Cover story: Changing channels

What an amazing 12 months it's been. In a year that started with the industry maturing into commoditisation and consolidation, the emerging e-business paradigm rose to shake the foundations of all that was known and held to be true.

"I have never seen a year of such change in the 20 years I have been in the industry," said senior International Data Corp (IDC) analyst Bernie Esner.

Throw in the complications of Y2K, which resulted in an unprecedented spike in demand in the second half of last year, and GST, which dramatically depressed the industry in the first half of this year, and it's no wonder channel players have had a tough time figuring out if they're Arthur or Martha.

However, the cause of the most interest, and certainly the most channel headlines this past year, were vendor's moves to sell direct to customers, or at the very least get closer to them.

This, not surprisingly, caused much consternation in the channel, coming to a head when Harvey Norman made the decision to stop selling Compaq products after that vendor confirmed plans to open Compaq-branded retail stores.

According to Esner, the direct trend is a result of vendors' tendencies tosegment the channel to a far greater extent and not assume that "one channelfits all customers".

In Compaq's case, it didn't believe it's existing channel was giving it the penetration it wanted in the small-to-medium enterprise, a segment dominated by white boxes, Esner said.

It seems the jury is still out on the merits of Compaq's aggressivestance. Esner dubbed the move as "gutsy" and one that would mark it as an "aggressor and leader in that market".

However David Hancock, direct of analyst Inform, saw the move as less successful. "Whether Compaq likes it or not, its sales have been affected," he said. "What we have seen is that companies that have hybrid policies and like hedging their bets are not coming clean with the channel and will [subsequently] have a hard time convincing resellers to work with them."

"We saw it again with Dataflow, when a number of prominent resellers refused to buy from them after they invested in an e-tail competitor."

As for Harvey Norman, it doesn't regret its decision to cease trading with Compaq one iota, said John Slack-Smith, HN's general manager of computers. "It was the right thing for us to do," he said. "The only impact it had was to force us to seek out new partners."

Slack-Smith said he does not expect other vendors to follow suit. "When you have an existing channel that's working successfully for you, why would you do it?"

Meanwhile, direct-only vendor Dell continued its strong growth over the past year and most certainly took a considerable chunk of the PC marketplace from the channel.

One medium-sized Sydney integrator said he believed Dell had made a major impact on the enterprise PC market. "A lot of sites are now choosing Dell when they would [otherwise] have gone Compaq and they're buying direct rather than from a reseller," he said.

"Increasingly, a lot of users believe they can do the PC integration themselves. I think it's a cyclic thing though and it's only when there is a crisis and the customer needs the reseller to pull some strings that they will finally realise the channel's value."

Ross Cochrane, managing director of distributor Express Data, said it was the channel's challenge to ensure that the traditional supply chain was as efficient as Dell's model.

"The direct model has obviously threatened the channel-oriented model and that threatens us as well," he said. "The channel can compete very effectively with direct vendors, especially in the business-to-business environment where the majority of business takes place."

Cochrane believes there needs to be more integration between resellers', Distributors' and vendors' IT systems in order to streamline the supply chain.

The desire of vendors to get closer to the end customer is not just a PC phenomenon, though, and in other segments of the market it is not always viewed as such a bad thing.

Brad Merrick, technical director of network integrator Path Communications, said he generally saw it as a positive that Cisco, his primary vendor, had made an effort to forge closer relationships with his customers. He does, however, admit to the occasional twinge of concern.

"I guess in the back of your mind, you do have the thought that if you give up too much information to the vendor, they may turn around and choose to go direct," Merrick said.

While the Internet has provided greater leverage for vendors to sell direct, perhaps more importantly it has given rise to a new form of channel and competition, the e-tailer.

"Competition has certainly increased in the last 12 months, articularly with the emergence of the online retailing category," said HN's Slack-Smith.

"How long that category is going to be around is the big question."

Michael Glezerson, general manager of e-tailer, responds to that same question with a resounding: "A long time". Glezerson considers e-tail as simply "another way of selling", albeit a "much more efficient way of doing it".

Like any reseller, an e-tailer must focus on customer service, Glezerson said.

"What we have done is built a better way for customers to come onto our site and compare 10 products side by side, for features, warranty, price and so on. That's not something you can do in a superstore, where you'd likely have a pushy salesperson breathing down your neck," he said.

While refusing to quote numbers, Glezerson said he had seen and was expecting "exponential growth".

"More and more people are getting onto the Net, and those that are already on there are spending longer on it," he said. "One of our major distributors said that e-tail probably represented 1 per cent of its sales two years ago, 3 per cent a year ago and today it's 8 per cent.

Interestingly, Glezerson predicted there would be little additionalcompetition in the e-tail ranks this coming year. "The barriers to entry are massive," he said, estimating it would cost at least $7 million for any new player to enter the market.

The challenge facing every e-tailer over the last year has been to attract new customers, with Glezerson confirming the majority of its expenditure had been on marketing and advertising. Despite, the growth of e-tail, HN's Slack-Smith said he's not the least bit worried about the competition.

"Competition only serves to make us better -- we thrive on it." It certainly wasn't impacting on Harvey Norman's business, Slack Smith added.

"The retail market is very buoyant," he said, pointing to PC hardware,particularly at the low end, as the biggest growth area over the last year.

"We have seen a significant increase in the gross volume of PC hardware we've sold through the year," he said. "The sub-$2000 PC has been thefastest growing category in our entire business and as a result our total sales growth has been greater than ever before."

Even bricks-and-mortar retailing is benefiting from the take-up of theInternet, it seems, with Slack-Smith noting that communications was a huge growth category for Harvey Norman.

