CFO

How to Gauge Your Technology Vendor’s Viability — Before Things Go Wrong

By Janet Schijns, CEO, JS Group
November 5, 2020
Janet Schijns

In short:

  • It’s worth your time to vet vendors thoroughly — and that starts with understanding how their particular corner of the industry is trending.
  • Gauge your tech partner’s viability by looking at their performance on specific KPIs, as well as references.
  • Red flags include high churn, low profitability and poor payment/credit history.

There are few things worse than choosing a provider for critical services only to have the vendor go out of business a few months down the road. If that business partner provided your IT expertise and infrastructure, its business failure could end up being yours too. With that in mind, asking for and auditing third-party financial statements, as well as getting customer references, should be a critical part of your supplier review process.

These partners — often called managed service providers (MSPs), value-added resellers (VARs), systems integrators (SIs) or agents — matter to your business’ success because they represent an efficient and effective way to acquire the technology and services you need without having to deal directly with dozens of different vendors. They can save you time and money and provide much-needed expertise in knitting together complex, best-in-class solutions.

First, you should understand what each type of partner does and how their corners of the industry are trending.

Partner Business Market Trend What They Do
MSP Steady to Up Specialize in desktop and productivity support. MSPs currently integrate cloud services to provide security, backup, desktop software and end-user support. Revenue comes primarily from customers via monthly subscriptions and secondarily from implementations.
VAR Downward Provide hardware and software for on-premises systems. Revenue comes from vendors (as a percentage of customers’ large capital expenditures) and secondarily from customers for implementation, consulting and ongoing support. Cloud services challenge this business model.
SI Steady to Up Implement and integrate complex business software. May include customizing systems to meet clients’ unique business processes/requirements. Revenue comes from customers for implementation and secondarily from ongoing maintenance.
Agent Steady to up Serve as experts in specifying and acquiring complex communications and networking solutions. Usually paid by vendors and act as an indirect salesforce, often selling a set of products known to integrate well together. Revenue from vendors is paid as a monthly percentage of the client’s contract spend.

The financial review process is complex when dealing with technology partners because profitability varies widely depending on the nature of their businesses. As a further complication, the partner landscape is rapidly evolving as technology becomes more central to business and services move to the cloud.

That’s good and bad for tech partners. Cloud and easier-to-adopt technologies provide both new opportunities and new competition from low-cost marketplaces that seek to replace the technology partner. Customers used to intuitive services from tech giants also now have greater expectations for partners both in terms of capabilities and ease of use — furthering the financial pressure on their business models.

There are only two ways for partners to increase their net profits, and they both require an effective strategy.

On the one hand, they can increase their gross profits, which requires growing sales and lowering direct service delivery costs. Or, they can reduce their ancillary expenses, which entails increasing efficiencies in service desk and project management activities and more.

Here are the business success metrics that your technology partners should track:

Business Success Metrics Your Technology Partner Should Track

Total sales revenue = price (of product) × quantity sold
Cost of goods sold = direct service delivery costs
Gross profit = sales revenue − cost of sales and COGS
Operating profit = gross profit − overhead and indirect costs
EBITDA = operating profit + non-operating income
Pretax profit = operating profit − one-off items and redundancy payments, staff restructuring − interest payable
Net profit = pretax profit − tax

How to Gauge Your Technology Partner’s Viability

In the technology industry, best-in-class service providers that rely on recurring revenue from end customers have the following key profit metrics:

  • 60% gross margins for services and subscriptions; 30% for hardware sales
  • Less than 30% SG&A costs
  • Higher than 20% EBITDA margin

If your technology partner is publicly traded, you can find these numbers in its quarterly and annual reports, such as 10-K filing to the SEC. Private companies aren’t required to make such filings but must make similar calculations when filing taxes. Whether they will be willing to disclose their profitability metrics depends on a few factors, including their business type, how big the potential deal is and, quite frankly, how healthy their numbers are.

Agents

Agents typically operate as small LLCs. When you ask to see their KPIs, you’re essentially asking for their personal tax return information. Because they operate as a broker between your business and a hardware, service or software vendor, an agent’s reputation and references are more important than its financial health. Should an agent business fail, the vendor will most likely ensure your service continues, though there could be a rough transition.

VARs

By contrast, the increasing viability of cloud services and price drops in servers and storage have strained the VAR business model in recent years. You will still pay a VAR large upfront sums to develop new services and for ongoing maintenance, while it also collects a fee from the provider whose systems it represents. A VAR’s refusal to provide financial health info should be a red flag.

