How to Build a Software Business in the Cloud

Ask anyone in the Distribution business if there is much money to be made in software and they will tell you it's only a numbers game.

Average front end margins on software are minuscule and most money, if any, is earned at the back end by hitting certain rebates. The bigger the vendor, the worse it gets. It becomes a numbers game as the only way to make any money is to sell very high volumes to get some rebates and then streamline processes so that the efficiency is so high that little intervention is required to actually transact sales. Automation is essential and heaven forbid a salesperson has to intervene to explain features and benefits in order to differentiate one product over another.

Welcome to the world of software distribution. Whose fault is it that there are no margins left in this business? Well a great deal of it can be put at the doorstep of the distributors themselves for cutting their own throats by extracting value and cutting prices exchanging sanity for vanity by chasing volume. But the vendors don't help as their lack of understanding of business models actually leads them to think that distributors can make money on 1 or 2% margins and think they should help them grow markets at the same time.

So as vendors want to make an impact in The Cloud they are applying the same mentality to the new sales model. Not only are they offering low margins but they are expecting Distributors and the wider channel to make markets for them while the profit and loss model moves from upfront sales to monthly annuities.

Software vendors are kidding themselves. Some then think they should change the model by taking the sale away from the channel forsaking partners who have helped them build the very business they enjoy. And in the same instance, the same vendors get angry that the channel is not engaging to help them make net 40% margins when the channel make hardly anything. In fact, as some models are 'pass through sales' only, the channel cannot recognise the 'volume revenues' they used to enjoy as they can only recognise the small margin offered as a sales commission.

Clearly, the traditional on-premise software vendors have a big problem. How do they get to the market opportunity fast to justify their investment? And how do they do it to make the same money they did before? And why should they give the channel more than they are used to - what value does the channel add in the supply chain to justify anything more?

Some veterans like myself will remember those halcyon days when a channel company actually knocked on doors, made demonstrations, did their own marketing and made some sensible gross margins on software products. There was a time when selling software was not just fun but profitable and vendors loved it because they had willing, capable foot soldiers to extend their reach. But the PC market matured and the rest is history.

Is it not ironic then, after vendors strangled the margin out of products, that they now think the same channel will be interested in their Cloud story and be expected to sell under the model on the same margins they currently have, assuming that they add no value?

There is a difference. For companies like Microsoft, they are receiving the first major challenge to their empire. It's called competition and it's in the form of Google. The threat is not just that Microsoft may lose ground in their Office heartland but if Google get a foothold, they also have Google's growing domination of Smartphone and impending growth on tablets in the operating system market to contend with. If Google, and Apple for that matter, get serious traction as the operating systems of choice on these devices then it will inevitably squeeze their domination on the PC. And who is to say that by 2014 that most office productivity will be done on smartphones and tablets, leaving the PC as a legacy dinosaur in the office? If so, then Google and Apple are slated to have over 70% of the tablet OS market and Microsoft just 13%. The writing is on the wall.

Microsoft is not alone. But it is the classic case in question. As it sits there revelling in another record sales and profit year, the slides by management must look lovely. Nothing will show that tablets will become the office productivity tool of choice. Nothing will show that smartphones will have the same compute power as PCs. Nothing will show that the PC market will decline. Nothing will show that Cloud applications will only exist in The Cloud and that clients of software will always be required. Nothing will show that Windows will ever lose its shine.

So the assumption by Microsoft and others will remain the same. Distributors will engage in selling Cloud based software and be happy with single digit or no margins as that's what their businesses like and what possible value can they add. The same goes for the wider channel - some tacit acknowledgement that there are some clever resellers, but that's it. They will all be happy losing the relationship with their customers, lose revenue recognition and have single digit margins - and still help vendors access the Cloud opportunity.

Read the words. It doesn't make sense. It's back to basics time. To fight the likes of Google it will take an army of foot soldiers who are capable of demonstrating, selling and supporting the new model of software. Salesforce.com and others didn't win their sales on the back of paying their salespeople peanuts - in fact, they are some of the highest paid salespeople in the industry. Salesforce.com recognised that you need clever salespeople, highly incentivised to not just win sale but keep them and expand them in order to succeed.

Vendors coming into The Cloud need to pay close attention to how 'The West Was Won' by those early Cloud vendors. Incentives for new sales and existing are rich. Salespeople are clever as in the main they had tough competition to sell and differentiate against.

For all vendors moving into Cloud sales, think about this deeply. Because if you engage with the existing model, not only will you get frustrated with channel, you will also not succeed. There needs to be a solid debate amongst partners on how to model the opportunity properly.

This is simply not happening at the moment. And so Cloud sceptics are having a field day at these vendors and the Distributors. And they may be right - vendors may miss the market because they simply have no idea how to engage and win it.

Beware of Google and Apple then, is my advice. They have a strategy and all the indicators point to them winning right now. There is limited time to get this right.


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