’s not necessarily the access to product,” said Nguyen. “They have a good inside sales and technical team that will help us in a sales campaign.”

Customers aren’t always looking for the lowest price, as long as the reseller can provide an assessment that shows a tangible return on investment. “When it comes to buying the product, pricing is no longer a factor because there’s so many other factors in the sale,” he said. Some manufacturers are starting to rationalize their partners and pick focused resellers who will push their product or a certain technology. “There are [vendors] that we deal with that have fewer partners and therefore allow each partner to have that higher margin,” said Nguyen.

But if the barriers to authorization are low and products are sold online, what margin on hardware can resellers expect? asked Nitro’s Poirier.

Manufacturers are trying to help with deal registration Web sites, but this just adds another level of complexity.

Many manufacturers are declaring record profits, he said, but their VARs are suffering with single-digit margins. Some manufacturers that Nitro works with, such as EqualLogic, are working to protect the value-added segment of the market with a meaningful deal protection program, he said. But when manufacturers give favourable terms to online or big retailers, VARs are at a big disadvantage. As a result, Nitro limits the number of manufacturers it deals with.

Another VAR, Protek Systems of London, Ont., has one storage array product that at this point is high-margin because of the supplier it works with. But Peter McMahon, the company’s vice-president of sales and marketing, complained that some vendors will slash prices “in a heartbeat” if things get competitive, “and suddenly take all the margin out of it.”

Protek tries to work with vendors that avoid selling through myriad partners. It’s working with a storage vendor, for example, that isn’t one of the main storage players and has a program in place where select resellers can make better margins on its hardware. “I like Cisco’s programs. They are trying much harder to reward people for knowledge, for investment in their company,” he said.

em>Vendor programs and rebates
Many manufacturers have rebates or promotions that can help resellers make better margins on the sale of specific products.“Be aware of the program opportunities out there from the various vendors you’re dealing with,” advises HP’s Hamilton. A reseller that deals with a broad product range has to get a handle on all the programs and promotional activities available. “Lean on your vendor partners to make sure they’re communicating those opportunities and they’re easy to capitalize on,” he said.

Having access to different programs is helpful, said TeraMach’s Nguyen, but it’s sometimes up to the reseller to ask the manufacturer about them. “We’re dealing with 12 different manufacturers with 1,000 different product lines,” he said. “So hopefully the channel manager or distributors like Arrow that are aligned with the different manufacturers are aware of any programs coming out of North America we can benefit from.” This can be effective, he said, if there aren’t too many program restrictions.

A changing industry

“The high margin in our industry is services, and the product will help us hopefully drive the services,” said Protek’s McMahon. “It’s unfortunate. There should be high-margin products.” But the IT industry does not police itself or put enough value on authorizations. “The problem is you have every Tom, Dick and Harry selling product,” he said. And that turns products into commodities.

“We need some floor-level pricing to be set to encourage customers to pick the supplier with the best service or best value-add,” said Nitro’s Poirier. “Customer satisfaction with the manufacturer takes a hit when they purchase based on lowest prices. If other industries can set floor pricing, I see no reason why manufacturers with record profits can’t provide a little safety to the SMB dealers serving them in the trenches.”

Whatever you do to distinguish yourself, it’s got to be measurable because the IT person you’re dealing with has to report to somebody, said HP’s Hamilton. But as a reseller, you can’t put hours in and add value if you’re not getting paid for it. That’s why the value has to become measurable.

“There were things that used to be constants in this business, like higher-end products meant higher margins, but we’ve seen an erosion at all different levels,” he said. “There will always be somebody who desperately wants a customer’s business and is willing to be extremely aggressive.”