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It’s not an academic question.

Readers of my recent blogs will know that I believe staying competitive in a Cloud-first world will require additional capitalization for many Microsoft partners.

As an owner, if you wish to secure that capital you must present a viable investment thesis to potential funding sources. In other words, you must convince potential investors that you can generate an acceptable return on their invested capital, as well as yours.

In practice, I am seeing 3 main ways to make that case:

1. Rapid growth and market share gain. You have a strong Cloud-based offering that is producing recurring revenue growth of say 30% or higher annually but could scale even more rapidly with a capital injection (remember the goal is to capture share before someone else does). Profitability is less important than a healthy gross margin structure, because you’re continuously investing in growth and refining the offer.
2. Aggressive SaaS pivot. You have strong recurring revenue already (for example maintenance on your own IP), that you want to convert to Cloud subscriptions because they have a longer life expectancy and are therefore more valuable. You also can take share from others if you were to be better funded for aggressive customer acquisition.
3. Market footprint consolidation. You have a strong market position, which can become dominant through acquisitions of competitors and a consolidation of their customer bases. In this case, the goal is to achieve better scale economies, and capture a price premium from customers because of your dominant market position. This expands both revenue and profitability levels.

In some situations, these theses can be combined to make an even stronger investment case. But the critical thing is to understand how you will create substantial gains in shareholder value, both for yourself and the provider of capital.

How strong do those shareholder value gains have to be? That requires a deeper conversation …

Contact me if you’d like to have that discussion.

In pursuit of The Elephant, I recently conducted a CloudSpeed poll to take the pulse of owner intentions in 2019.

The results worried me.

Why?

Nearly 80% of respondents felt that they could fund their digital transformation “organically” – that is out of internally generated profits. Or, that their business is already transformed for long term success in the Cloud. Over half of respondents relied primarily on gut feel to form that view.

But as one respondent put it, “This is the first wave of cloud-first transformations. More will occur, and each will need to be a capitalized event. For wave 1 we are ready and still trying to understand and analyze what wave 2 will look like.”

I strongly agree with that. Cloud transformation is an ongoing journey, not a single destination. So even if you are well positioned for wave 1, the game is far from over. It’s really just begun. I believe staying competitive will require additional capitalization for many if not most.

Here’s why.

The Cloud is fundamentally a first-past-the-post system. Whoever gets the customer subscribing to their solution profile first wins economically, because their cost of retention will be far lower than the cost a competitor would incur to win that customer away. So the goal has to be to capture all the share you can, now. Before someone else beats you to it.

Bottom line, I believe that if your revenue is not growing by 20%+ annually, it almost certainly means you are losing long-term share. Share that you will be unable to cost-effectively capture later.

In my experience, few can achieve those kinds of growth rates with internally generated profits alone.

Don’t get me wrong – if you can achieve significant revenue growth with organically generated (and retained) profits, great. But if not, use outside capital to leverage your position. That’s the high-level formula for shareholder value creation in the Cloud. As opposed to building a “lifestyle business”. I believe that’s a losing proposition in the Cloud, at least for all but very niche players. And sometimes, even then.

The other thing I strongly recommend is, think about your potential capitalization needs now rather then when you run out of money. Identify your maximum sustainable internal growth rate and then compare that to what you think you could capture in terms of total long-term market share. If the latter is greater, go after it now by recapitalizing. Get your market share now before others do.

The good news is, capital is available. The bad news is, relatively few are taking advantage of that. I believe this game will go to those who leverage capital. And I think the winners and the losers are being separated now, even if they don’t yet realize it.

If you want help with your recapitalization, contact me.

As I pointed out in a previous blog, one of the options an owner has in this era of digital transformation is simply to “sunset” their traditional business model and “milk” it for as long it can possibly last.

You might be asking, how much exactly is that worth?

The answer is, it depends.

But in general, here is what your revenue and earnings trajectory will most often look like. Call it your Sunset Trajectory.

To start with, any business has a certain inherent revenue momentum. Hopefully, it is positive to at least some degree.