"The growth in the communications side of the business has also beenenormous. Internet-ready devices and mobile phones with WAP capabilities and so on are always in demand as soon as they reach a price point the consumer sees as representing value for money."

Perhaps the segment of the channel most directly affected by the growth of the Internet has been the Web development community. Or, should we say, the Web integration community. Over the last year, driven by the massive demand for their services, Web developers have come of age and many now prefer to be known as Web integrators.

Zivo is one such company. A year ago it had 120 staff. It now has almost 300, with offices scattered all over Asia. "The biggest change to our business over the last year has definitely been the size of the projects and the opportunities we're now involved with," said Anthony James, Zivo's director of business development.

"Our clients aren't just looking to build a Web site, they're looking to build a business and our work now touches every facet of theorganisation from back office, to fulfilment and new ways of going tomarket," he said.

Whereas a year ago, a $100,000 project was a big deal, it was now more common for projects to be worth in excess of $500,000, James added.

The aim of today's Web integrator is to provide customers with anend-to-end solution. While this involves the traditional creative andtechnical components of Web integration, it also includes new areas like Web branding and marketing.

"Generating an audience for a Web site is just as important as building it in the first place," James said.

However, it is not just traditional Web development firms who are targeting this fast-growing market. Many systems integrators and consulting firms are adding e-business divisions to their operations.

This has been largely a result of the more general trend of resellers and integrators expanding the level of value-add they can offer customers.

According to Inform's Hancock, for the first time last year, resellersgenerated more revenue through services than they did hardware or software, said Hancock.

He said resellers predicted services would continue to outpace hardware or software sales, although they indicated it might not grow quite as quickly as it had in recent years.

This suggests that, over the last year, many resellers have successfully made the transition to services models and were now looking to consolidate their new business models, he said.

In the integration space, it was that same word -- consolidation -- that was on everybody's lips, with companies like CSC, Logical and Com Tech opening up the purse strings to acquire smaller competitors.

"We are certainly seeing less competition from smaller freelancers and are more often competing with the big new consolidated entities," PathCommunication's Merrick, said.

Few integrators grew faster than Powerlan, which took advantage of thebullish valuation of tech companies on the local stock exchange to list, raise capital and expand aggressively.

"We could see the market consolidating and many of the products we were selling were becoming commoditised," said Powerlan's managing director, Theo Baker. "We weren't a niche player, so in order to expand and ensure our longevity, we undertook a listing to raise cash."

With the listing under its belt, Powerlan embarked on an aggressiveacquisition strategy, growing from a three-office company with $60 million in revenue to a company with 34 offices in 10 countries and a revenue run rate of $280 million.

"We didn't see a future as a traditional reseller or integrator. We wanted to move up the IT&T value chain into consulting, e-business, application development and so on."

With the previous year centred on growth, the company's aim for the next 12 months will be bedding down its acquisitions and updating its internal systems right throughout the organisation. It will also look to organic growth in new divisions like its security and SAP integration divisions.

While Merrick pointed out that Y2K had been a blessing for most integrators last year, he will be looking to voice and Internet infrastructure to provide continued growth this following year.

Express Data's Cochrane highlighted security and bandwidth management as emerging areas that resellers are finding profitable. The move to application service provision (ASP) would also ensure server-based computing was a high growth area, he said.

ASP was of course an IT hot button over the last year. How it will ultimately affect the channel is still to be seen, but the concept certainly has many channel players thinking and some worried.

George Caravias, managing director of ASP business Alta, said the channel has most reason to be threatened by the low-end of the ASP market, where users would be served productivity software like Microsoft Office and collaborative applications like Mail.

"It's very likely that this will result in the channel being circumvented," he said.

However, at the high end where Alta plays, existing channel players still have an important role to play, Caravias said.

"We look for channel partners who add value and who deliver a completesolution to a client," he said. "ASP-delivered software is just another part of that solution."

The biggest challenge for resellers and integrators working with an ASP, or even those considering launching their own ASP capability is to migrate from receiving payments in one lump sum to receiving it over a period of time.

"It's a very different business model that involves very different cash-flowsand it's not easy to make that transition. Resellers need to start thinkingabout it, though," Caravias said.

While many in the channel have felt the crunch of impending consolidation,perhaps distribution has felt it most tightly. Most recently, it was 17-year-old software distributor Dataflow which crumbled under the intense pressurethat many distributors are facing.

"Margins have declined but costs are the same, so you need to be doingsignificant volumes to make the kind of return you need to be successful,"said ED's Cochrane.

"Those distributors with strong vendors with new product sets are doingreasonably well, but if your distributing the number three and four playersyour probably finding the going a lot tougher."

Hancock said Inform research showed resellers most valued distributors whoprovided excellent technical support and Web facilities. Neither of theserepresent inexpensive investments from distributors, making it even tougherfor smaller distributors.

Indeed, distributors were feeling the heat to add value as much as anybody, saidMichael Shea Ingram Micro Australia's general manager.

"I certainly feel the distribution role is changing and resellers are askingus to provide more and more services and back-end functionality," he said.

"We're looking to provide resellers with everything from configurationservices, technical advice, warehousing and fulfilment, all the way throughto areas like accounts receivable."

However not everyone in the market is clamouring for these value-addedservices. "I just want distributors to focus on their core competency of getting me the product at the most cost-effective price," said HN's Slack-Smith.

Shea said that while the likes of Ingram, Tech Pacific and Express Data hadthe economies of scale that would see them dominate the general distributionmarket, there was still very much space for smaller distributors to serviceniche markets.

In a year of such turmoil and change, those left standing, and particularlythose who feature in the Channel 100, can feel justifiably proud of theirpositions. Yet not for too long. It all needs to be done all over again, thiscoming year.

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