The Partner P&L - A Key to Building Successful Channel Partners in the Software Industry

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Whitepaper from TBK Consult

Author Hans Peter Bech, M.Sc. (econ)

© Hans Peter Bech 2014 First edition Unless otherwise indicated, Hans Peter Bech copyrights all materials on these pages. All rights reserved. No part of these pages, either text or image may be used for any purpose other than personal use. Therefore, reproduction, modification, storage in a retrieval system or retransmission, in any form or by any means, electronic, mechanical or otherwise, for reasons other than personal use, is strictly prohibited without prior written permission.

The Business Model Canvas Framework is made available by Business Model Foundry GmbH, Kalkbreitestrasse 71, 8003 Zürich, Switzerland Published by TBK Publishing® (a division of TBK Consult Holding ApS) Denmark CVR: DK31935741 www.tbkpublishing.com ISBN: 978-87-93116-09-2

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Table of contents: Targeted audience

4

Abstract

4

Author

4

Acknowledgements

4

Introduction

5

The Business Model Framework

6

Defining the Partner P&L

6

The Business Model and the Value Chain

7

What do we want the business partners to do?

Revenue Cash Flow from Revenue Cost of Goods Sold

Operational Expenses

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Sales and Marketing Expenses Services General & Administration Leadership & Business Management Capital Expenditure Cash Flow from Operations

3

8

8 9 10

10 10 11 11 11 11 11

The Bottom Line

12

Helping Accelerating Time to Cash

12

The Partner Program

13

Partner Recruitment Partner Management

13 13

A Note on Margins

14

About the author

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Targeted audience

The target audience for this whitepaper is the board of directors, the CEO and the sales and marketing executives of software driven companies1 with ambitions for achieving global market leadership. The whitepaper primarily addresses the challenges of B2B software companies with long value chains.

Abstract

Most software companies approaching the market through independent channel partners fail. How come that software companies, who are successful selling directly fail when they try to approach the market through independent channel partners?

Alexander Osterwalder’s business model approach is the underlying framework for understanding that the software vendor and his independent channel partners are running very different businesses. They have different value propositions and their cost and revenue flows are completely different.

This whitepaper introduces the Partner P&L as the most critical framework for building and managing independent channel partners in the software industry.

The whitepaper explains what the Partner P&L is and ties it to the partner program, partner recruitment and partner management.

Software companies that fully understand their independent channel partners’ business models and associated P&L are much more likely being successful with the indirect channel approach.

Author

Hans Peter Bech, M.Sc. (econ.)

Acknowledgements

Design and lay-out: Flier Disainistuudio, Tallinn, Estonia, www.flier.ee

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Proof reading: Emma Crabtree

Independent Software Vendors (ISVs)

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Introduction

Using independent channel partners to resell, implement and/ or service customers has a long tradition in the history of the software industry.

For some software companies the channel has been a major contributor to global success, but for most software companies making it work is a depressing and constant struggle.

The word “channel” is used in the software industry to describe independent companies that assume various roles and obligations in bringing a software product to the customers. The definition is rather broad, since the roles and obligations can vary substantially from “simple” reselling to systems integration, solution development on top of the software, implementation in terms of consulting, project management, customization, training and support.

The common denominator is the fundamental condition that the individual channel partner is an independent contractor operating in his own name2, at his own expense and at his own risk.

This whitepaper explains why fully understanding the details of independent channel partners’ business models and especially the partners’ P&L are the critical paths to building a successful indirect channel3.

In this whitepaper we will use the term “business partner” irrespective of the specific role assigned to the 3rd party company.

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You will notice that the whitepaper doesn’t mention any product. We assume that we already have a product, which is and has proven capable of driving very competitive value propositions in certain segments of the market. Building a successful channel of business partners has very little to do with our product per se, but is all about how to do business with our product.

In channels designed as franchises however, this is not the case.

For a discussion of when "to partner" and when not "to partner" please see the whitepaper "Growth Through Partners" (TBK-WIPA-006) 2 3

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

The Business Model Framework

In 2010 Alexander Osterwalder gave us the business model framework4. To fully understand the difference between the business of software vendors and that of their independent channel partners I will urge you to get acquainted with the business model framework. TBK Consult has published the whitepaper “The Software Partner Channel in a Business Model Context5” which may be helpful.

