The Channel Company CEO Bob Skelley: ‘Services Leading The Way’ In Partner Profitability

‘A mix of project-based professional services and recurring revenue services. When you put those two together – that’s the successful model that we’re seeing,’ says Bob Skelley, CEO of The Channel Company.

Solution provider profitability is directly tied to the amount of services, not product resale, a partner is providing to their customers today, according to a new report by The Channel Company.

“We’re well down the path of services leading the way of profitability,” said Bob Skelley, CEO of CRN parent firm The Channel Company during his keynote at XChange 2019. “It’s not just about services, it’s about the diversity of those services. So a mix of project-based professional services and recurring revenue services. When you put those two together – that’s the successful model that we’re seeing.”

The Channel Company’s IPED consulting group conducted surveys on more than 500 solution providers as well as dozens of qualitative interviews for its 2019 State of Partner Profitability: ‘Funding the Future’ report. The report found a direct correlation between gross margins and a solution providers revenue mix of services sales versus product resale.

[Related: Service-led Partners Driving Twice The Gross Margin Vs. Product-Led Peers]

The average gross margin for a solution provider is 22 percent if their total revenue is 78 percent product resale and 20 percent services. That gross margin climbs to 28 percent when services account for 34 percent of total revenue versus 59 percent product resale. For a solution provider who’s services sales account for 68 percent of total revenue, gross margins skyrockets to 45 percent.

“That 45 percent gross margin is more than double the 22 percent margin of the traditional model,” said Skelley. “The impact of your services mix versus resale mix drives gross margin profitability. … All of these big MSPs are starting to have two-thirds of their revenue being services-led because you double profitability compared to the traditional resale model.”

Jason Rook, vice president of market development for 10th Magnitude, a Chicago-based top Microsoft Azure partner who gained Microsoft MSP Expert status this year, said the “vast majority” of margin in the channel today comes via services.

“The future is all about services,” said Rook. “It’s really about driving toward services relationship with customers that then drive recurring revenue for you. It’s stability for both the solution provider and their customer. We know that is where the vast majority of the margin is today.”

Rook said his born-in-the-cloud company is about 95 percent services-led in terms of his company’s total revenue. This services-led approach has led to a combination of either triple-digit or high double-digit revenue growth year over year for 10th Magnitude over the past eight years. The solution provider has consistently achieved over 50 percent gross profit margins with similar expectations in 2019.

“That growth is because we are an entirely services-led business,” said Rook. “The channel ecosystem has changed. Not too many people sell server hardware anymore which use to be a huge component – like server hardware maintenance contracts and those types of things – that whole business is basically gone. Ten years ago, that was a hot business. Some of that volume and margin that people got around classic on-premise hardware has evaporated very rapidly.”

Karen Penticost, vice president of Business Development and Strategic Partnerships for solution provider Envision Technology Advisors, said her company has been leaning “heavily” towards digital transformation, security and consulting services.

Pawtucket, R.I.-based Envision recently hired a new managed services director and has been growing Microsoft 365 services at a rapid pace with around 60 percent of the company’s total revenue coming via services. “Managed services is great, but you still need to keep our engineers busy and hardware sales does not do that,” she said.

Another key finding in the 2019 State of Partner Profitability: ‘Funding the Future’ report, is what type of services are driving the highest margins in the channel.

Solution providers are generating the highest margins around selling professional deployment services, paid assessment services and ongoing managed services. Within those three categories, rich margins are being obtained around cloud migration, hybrid cloud, application migration and ongoing security services for advanced threat detection and disaster recovery.

“It’s not really about finding new customers, it’s more about retention and expansion within the current customer community. There’s so many more things [partners] can bring to the table for them,” said Skelley.

Another major discovery in The Channel Company’s report is that the percentage of recurring revenue inside a solution provider’s services business has a direct impact on profit margin.

For the average product resale focused solution provider, 30 percent of services revenue are recurring creating with a gross profit of 36 percent. For a channel partner who does a mix of both services and product sales, 43 percent of services are recurring with a gross margin of 44 percent. A service-led solution provider with 60 percent of their services being recurring captures a whopping 55 percent gross profit.

“This is a double effect. First, there’s an impact of services in general on profit margin. Then there’s the percentage of those services revenue that are recurring that has a material impact on the gross profit for your services business,” said Skelley.

The good news is that services sales are steadily climbing in the channel.

Total services sales are accounting for 65 percent of solution providers’ total revenue in 2019, up from only 48 percent in 2013, according to the report. That figure rose to 55 percent by 2016, then 61 percent in 2018.

“In a six-year period, services revenue rose from 48 percent to now 65 percent -- that’s a pretty remarkable change,” said Skelley.