A question that often comes up in our conversations with software vendors is: What is the business model for reselling enterprise software? Here’s a description of that model, which provides insight into how to optimize the very structure of the vendor’s Go-To-Market.
We sell a software with a list price of 100€. Our Go-To-Market is based on direct and indirect sales forces: We have a network of reseller partners. We focus our reseller partner network on the sale of new licenses; we will therefore not discuss here the sale of license renewals or subscription renewals.
Different levers are used to stimulate the activity of the resale channel partners. Let’s see what the economic impact of each lever is.
100€: List price of our product (MSRP, Manufacturer’s suggested retail price).
Simple vision of the economic model
70€ : The Net Seller price, after the traditional 30% discount for a partner.
80€ : Price proposed by the partner to the customer after a 15% margin. The reseller will use the highest possible margin percentage. For the end customer, this is a 20% discount on the MSRP or list price.
Note: A VAR (Value Added Reseller) partner will earn additional revenue from this sale by adding services, which complexity depends on the nature of the software sold. These additional revenues can range from 0.1 times the sale price of the product (product installation service) to 2 to 4 times the sale price (consulting and integration service). The additional revenue from services could therefore be between 8€ and 320€.
This is the simplest view of the partner business model – now let’s add some complexity.
A more sophisticated view of the business model
Registering a reseller agreement can provide an additional 10-15% off the list price. Such an agreement endorses the promise of efforts to bring a specific product to market – the initial discount thus changes the net price to the seller, and consequently the selling price to the end customer.
55€: The new net price for the seller, after an additional 15% reduction on the traditional discount; The total discount for the reseller with a resale agreement is therefore 30% + 15% = 45% on the initial list price.
72€ – By increasing his margin to 30%, the partner will be able to offer the new selling price at 72€ (55€ x 1.30). In this case, the customer will benefit from an additional reduction in the proposed price, from €80 to €72, i.e. an advantage of 28% on the catalog price instead of 20%.
In addition to these structural arrangements, there are various sources of additional costs that the supplier who wishes to develop an indirect sales channel must assume:
Additional costs to motivate the partner and guide their behavior:
- “SPIFs” or “Special Incentive Funds” are incentives designed to motivate the partner’s sales force. Sometimes of the order of 1% of the catalog price, SPIFs are allocated to the partner’s sales forces, according to more or less restrictive objectives, and are generally applied to a product or a family of products and over a determined period of time, generally very short (of the order of one or two months). Thus, over a given period of time, each sale of a given product gives rise to a certain amount of bonus, with or without a threshold. Let’s imagine here a threshold of 300,000€ of sales over a certain period of time, after which for example 3% of bonus will be distributed: Here, 3€ extra per product sold at 100€ per 300,000€ of sales.
- “Rebates” are sales volume incentives intended to reward the partner if certain objectives are reached, and are calculated on the net amount realized by the partner. They range from 3% to 5% of the net amount paid to the supplier and are based on the partner’s achievement of quarterly financial targets agreed with the supplier during the business planning process at the beginning of the year. These amounts are paid only after targets are met; for example, for a 5% discount that depends on quarterly targets, €3 will be paid (5% of €72) if targets are met.
- MDFs, or Marketing Development Funds, are funds allocated by the supplier to the partner for marketing activities. These amounts are based on both the partner’s achievement of quarterly financial goals agreed upon with the supplier during the business planning process at the beginning of the year, and the level of partnership in question. (Qualifications such as “silver,” “gold,” and “platinum” are common in the industry; these qualifications are allocated based on the amount of sales achieved in the previous year and carry increasing benefits.) Let’s consider here for example an amount of 3% of the net amount paid to the supplier, depending on the achievement of its objectives: 2€ in our case (3% of 72€), which will be allocated to marketing activities
Costs to resolve or mitigate conflicts between sales channels:
It often happens that some customers who are addressed indirectly (i.e. by the supplier’s partners) can also be addressed directly by the supplier, i.e. with its own direct sales force. In these cases, conflicts can arise: What is signed and earned by one will be missed by the other, which is not neutral for a salesperson who receives commissions.
It is therefore necessary, so that the indirect sales program is not counterproductive, to neutralize the impact of the sales channel on direct sales. Several setups exist, the most common of which is to compensate the direct sales force when the deal is signed by a partner if there is a need to compensate them.
If we consider that the direct seller could have sold 20% more to the customer than the price conceded to the partner (55€ in our case), then the direct seller can consider that he would have sold his product to the customer for 66€; at 5% commission, this is a loss of 3€ commission (66€ x 3%).
Finally, the costs of the partner management organization
The management costs of the sales channel, the salary and commission of the partners’ managers, the pre-sales resources sometimes mobilized can cost about 10% of the net amount to the seller, i.e. 6€ (55€ x 10%)
The summary of this version of the total cost of selling through resale partners with whom an agreement is reached is therefore as follows, for a list price of 100€:
- 55€ – Net price to reseller, after deal registration
- 47€ – After SPIF (3€), discount (3€) and MDF (2€)
- 38€ – After direct sales compensation (3€) and channel management costs (6€)
If there is no resale agreement, then the margin flow would be :
- 70€: Net to the reseller, who without a resale agreement only gets a 30% traditional discount. Without a resale agreement, neither SPIF, nor MDF, nor rebate can be applied
- 63€ : After the costs of the partners’ organization (10% of 70€)
- 59€ : After direct sales force compensation to eliminate sales channel conflicts (5% commission on 70€ plus 20%)
The impact of a reseller agreement on the margins left to the partners and the cost of sales is therefore substantial for the supplier. For the software supplier, depending on the model chosen, the revenue generated by the reseller ranges from €38 to €59, so on average €50: The ratio of indirect sales costs is therefore between 60% and 40%, 50% on average.
Note that this figure is an average, and that for a particular vendor it will depend on the structure of the network of partners involved and the volumes of business handled respectively by the partners who benefit from an agreement and the others.
Optimize market coverage
Software vendors sales forces are generally more expensive than those of resellers, and as a result they must focus on the most important accounts in order to maximize their cost effectiveness. The direct accounts must therefore be selected in such a way that a direct coverage is more profitable than an indirect coverage (whose COSr, Cost Of Sales ratio, is about 50% as we have just seen).
The average ratio of the costs of sales of an editor must be, for those which address wall markets, lower than 50%, without which the model of segmentation and addressing of the markets is to be re-examined; the target ratio will depend on the proportion of the business made in direct and indirect, and will depend moreover strongly on the relative volume of the renewals of contracts, whose profitability is in general strong
The profitability of a vendor therefore depends a lot on the amounts of renewal contracts to be signed, and also on an optimal definition of its Go-To-Market for the capture of new contracts. The optimum of this GTM depends on the segmentation of the markets and accounts that will be addressed by the direct or indirect sales forces according to the profitability of their coverage – the COSr is thus the determining element of these choices, as explained in the blog we already wrote in 2022: Go-To-Market
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