Defining the Partner P&L

A P&L is the global standard abbreviation for the Profit & Loss statement. How much revenue do we generate in any period of time, what are the expenses and the resulting profit. To fully comprehend an investment scenario, we also need to understand the balance sheet and the cash flow.

The P&L is the result of how we organize and drive the other 7 elements of the business model. We may set objectives for what the P&L should be in a certain future period6, but we can only impact the P&L through the other 7 building blocks.

A normal high level P&L will look like this:

Million EUR

Q1

Q3

Q4

Full Year

Revenue - Cost of Goods Sold (COGS) Gross Margin

2,56 0,56 1,99

3,68 0,92 2,76

2,35 0,42 1,92

5,13 1,69 3,43

13,70 3,59 10,11

Sales and Marketing Other Operational Activities G&A Operating Expenses (OPEX) Profit (EBITA)

0,64 0,35 0,50 1,49 0,50

0,85 0,38 0,51 1,74 1,02

0,56 0,42 0,48 1,46 0,46

1,28 0,50 0,53 2,31 1,12

3,33 1,65 2,02 7,00 3,11

-0,10

-0,22

0,10

-0,60

-0,82

0,40

0,80

0,56

0,52

2,29

Financial items Net profit before tax (EBT)

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Q2

The big question when recruiting independent channel partners is: How will the business with our product impact the partner’s P&L?

http://www.businessmodelgeneration.com TBK-WIPA-009 6 Often called "the budget" 4

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Behind this high level question are a series of sub questions: 1. What business potential do I have in a 3-5 year perspective?

2. How much do I have to invest to bootstrap the business?

3. What is the cash requirement for these investments?

4. What is the “time to first revenue?”

5. What is the “time to profit?”

6. What are the critical success factors?

7. What are the most important risk factors that I have to manage?

8. What will you recommend me to do?

9. How will you help me become successful?

Independent channel partners are extremely sensitive to the impact on their P&L and are in general much more reluctant to make investments than software vendors are7.

To help our potential partners review the impact of building a business with our products we must break down the P&L in more detail.

The Business Model and the Value Chain

Business partners are individual businesses making their decisions based on the same investment and P&L principles as another independent businesses. However their business models8 and their value chains are typically completely different from that of a software vendor.

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The “investment horizon” of the average business partner is much shorter than ours (the software vendor). Business partners are looking for very fast return on investment; they expect us to explain how that’s going to be achieved and how we will be there for them in the short as well as in the long term.

Today's business partners are reluctant to deal with software vendors who are out to make a quick buck and who demonstrates a “hit and run” mentality. Most established business partners have had bad experiences with unambitious software vendors who are content with the “1%” market share. Business partners Please see the whitepaper Designing Effective Channel Partner Programs in the Software Industry TBK-WIPA-012 8 Please see the whitepaper: The Software Partner Channel in Business Model Context. TBK-WIPA-009 7

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

want to work with the market leaders simply because the market pull is much stronger and the long-term profitability is perceived as more attractive despite the competitive scenario9.

What do we want the business partners to do?

Taking a new product to a new market through a channel of new business partners is no trivial task; neither for us nor for our independent channel partners.

Figure 1: The Software Industry Value Chain

Figure 1 illustrates the typical value chain in the software industry. Which of the activities illustrated do we expect our independent channel partners to take care of?

For each activity we want the independent channel partner to assume responsibility for there is a corresponding investment in learning and an associated cost of running the operation. Thus there is a deterministic relationship to the Partner P&L.

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Revenue

The independent channel partner will obviously make a margin on reselling our products. In the software industry it is not unusual that software is sold in a package combining various software products and associated services. The more auxiliary revenue our products can generate for the independent channel partner the more attractive and “sticky� is the business in the long run and the harder it is to bootstrap the business in the short term.

As the independent channel partner builds an installed base of

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Please see the whitepaper: The Software Partner Channel in Business Model Context. TBK-WIPA-009 9

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

customers he will experience revenue streams from add-on sales, software maintenance subscriptions10, professional services and support services.