SIs and MSPs

SIs and MSPs lie in between the two models, though they do derive their income from you (the client) and not substantially from vendors. Cloud services generally simplify the job of the SI and MSP but don’t necessarily eliminate the need for their expertise. SIs and MSPs that have adapted to the cloud model can be highly successful, as they act as integrators and customizers of these services. Customer references and a list of businesses similar to yours that they’ve worked with may provide a view into the health of the company as well as its success in adapting to new service delivery. In the case of SIs in particular, the software and service providers they work with may be good sources of information on their capabilities. None of that obviates the need for some hard data on their viability.

And, these numbers alone are not enough to determine financial health. The KPIs that lead up to these results matter too and may indicate problems to come on their own.

Here are some of the more common KPIs that service firms track:

  • Customer churn
  • Actual revenue vs. target revenue
  • Gross profit margin ((revenue – COGS) / revenue)
  • Aging accounts receivable
  • Net profit margin (net profit / total revenue)

You should care which KPIs your partner is measuring — and how it’s performing financially — because, at a high level, a healthy partner is a helpful partner for your business. At the rubber-meets-the-road level, partners with high customer churn, aging receivables or other poor profit metrics should raise big red flags.

Red Flags in a Tech Partner

Let’s look at just three of the many risk factors:

Customer Churn

Let’s assume that Partner A is churning customers at 2x the industry rate. This not only indicates a service-quality or customer-support issue, but it also signals a risk for your company. These partners often resell the solutions you use in your business, and that resale agreement may be based on a volume they can no longer sustain as they lose customers.

The result? The partner must raise your prices on the next contract cycle or lose margin on your business and presumably others; worst case it may no longer be able to provide the technology you use, a problematic situation I previously discussed.

Neither of these scenarios is good news for you. When evaluating a partner, ask to see their churn KPIs. Even better, ask for customer lists for the past few years to see who’s dropping off. If the partner doesn’t have metrics or won’t share customers, steer clear.

Cost of Goods Sold

Services salaries skyrocketed over the past decade as experienced technicians continue to be in short supply. As costs rise for seasoned techs, the partner is faced with a dilemma: Do they hire less-experienced staff and thereby risk customer satisfaction, hold prices steady but make less profit, train internally at a cost or raise prices?

Each of these options comes with a risk to the provider’s business — and yours. When choosing to buy or renew with a partner for services, ask for their internal training plan, technician certifications, technician CSAT and technician turnover. It does your business no good if the partner can’t make a reasonable profit on the services it provides.

Vendor Non-Payment

VARs and MSPs buy products and services from vendors/suppliers in order to resell them to their end customers. These products and services can range from hardware to software and from simple support to complex consulting services. Generally they are billed by the vendor (or its distributor) and then add a markup to arrive at the end customer’s overall bill.

If a partner stops or slows down payment to the vendor, that puts your business at risk. In fact, in certain instances, the vendor will “turn off “ the service due to non-payment, leaving you without a solution or out of compliance with the end user licensing agreement.

When selecting a third-party partner, ask the tough questions and get their payment/credit history to avoid this. Unfortunately, you can’t get this information from vendors, even those you do business with. In some cases they don’t have it; in other cases it would violate their reseller agreements. So you’ll need to be upfront with the partner that you need this insight.

As you can see, because the partner’s profitability impacts your service reliability and price, a financially unhealthy partner could spell trouble for your firm. Acting with foresight and discipline when selecting a provider can lessen the risks. Here are some simple recommendations:

4 Ways to Minimize Risk With Technology Partners

Take the time to update your third-party evaluation process for technology partners to include the aforementioned metrics.
Ensure your services agreement terms allow you to contract directly with the vendor should the partner fail to perform.
Conduct quarterly reviews with all third-party partners, focusing on key KPIs.
Expect to sign and abide by nondisclosures on the information you’ll receive. That’s critical to the partner’s willingness to share with you.

And finally, speak up promptly if you perceive a problem with a partner. The industry is changing quickly, and being aware of the risks, noticing downticks in performance and monitoring the financial health of your partners is the best way to make sure they continue to support your needs. After all, technology is critical to your long-term success.

Stay tuned: In my next article, I will cover the evolution of the channel and how partners providing analytics, automation and 5G solutions are critical to your long-term digital success.

Janet Schijns is the CEO of JS Group and a former Fortune 500 C-suite executive with experience ranging from Verizon to Motorola to Office Depot. Her clients regularly increase their revenues by more than 40% and achieve high levels of market-share growth. Areas of expertise include routes to market, channel programs and solution development, and she has worked with vendors, distributors and partners in a wide range of technology areas including services, cloud and advanced solutions.

Mark Bianco

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