In the short term, you can rationalize certain costs quickly. Staff can be laid off, for example, and new customer acquisition costs slashed. Some, but by no means all, overhead can be reduced as well. All this does not immediately impact revenue momentum, however. There is a time lag. So, for a while earnings rise faster than revenue.

Unless, of course, a recession intervenes. Which I would point out, we’re very likely due for any time now if history repeats itself. Which it has a habit of doing. But let’s park that for the moment.

Eventually, recession or no, your customers work out that you’re going out of business. You just haven’t told them yet. When that happens, revenue starts to decline.

You’ve already cut all the costs you can, so now your earnings start to fall faster than revenue. At some point, they turn negative. Then, you turn off the lights and go home. You’ve extracted all the money you possibly can.

The real question, of course, is what might your Sunset Trajectory look like? And how does it compare to what you could extract by selling the business, or investing in your own digital transformation?

If you’d like to work that out, contact me.

Remember the advent of client/server? Most Microsoft practice owners do, because it created the ecosystem we know today. Thousands of businesses emerged, based on that technology. And in time, thousands of mainframe-based businesses disappeared. That’s the way disruption works.

Now, it seems clear that the co-called 3^rd platform (social, mobile, cloud, big data) is set to eliminate thousands of client/server-based businesses in their turn.

If you own such a business, I believe 2019 requires your making a fundamental choice.

Sell

For some, the best choice may be to monetize the customer base you have accumulated and leave another to migrate them to a Cloud-first world. The central challenge here will be to find a strategic buyer who at least comes close to meeting your valuation expectation as an owner. If your business is project services-heavy, unfortunately, your options may be limited unless you are able to demonstrate strong and credible differentiation. What exactly will your valuation rationale be?

Sunset

For others, particularly those who do not wish to undertake a multi-year business model transition, it may make sense to rationalize all possible costs and simply ride existing momentum out for as long as it lasts. The difficulty here will be how much longer the traditional model can be “milked”, given shifting demand. Absent relatively high levels of recurring revenue (ideally product-oriented), the sunset risks being quicker than you anticipate and the value extraction low. How much would this option be worth to you?

Adapt

For those with neither a strategic buyer in the wings nor material recurring revenue, your only remaining option is to adapt. This will require dealing with The Elephant. Are you adequately capitalized to complete your own digital transformation?

Whatever your choice as an owner, I strongly suggest that in 2019 you give serious thought to how you would answer the questions each option poses.

And then act accordingly …

When it comes to Business Central, I believe there is an elephant in the room. An invisible one. Potentially, a deadly one.

That elephant is inadequate capitalization of the Partner community at large.

Here’s why I believe this:

In the past, all a publisher like Microsoft really had to do to capitalize a channel was provide favorable payment terms for perpetual licenses. A VAR or ISV paid in say 120 days and collected from the customer sooner. That generated the working capital needed to run and grow the business. A competent entrepreneur could bootstrap their way to success with this support alone. And so, a channel formed.

But  it doesn’t work that way in a Cloud-first world, because:

1. Subscription revenue gets collected over time, not upfront. Even collecting say a year’s license subscription from the customer in advance and paying the publisher monthly falls well short of providing the working capital needed for business model transition. The cash flow trough begins.
2. Customer acquisition costs are upfront, but revenue is not. This deepens the cash flow shortfall. Especially, if marketing expenditures rise, which they inevitably need to do to get any sort of customer add momentum.
3. Upfront project fees go into freefall because the customer expects to pay a “sensible” multiple of their (far lower) license subscription for services. The cash flow trough deepens even further.
4. The customer demands “productized” add-ons rather than high fees for customizations, which the VAR or ISV must either build or re-configure, resulting in further upfront costs not offset by immediate revenue. The cash flow deficit hits the red zone.