The detailed revenue part of the partner P&L will then look like this: Year 1

EUR

Year 2

Year 3

Year 4

Year 5

Revenue: New licenses (our software) Complementary licenses Professional services Other revenue New Business Revenue Add on license revenue Add on complementary licenses Software maintenance subscriptions Add on professional services Support Other add on revenue Revenue from the installed base Total Revenue

Cash Flow from Revenue

With the proliferation of cloud-based software as a service type business models it is worth emphasizing that revenue and cash flow is not the same.

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We still have the traditional delay from date of invoice (revenue recognition) to the day when we receive the payment. However, in the world of software as a service it is not unusual that we invoice for subscriptions into the future receiving all the cash today. In this scenario we have a much faster cash flow than revenue recognition as our auditors will require us to record the revenue as we deliver the service.

Unfortunately the situation for most software businesses is a genuine delay in the cash flow compared to the revenue recognition. As independent channel partners are seldom rich in cash we need to help them shorten the time to receiving income as much as possible.

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Software as a Service has a different revenue profile, but the P&L principles are the same.

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Cost of Goods Sold

Most revenue items have directly related cost components. We call these cost components Cost of Goods Sold or COGS. The price we charge our independent channel partners for our software and services is revenue for us and COGS for our partners.

Thus for each revenue line we will have a corresponding COGS line.

The cost of producing professional services is sometimes considered fixed operational cost or only the cost of utilization11 is included as COGS. Professional services staff may also have shared responsibilities and participate in pre-sales, product management, R&D and other activities which do not produce professional services revenue.

We will have to work with each independent channel partner to understand how he accounts for revenue and the corresponding COGS.

Operational Expenses

Expenses12 that are not directly related to the individual revenue streams (in the shot term) are called Operational Expenses or OPEX.

Sales and Marketing Expenses

In most businesses it makes sense to also record the sales and marketing expenses separately even though they cannot be related to the individual sale13.

The introduction of new products will require either additional or the reallocation of sales and marketing budget and personnel.

Assuming that the introduction of a new product can be done effectively within a current budget and by just adding more work to current staff is usually unrealistic.

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Therefore it is highly recommended that we specify the activities and the budget we believe is required to produce the revenue numbers we have estimated.

Utilization is the hours actually billed to customers.

Except financial and extra ordinary items 13 Companies in general spend more sales cost on projects that they lose than on projects they win. Allocating this cost to projects you win will be meaningless.

11 12

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Services

If our products require associated services then we must estimate the head count and the expected cost of hiring, training and keeping these resources.

General & Administration

There is usually an administrative component of any business relationship. I recommend reviewing the requirements for smooth order management releasing sales and management resources from having to extinguish fires as the business starts flowing and growing.

Leadership & Business Management

No business runs all by itself for very long. Starting a new business requires extraordinary leadership and business management. Frequent reviews are required to monitor the impact of initiatives and activities and making corrective actions as we climb the learning curve.

Capital Expenditure

Businesses recognize investments differently from operational expenses. Investments are activated on the balance sheet and written off (depreciated) over the expected lifetime of the investment. Thus investments will have a substantial impact on the cash flow at the start of the project and show up as capital expenditure on the P&L over the lifetime of the investment project.

As our independent channel partners are investing in the business with our products and with us, it is worthwhile investigating if some of the expenses can be activated therefore relieving the impact on the P&L.

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Cash Flow from Operations

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In the software industry the P&L of most business activities are dominated by the salary component. Salaries have to be paid every month and are usually non-negotiable. An investment scenario where the time between revenue (time of invoice) and the cash from revenue is long requires much more cash than the P&L will indicate. It is therefore recommendede that any investment scenario is accompanied by a sober cash flow analysis.

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

The Bottom Line

When we have developed the P&L for the investment in our relationship with the independent channel partner we will typically look at a scenario as illustrated in fig. 2.

Figure 2: Typical independent channel partner P&L scenario

In the scenario illustrated there is a loss from operations in the first 18 months. The accumulated loss in Q3 of the first year is €128.250 while the cash requirement is €208.25014. The scenario is profitable in Q2 of the second year while we will not have recovered our cash flow before Q4 in the second year.

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I can assure you that this is not an unusual P&L for an independent channel partner starting with a new product in the B2B software industry. I can also assure that most independent channel partners will give up if they have not made such a P&L analysis up front knowing what they can expect.

