Where are the profits?

Bad management and too much focus on sales and not profitability are causing resellers and distributors to fail in an otherwise growing IT industry, according to attendees at CRN's inaugural Distributor Roundtable.

So far this year, resellers and distributors such as Enstor, Premier Technologies and EAA, to name just a few, have hit the wall, raising questions about the ongoing profitability of the greater IT channel.

Ross Cochrane, managing director at Express Data, tells attendees that poor management is responsible for these collapses and reseller principals are not doing a good enough job in controlling sales staff.

"They [sales guys] just want to win deals - most of the reps you speak to in a reseller have got no idea about profitability," he says.

"What they want to do is make their quota, get their commission and life is rosy. Poor management in most resellers means that guys don't know what their reps are quoting, they don't have limits on what they can go to and the guys are trying to win deals that are either big, high risk and low return," he says. "Management quality in the IT industry is pretty poor."

Resellers winning large deals that they would not normally win also starts to set the alarm bells ringing, Cochrane says.

"The guys take the mentality they have from selling boxes into selling products and services and they don't understand the real cost of doing it," he says.

Nick Verykios, marketing director at niche distributor Firewall Systems, believes the "death of profitability" occurs when the final transaction gets made with the reseller.

"We are doing deals with our vendors and resellers in security that have been profitable all the way right up until the time the transaction gets made - and the person who screws it up is the reseller.

"One or two strong players go into it [the deal] and someone else who goes bust, wins it. There is plenty of profit in killing a dead model and kick-starting a new one," Verykios says.

Firewall Systems has been profitable since inception, turning over $15 million in the past 12 months. "We could have done $40 million, perhaps $50 million," he says. "A lot of resellers are still working on that mentality, that 'I want to be a $100 million [company]', 'I want to get that $5 million deal that I will never make money on'."

While these resellers can afford to complete the deal at a GP (gross product) level, they lose money in the ongoing costs associated with servicing the client. "We are in a specialised area and the costs after that initial product and service transaction are ongoing for a reseller.

"That's where we are seeing some of these guys lose money. Ultimate IT were high value add; they couldn't afford that because they were doing transactions that they couldn't afford," Verykios says.

Altech's national sales manager Kevin Hartin adds there are many distributors that also have the same mentality.

"Looking at it from a consumer IT perspective, the number of distributors who have gone off to Flemington or Auburn and knocked on Gerry Harvey's door and were going to turn the world around - who have gone off six months later with their tail between their legs because they didn't understand the business process they were getting into - they didn't understand the cost of doing business with retailers." He agrees that ultimately, these issues boil down to bad management.

Teach them

Training resellers about how to sell profitably is key, according to Daniel Lee, managing director at LAN 1, who says the distributor has been assisting with this process. "We have been training the resellers about profitability - how to sell, how to be a professional - and we are using MDF [marketing development funds] to do that. I think that's the best way of spending the MDF."

At the end of the day, however, the individual salesperson is going to be driven by remuneration, he says. "You can teach them everything, but he is going to get any deal possible for the company and he just wants to get his commission."

Lee argues that there should be courses in place for account managers, business development managers and product managers. "Transferring the knowledge to the next generation of people that you bring in is a huge challenge. It's a holistic and long process, but you've got to start somewhere," Lee says.

Altech's Hartin describes channel staff before the advent of the PC as "professional salespeople" cut from a completely different cloth than today's IT sales executives. "They were educated on their products and the role of selling back then was doing business, not just getting the order and going onto the next one."

Stead Denton, managing director at distributor IPL, argues that in the voice and office equipment market where IPL plays, professionalism is still a high priority. "There's service and consumables. You don't just go out and sell a PC or a laptop and walk away - in the IT business it's completely different. It's your eight points, 10 points and hope the guy comes back one day," he says.

Still, there are plenty of areas in IT where there is still margin, adds Express Data's Cochrane. "There are a lot of skilled people out there selling into corporates with large solutions making big margins with a lot of services behind it." Firewall's Verykios adds that there is good margin in security. "They guys that are cutting the big security deals deserve to make their money because they know what they are doing," he says.Another factor affecting profitability at a distributor level is the shift to tier-1 systems, according to Altech's Hartin.

"If you go back five, six, eight years ago, the OEM market, the system builder market was significantly bigger than what it is today.

The shift from system builder to tier-1-type OEM systems has changed the profitability at a distribution level. "You can still go out there and make eight and 10 points distributing locally-built systems but I would defy anyone who's distributing an HP or a Toshiba to make more than two or three points," he says.

Nevertheless, David Dicker, director at Dicker Data, argues that while there is growth in general purpose computers unit-wise, he does not believe there is too much growth in dollars, even when the distributor provides service.

Even in growth markets, he does not believe there is a "critical mass of dollars to make them fabulously attractive.

"I think the main IT industry is suffering and has probably been suffering since 1999 since the Y2K scam and since then, all the vendors have been in denial and have tried to prop it up, and it's just steadily moved down to where it's likely to move down to," he says.

Dicker believes there "no opportunity to make a huge amount of money as a distributor".

"I think the market is ripe overall," says Express Data's Cochrane. "We've got to look at the positioning of the IT market today, the demand, the awareness, the broadband uptake - all the factors are positive for this to be a vibrant and growing industry.

"I think the opportunity is going to be there. It's about how you play in it and get the right return out of where you play," he says.

Still, the reality is that distribution is a low return business, Cochrane adds. "Open up the Fortune 500 magazine worldwide: wholesale electronics is the worst category. The returns that are made by Ingram - largest in the world - less than 1.5 percent return on sales.

"No-one would invest in distributors. Private equity firms will look at it as an on-sale. To have an operating business that's making 1.5 percent, when businesses are looking to make 10 and better, it's not the kind of business we'd all be investing our money in."

LAN 1's Lee adds that these days, the distributor has to sell more units to make the same amount of money. "Four years ago, we would ship maybe 100 DSL modems per month, we would have been popping champagne. Today, we are shipping 20,000 per month and there's still no champagne," he says.

Non-traditional mass merchants such as Target and Big W that have entered the marketplace have also had a big impact on the typical street-level reseller, affecting the distribution channel, according to Peter Agamalis, director at distributor Impact Systems.

"And you've got the simple fact that tier-1 brands have reduced their price points. Combine those together and you've got people like Altech, Impact Systems that are trying to siphon opportunities from these guys, but they are always being minimised to offering services; they can't supply product [only] because they're being beaten by the Big Ws and the Dells. The reality is that times have changed," he says.

Altech's Hartin adds that if the distributor tried to survive selling products, motherboards and video cards only, competing with the "yum cha" end of the market, it would go out of business.

"We look at niche opportunities within our product range and you have to find this balance. That balance is what gives us the ability to keep growing."

Express Data's Cochrane questions why some distributors continue to sell to resellers that are a "very low profit return" and do very low volumes of business at such aggressive margins. "The distributors have got a lot to answer for because I think that the discipline inside the distributors is poor as well.

"A lot of distributors are allowed to do deals to customers who really shouldn't be getting that price. Give the price to the small guy and you're going to have to give a better price to the big guy. They blame the customer for sending them broke," Cochrane says.