Partner owners, for their part, respond with some combination of the following:

1. Stubbornly believe that they control the customer and can therefore override subscription demand and avoid the whole cloud thing altogether.
2. Attempt to “sweat” their customer base and new prospects with the traditional perpetual model that has high upfront revenue, while the undertow of subscription demand flows in the opposite direction and pulls them underwater.
3. Personally fund the cash flow trough in the mistaken belief (hope) that it will be short-lived and magically self-correct.

None of this is effective, of course. At some point, the Partner simply runs out of cash. 

What happens then?

The publisher fails to achieve their growth and market share ambitions because the channel they rely on to deliver it is undercapitalized, and VAR/ISV owners preside over the slow death of their (traditional) businesses. End of digital transformation story.

The only mathematical way out of this is for everyone to first acknowledge the elephant exists. Then, Partners must build realistic budgets/forecasts that identify the funding needed for their own digital transformation. Finally, that funding must be secured.

As the end of 2018 approaches, and everyone reflects on what they want 2019 to hold, I believe we all need to have a candid conversation about capitalization, and deal with it as a top priority.

My opinion …

What’s yours?

Survey findings are now available for the latest CloudSpeed survey, with over 100 Partners sharing their anticipated sales, traditional seat migrations, workload attach rates, and resourcing requirements to name a few.

I believe you will find the results of this survey both interesting and helpful in making the most of the Business Central opportunity. If you have already participated, you should have received the results. If not, let me know.

If you would like to receive the results, please contribute your perspectives here and I will send you the survey findings.

How prepared are Microsoft Partners to fully capitalize on the fundamental market changes that are driving demand for Dynamics 365 Business Central? What key business levers are the most important to achieve sustained profitability? What lessons can be learned from other Partners in the field today? How can the entire ecosystem fully exploit this market opportunity?

To answer these questions, CloudSpeed is conducting a survey among Partners interested in Dynamics 365 Business Central. By participating in this survey, you can be among the first to receive the findings, plan your next moves, and drive your business forward.

All individual responses are confidential and there is no cost to participate.

I invite you to complete the online survey now. It takes under 10 minutes, and your participation will help ensure everyone makes the most of the Business Central opportunity.

dana

In this digital age, the IT services market is not working effectively for any stakeholder group – Customers, IT Professionals, IT Resellers, IT Vendors, and Distributors alike. Each remain exposed to critical risks and fail to realize the full promise of digital transformation.

Moreover, the risks and economic rewards are likely unbalanced in the face of this market shift. Customers need more predictable outcomes and tangible business value from their technology investments. The IT Professionals and IT Resellers who deliver them deserve to reap superior economic rewards. IT Vendors and Distributors need to preferentially support those who best advance everyone’s interests, including their own.

In short, all industry players need to better serve customers, while helping themselves achieve superior business outcomes. Lessons from digital frontrunners in other industries strongly suggest that increased transparency and visibility is a vital requirement, and overdue.

Download the CloudSpeed Whitepaper here.

The results of the CloudSpeed Capital Adequacy Study are now in, and the bottom line is that although most Microsoft Partners have made strong progress in adapting their business models for success in a Cloud-first world, many also have a significant portion of the journey left, and may experience difficulty funding it. If you want a copy of the full findings, complete the survey here. If you have already participated in the survey and not received the findings, let me know. 

Having worked with Dynamics Partners for a decade now, I believe this is a pivotal time for the channel.

As I see it, there are 2 choices a Partner can make, with very different consequences:

1. Continue selling as many perpetual deals as possible, until there is no longer any real demand. Simultaneously squeeze out as much profit as possible, by cutting costs to the bone. Then close up shop, because there will likely be no buyers for what’s left.
2. Aggressively pivot the business to the Cloud, make the investments needed to develop some IP and acquire Cloud users, and ride out the cash flow trough until recurring revenue builds to a point that restores profitability. Collect “rent” on Cloud users well into the future, or sell the business.

I believe this is a pivotal time to make that choice because of the convergence of strong Cloud demand, product readiness, and a favorable margin structure. I also believe that because of this, the gap between the economic winners and losers will greatly widen from here out.

Just my opinion …