Helping Accelerating Time to Cash 12

As software vendors we must help our independent channel partners accelerate the time to cash and to protect their investments. We cannot just sign an agreement with our independent channel partners and then expect that they will figure out how to make a business with our product all by themselves. Some may be successful, but most will not.

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Based on a 90 days delay in receiving cash from revenue.

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

Independent channel partners are particularly sensitive to making investments when we are new to the market with no brand awareness and no proven track record.

The more investments in branding and lead generation we expect our independent channel partners to undertake and finance the more prepared we will have to be for discussing how to protect the investments that our independent channel partners are making. Independent channel partners are not comfortable making investments that other independent channel partners who join the party later will benefit from15.

The Partner Program

Software vendors choosing to approach the market through independent channel partners must have very strong partner programs16. The success of the software vendor depends entirely on the success of his independent channel partners.

In the bootstrapping phase we are very much dependent on recruiting partners that will and can break the markets with us.

As we grow our partner channel we can take more chances.

Partner Recruitment

Partner Management

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5%

For partner recruitment the partner program must be designed to accelerate the time to revenue and the time to cash. However, for certain types of software products the average sales cycle can be very long. Average sales cycles over 12 months are not unusual in the B2B software industry. In such situations the software vendor and the independent channel partner must agree on Key Performance Indicators ensuring that business development process is on track. The Partner P&L must be updated regularly to reflect the expectations as the business develops.

As we grow our portfolio of independent channel partners we will learn that they do not all have growth potential. It seems as though independent channel partners fall into three groups.

10%

The stars: 5% of our partners have the ability to grow their business independent of our support.

85%

The Growth Potential: 10% of the partners have growth A phenomenon called "externalities" Please see the whitepaper "Designing Effective Channel Partner Programs in the Software Industry" TBK-WIPA-012

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The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

potential, but need support releasing it.

No Growth Potential: 85% of our partners have no growth potential. They will mange a small portfolio of customers, but will not grow beyond this small installed base.

The Partner P&L will be very different for each category and so will our options for making investments in growing the channel.

We will have to focus our investments in the Stars and the Growth Potential, while we minimize the cost of managing the 85% of partners with no growth potential.

A Note on Margins

Often software vendors will partners higher margins on higher margins are supposed investments the independent getting started.

offer their independent channel the first deals they make. The to compensate somewhat for the channel partners are making in

Software vendors should be extremely careful of giving away margins on their products. In the long run even small variations in the margin we pass on to the business partners will have a substantial impact on our own P&L and valuation.

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In general it is my experience that high margins have very little motivational impact on the business partners’ behaviour.

Margins are like the salary to employees. They are a hygiene factor. Changes in margin levels17 may have a small impact, but in the early days of the business partner relationship it is the time to revenue and time to positive cash flow that has the biggest impact on the behaviour. In the early days of getting an independent channel partner started, high margins will have no measurable impact on behaviour and willingness to invest.

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Margins increase with increase in revenue

The Partner P&L – A Key to Building Successful Channel Partners in the Software Industry

About the author Hans Peter Bech has been developing and managing global partner channels in the software industry for more than 30 years.

Hans Peter built the partner channels for companies such as Dataco (now Intel), Mercante, Dansk Data Elektronik (now CSC), RE Technology (now Barco), and Damgaard/Navision (now Microsoft).

As a management consultant Hans Peter has been providing consulting on channel development and management issues to companies such as Microsoft, Danfoss, Proekspert, Jeeves Information Systems, eMailSignature, SoftScan (now Symatec), Netop, EG A/S, CSC Scandihealth and Secunia.

Hans Peter is the author of several whitepapers on channel development and management and he frequently writes articles on the subject.

He started his career as a management consultant in 2003 and founded TBK Consult in 2007. Since then he has built the company to its present position with 24 senior consultants in 16 countries.

Hans Peter oversees the development of TBK Consult as well as performs management consulting assignments for selected clients.

Hans Peter holds a M.Sc. in macroeconomics and political science from the University of Copenhagen. He speaks Danish, English and German and is a certified ValuePerform, ValuePartner and Business Model Generation consultant.

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More about Hans Peter Bech

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TBK-WIPA-017