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And by that I mean, what do want your business to be worth in the Cloud era?

Over the last 10 weeks, I have spoken or met with several dozen Microsoft Partner owners, from all parts of the globe. I’ve asked certain core strategic and economic questions of them all. We’ve done their Cloud math, together. And I’ve learned, everyone has a different number.

Now for starters, we’re all in agreement that the Cloud is a disruptive event. Which makes it both an opportunity and a threat. And it’s upon us, now. So owners have a burning need to identify what their business will be worth in a Cloud-first world.

But among the owners I’ve worked with, the Cloud Number Range is wide. Surprisingly wide, in my opinion.

In my travels, I’ve found certain key things tend to drive what your Cloud number ends up being:

• The market segment you pursue. Or put another way, the demand wave you chose to ride. Each segment will tend to have its own inherent potential.
• How crisply you can define your offering, and why customers would buy it. Specifically, what quantifiable business risk are they avoiding by using your offering, or what economic advantage will they achieve?
• How aggressively you are prepared to pursue your chosen market segment. Put simply, the more customers you capture before someone else does, the more your business will be worth. If your Cloud revenue is not growing by at least 20% per annum, you’re in effect losing share to someone else. Never a cause for happiness.
• Your ability to raise the capital needed to aggressively grow your customer base. Unlike the traditional business model, the strong evidence is that you cannot effectively “bootstrap” a high-value Cloud business.
• The degree to which you can wrap managed services or “subscribeable” IP around Microsoft offerings. Because they are both recurring revenue streams, and generally deliver higher margins than one-time project services, the valuation multiples you achieve are correspondingly higher.

Want to do your own specific Cloud math? Want to identify your Cloud number?

Let me know …

No matter where in the worldwide Microsoft ecosystem I go, I find that Partner businesses are experiencing at least some measure of financial pressure. Having benchmarked now nearly 100 such businesses (VAR’s, ISV’s, SI’s, MSP’s) over the last 7 years or so, I have also noticed a fairly steady decline in overall profitability.

For the most part, this is caused by shrinking margins.

What I’ve also noted is that although different Partner businesses will have different revenue stream compositions, not all margin is created equal. In fact, there is a “hierarchy” to margin potential, depending on the revenue stream one is talking about. This is represented in the following graphic.

Starting at the bottom of the margin ladder, hardware at best delivers 20% gross margins. In many cases, it can be half that. 3^rd Party Software tops out at around 35%, and that almost always requires the sale of business applications software such as ERP. Other software carries generally lower margins. Project Services comes next, in some cases driving 45% gross margins, although this requires careful management attention to achieve. In essence, you are selling labor and there are inherent limits to how much margin you can drive. Managed Services can deliver as much as 55% in gross margins, because it is a form of “insurance” that customers buy, should they need it. They tend to overestimate the support they will require, and under-consume. So you earn a higher margin than is possible for project services. And finally, Intellectual Property can deliver as much as 75% gross margins, because it is a product that is “manufactured” once and sold multiple times.

It is also important to note that the only revenue stream that is not under pressure these days is Intellectual Property. This is largely a supply-and-demand phenomenon. Intellectual Property has high perceived value to the customer, so it can be premium-priced. There are also fewer entities producing it, so there is little competition to drive prices down. Consequently, margins remain high.

So the cure for shrinking margins, quite simply, is to shift your revenue composition in favor of higher margin activities such as Managed Services and Intellectual Property. Not only do they drive higher gross margins, but they are things a Partner can control.

Tap into the clear demand for Cloud solutions, and you will have a double-win – your margins will increase, as well as your company’s valuation.

In my travels across the Microsoft Partner ecosystem these days, I sense a growing anxiety among owners, globally.

Many are working harder now than they have in years. And not making the money they once did. They do not find this encouraging, obviously.

There’s also a sense that, when the time comes to liquidate their interest in a business they have spent years building, they may well be disappointed by what potential buyers will be willing to pay. And that indeed buyers will be in short supply, relative to sellers.

Unfortunately, I believe these concerns are largely justified.

At the core, the problem is that the Cloud-first world we now live in has disrupted the traditional Partner business model. Such periodic disruptions, we know, are central to our industry and indeed capitalism itself. And by definition, they are outside our control. All we can do is respond and adapt.

So what can an owner do?

While there are never simple answers to complex problems, those who are building rather than destroying shareholder value tend to be doing the following:

1. Understanding what can be leveraged, and what cannot. If only by accident, all Partners will have evolved a certain market focus, and means of differentiation. Success in a Cloud-first world requires first identifying what an owner has built that will be relevant going forward.
2. Identifying sound market opportunities, given the above. And what the requisite investments and likely payoffs will be. Not all opportunities are created equal, and only one or two can be realistically pursued.
3. Freeing up needed investment capital. This is done through benchmarking, which establishes where operational and financial performance can be improved, such that additional operating margin is generated.
4. Determining the Cloud-first value proposition and appropriate messaging. If you’re not visibly (and compellingly) promoting the Cloud, you’re not considered by potential prospects to even be in the game. Unfortunately, many Partners are trapped here.
5. Crystalizing the Cloud-first offering. Specifically, what products and services will be sold? Intellectual property identification is also key here; it often underpins greatly the viability of the business case, because it has the best possible margin structure.
6. Building marketing muscle. Digital demand generation is critical in a Cloud-first world, and something few Partners are today good at. Absent an adequate online marketing engine, sufficient revenue generation is impossible.
7. Building a Cloud sales capability. Buying behavior has changed, and a Cloud-first world demands a different sales methodology, staffing, and compensation structures.
8. Building a Cloud-first delivery and support capability. Implementing and supporting solutions in the Cloud also requires a new delivery configuration, to keep churn low and cross-sell rates high.
9. Formulation of go-to-market approach. This brings it all together and crystallizes the Cloud Business Plan. There will be investments required, and unless the owners/board can see a greater business valuation at the end, they just won’t sustain a real drive to the Cloud.

Leaving, really, one key question remaining – what is the payoff for all this work?

Just as the Cloud is making traditional business models worth considerably less, it is making others worth considerably more. In some cases, 2-4 times more, or better. The reason an owner invests in transitioning to a Cloud-first business is simply to create shareholder value rather than destroy it by inaction.

It’s a harsh choice, perhaps, but an inescapable one.

And the time for action is now.