Analysis

Microsoft has been investing heavily in cloud computing and a subscription model for its software. This is a significant undertaking that will cause both pain and joy to its customers and partners. To Microsoft’s credit they have focused their attention on the applications most used by businesses such as Microsoft Office, SharePoint, and Exchange. The online and subscription versions of this software together comprise the popular Office365 offering. While cloud computing and software subscriptions may ultimately benefit Microsoft’s channel partners and their customers, the transition to the cloud business model will create short-term pain for the Microsoft ecosystem. The most pain will come from the change to a new revenue model and the need for some channel partners to redefine their value-add. Other partners that have crossed this chasm surprised and pleased with the change.

The Commitment to the Cloud

Since Salesforce.com introduced businesses to the idea of Software as a Service (SaaS) 16 years ago, one vendor after another has taken up the idea of offering information technology resources in an online form that we call “the cloud”. Microsoft is no exception. Under CEO Satya Nadella, Microsoft has accelerate their cloud offerings to include Infrastructure as a Service (IaaS) and Platform as a Service (PaaS)[1] via Microsoft Azure. Azure is Microsoft’s competitor to Amazon S3, Oracle Fusion, and IBM Softlayer. Microsoft Azure effectively delivers Microsoft software infrastructure products such as Windows Server, Hyper-V, .Net, and SQL Server, as well as other common software components such as Java in virtual online environments instead of on-premises servers and storage. Key products such as Microsoft Office, SharePoint, and Exchange are also delivered as cloud offerings. This is in addition to their Microsoft Dynamics software that has been offered as SaaS for some time. While much of this has been available for some time, the pace of new introductions and programs has increased.

Cloud products not only change how IT software and services are deployed but how they are paid for as well. Instead of typical per user or server licenses, often called “box licenses”, software and hardware are paid by consumption. For software, that means monthly or yearly subscriptions per user. Cloud hardware pricing is typically based on the resources consumed (network bandwidth, CPUs, gigabytes of storage, etc.) per month. Cloud subscription pricing eliminates the box license that has been the mainstay of the IT industry for over 40 years.

Microsoft Embraces Hybrid Cloud

Microsoft, like many other IT vendors, recognized that not all applications are best delivered in a browser. Productivity applications such as Microsoft Word or Microsoft Excel are only functional as mobile or browser applications when they are more limited. In response, they have adopted a strategy typical of other major IT vendors called hybrid cloud. Hybrid cloud environments keep some resources local while others are delivered online and operated from a browser. Microsoft Office365 is a prime examples of this strategy. One subscription provides access to limited but functional versions of all the Microsoft Office applications as well as copies of the full featured desktop applications. This provides end-users with the choice of which works best for them at the moment.

Customers Gain

Cloud computing fundamentally changes the way businesses deploy IT resources. It is no longer necessary to purchase servers and storage and then install server software and applications on them. Instead, IT resources and even whole applications can be accessed online from off-premises cloud data centers that the software vendor operates. This eliminates the need for many in-house IT personnel or outsourced IT services. Microsoft is aligning its value proposition with its customers. This may be disruptive or welcomed to some channel partners. In either case, if partners can navigate the disruption, there is advantage for them for them to move to services and renewable subscription revenue,

At the same time, the change in the pricing model converts large, one time, capital expenses for IT to monthly or yearly operational expenses. Businesses can now purchase IT out of cash flow instead of having to fund IT from savings or loans. This is especially important for smaller businesses with fewer capital resources. Cloud subscription pricing also allows companies to be more flexible in how they spend money on IT. Monthly pricing especially means that the money spent on IT can fluctuate with needs of the company.

For Microsoft customers, in particular SMB customers, cloud deployment and pricing is especially beneficial. Almost every desktop needs Microsoft Office applications and Neuralytix research shows Exchange continues to be the most deployed email systems for businesses. Cloud deployment and subscription pricing makes it easier to onboard new employees, recover licenses when employees leave, and hold onto working capital instead of tying it up in software and hardware. It is curious to note that most end-user facing hardware, such as laptops desktops, have not yet followed the subscription model, as cell phones have been doing for years. The recently announced subscription model for Windows 10 is a step in this direction. This transition will, however, be more painful for suppliers than the software transformation,

Exchange and SharePoint are also quite difficult for many businesses to deploy and manage. Moving these application to a cloud service means that Microsoft assumes responsibility for keeping these services running, performing backups, and other skills intensive IT tasks. Businesses no longer have to purchase and maintain servers and storage and continue to upgrade them as capacity is reached or failures occur. For smaller businesses, it may be possible to eliminate onsite servers and storage entirely.

The Short Term Pain

The shift to cloud computing may be difficult for some of Microsoft’s channel partners. Cloud computing is a profoundly different sales and revenue model for the delivery of products. Neuralytix believes this is now, or will shortly be, true for all IT channel partners. Most other hardware and software providers have been trying to migrate their partners to a services and subscription model for years. Many channel partners, by listening to their customers, saw the cloud trend in advance of their supplier’s partners. For Microsoft channel partners used to selling box licenses, this means needing to learn how to sell subscriptions and more value-add.

There will also be less opportunity to sell hardware since servers and storage are on-line and not owned by the customer. Deployment services will also be affected since cloud applications do not require hardware deployments and software installations. The upshot is that Microsoft channel partners that do not have value-add beyond selling hardware and installing and configuring the software on it will suffer through the change. While this will impact the larger hardware focused partners as well as the distributors, it may provide a wakeup call to retool their businesses and ramp up their services and, software solutions.

An analysis of Microsoft’s Cloud Service Provider (CSP) program shows that Microsoft’s intends the cloud offering to mirror the on-premises resale route to market, including the typical tiered distribution model. It is not clear how the first tier distributor will realize revenue, or how long Microsoft can sustain the tier model and stay competitively priced?

The way Microsoft channel partners are compensated is also changing. Like most large independent software vendors (ISVs), Microsoft has traditionally compensated its channel partners on sales. For cloud products this is shifting to a consumption model. Compensation will be based on the on-going growth and use of licenses rather than pre-purchased licenses. This means that channel partners can no longer rely on traditional large, one time, sales and will instead realize revenue over a longer time. They will need to work with customers to help them fully utilize and integrate Microsoft cloud software which is essentially a services offering. Many partners have already transitioned and built successful services practices to management of the cloud on behalf of the customer.

The Long-Term Gain

No matter the pain to Microsoft’s channel partners, these changes hold opportunity. To begin with, this is a change that is customer driven, and in some cases partner driven. No matter what Microsoft might want to do, businesses are now aware of the benefits of the cloud model and are demanding it. In other words, it’s going to happen whether or not Microsoft or their channel partners like it. Making the switch will protect against other vendors’ – for example, IBM or Saleforce,com – channel partners drawing customers away.

The cloud model, will allow channel partners to sell into situations that they would have previously been shut out of. There are many smaller companies that would never have considered Exchange or SharePoint, let alone Microsoft Dynamics, because of the cost and complexity of deploying these solutions. They will now be able to consider them, in the cloud form. Similarly, cloud applications overcome certain financial objections, especially the upfront costs of Microsoft’s business applications. These customers will be able to concentrate more of their working capital on training, configuration, integration, and other value-added services all of which can/should be/are offered by the partners, instead of licenses and hardware. The partners will be able to focus their attention and get back to their core value – offering unique services to their customers.

The shift to the cloud itself provides opportunities. Businesses don’t buy applications; they buy solutions. Channel partners are in a unique position to include other vendors’ products as well and integrate them into a seamless solutions. For example, integrating Microsoft Office365 products with Adobe Creative Cloud can help to create solutions for small digital advertising firms. A secure publishing workflow that includes Microsoft Office356 applications, Adobe Creative Cloud, and any number of business grade file sync and share products has a better business longevity than selling a box license for Microsoft Word.

Channel partners also have the opportunity to cement their long term relationships with customers. Under the Microsoft CSP program, the channel partners will control the monthly and yearly customer billing. In addition, channel partners will also handle provisioning and management of subscriptions. Channel partners will be in control of the customer relationship. Microsoft is very clear that it does not expect any change in the sales mix. Most of the cloud offerings will be delivered by partners. This should be reassuring to the channel; they know that Microsoft is changing the delivery but not the route to market.

Support services, and the revenue that accompanies them, may also shift to channel partners. Just managing renewals in complex cloud solutions, where different user subscriptions will be renewing at different times and potentially different costs, is going to be a chore that many businesses will want to outsource to their channel partners. Moving customers to the cloud also provides opportunities for migration services. Many customers will not have the wherewithal to move their current data and configuration to cloud applications. Some will need basic training in how cloud computing works, especially content sharing functions, for their employees. The need for new value-added services represent opportunities for the partners.

Finally, over the long-term, the financial picture will change for the better. Instead of having to rely on fluctuating revenue that is dependent only on winning big deals, subscriptions will create a sustainable, repeatable revenue stream that can be relied upon each month. The Microsoft CSP also doesn’t require upfront license commitments the same way that the current box license agreements do. There, are however, barriers in the agreement to insure that partners have the right resources in place to support the Microsoft cloud portfolio. This makes the Microsoft CSP less risky for channel partners, especially smaller ones. Microsoft also has a partnering ecosystem that allows more focused partners to combine with others that have complimentary skills. This will act as an onboard ramp for smaller or less services-oriented partners to grow into the new subscription and services model. This may be something a distributor can offer but they will need to be compensated for this. Who and how will they be paid remains an outstanding question.

Guidance

Neuralytix believes that the cloud and subscription model will become the norm in software and within the Microsoft ecosystem. Channel partners that wish to thrive will need to:

Accelerate business model and sales shift from selling hardware and software products to solution selling clouds.
Change the value add equation. Channel partners will no longer be able to rely on deployment services and will need to focus on migration, renewal, training, and support services. Basic configuration will also become meaningless while customization and integration services will be in great demand. Some partners have already crossed this chasm. For those that have not yet done so, the time is now.
Leverage the subscription model to create revenue streams thought services and renewals. Many channel partners look to major software releases such as Microsoft Windows 10 as an opportunity to sell upgrades and new hardware. The cloud model provides for continuous improvements as part of the subscription, even for desktop applications such as the desktop versions of Microsoft Office applications. Instead, services that help customers manage the constant stream of changes in their applications, such as SharePoint Site changes and training for new features, will be more important.

Microsoft has embraced the cloud and subscription models because their customers have embraced them. Channel partners that look for opportunities both in the new way of delivering IT and the shift to the cloud will thrive.

[1] Platform as a Service consists of virtual hardware resources plus a software stack. The stack differs based on the needs of the application. One PaaS installation may be a Linux OS with MySQL and PHP or Java while another may be Windows Server with.NET preinstalled.

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Microsoft Channel Partners Feel the Pain and Ecstasy of the Cloud