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April 21, 2014

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Economics of the Indirect Channel

by Adam Famularo

A question that comes up a lot lately is how do you breakdown the economic model in an enterprise software market that supports a channel partner business – here is my best attempt to demonstrate a look at the flow of margin.

Will start with one dollar “$1” and will break down all the different levers used to drive business through channel partners.  Important to note that this focus is on new license sales.  Renewals, which yield much higher margin, will be left for a separate discussion.

 

$1 – represents the MSRP or List Price of your product

$0.70 – 30% traditional discount to a Partner or Distributor, this is also referenced as the Net to the Vendor

$0.84 – 10-20% will be the markup for Partners will use the higher percentage for this model

$1.68 – additional partner revenue comes from services revenue that can be 2-3x the price of the product sale, using 2x for this model

$0.84 – becomes the street price for the product, view for the customer is a 16% discount off of the MSRP or List Price

 

This is the simplest view of the partner economic model – now let’s add some complexity.  Note, since there are so many derivatives of the formula above, I will use the most expensive version to demonstrate the largest expense a vendor should be aware of – when calculating for a forecasted spend I would focus on a median point.

 

Deal Registration – 10-15% off of list price,  based upon partner registering a deal with the vendor and meeting other criteria like selling into a vendor’s desired market or product – front end discount that changes the net to the vendor and street price to the customer

$0.55 – becomes the new net to the vendor, a total 45% discount from the original list price

$0.74 – is the new street price as the partner increases their margin to 35% (in a competitive situation this percentage will likely drop.  The customer also benefits as the street price drops, in this example by 14%.

 

SPIFs or Special Incentive Funds – <1% off of list price, a fixed dollar amount that is positioned to the partners sales team to encourage them to sell a given product over a specified period of time.

$0.03 – in this example, we are offering each sales rep an extra $100 for each time they sell a $3,000 product.

 

Rebates – 3-5% off of net to the vendor, based upon the partner achieving quarterly financial goals that are agreed to with the vendor during the business planning process at the beginning of the year.

$0.03 – this is a 5% rebate from the new net to the vendor after deal registration.  This does not get paid out unless the partner completes their quarterly goals as agreed to in the business plan.  For budgeting purposes, you would need to budget a percentage of your partners that will achieve these goals.

 

MDF or Marketing Development Funds – 2-3% off of net to the vendor, based upon the partner achieving quarterly financial goals that are agreed to with the vendor during the business planning process at the beginning of the year.

$0.02 – this is a 3% rebate from the new net to the vendor after deal registration.  This does not get paid out unless the partner completes their quarterly goals as agreed to in the business plan.  For budgeting purposes, you would need to budget a percentage of your partners that will achieve these goals.

 

Channel Neutrality for Direct Sales – 20% compensation uplift from the net to the vendor.  This uplift covers the margin difference that a direct sales rep could have made by selling the product at the current street price.

$0.03 – At a 5% commission rate, is the amount the direct sales person will then be commissioned on using a 20% uplift or a $0.66 net to vendor.

 

Commission Rate for Indirect Channel Sales – 10% from net to vendor, in the 10% I am including the channel account manager, inside sales support and any pre-sales resources.

$0.06 – At a 10% commission rate, this would be the total paid out to the channel sales team from the deal registration example.

To note, I am not including the base salary costs as well as any costs of vendor provided funded heads in this model.  These would be additional costs of sales.

 

Here is a summary for the most expensive version of the total cost of doing business through channel partners:

$0.55 – after deal registration

$0.47 – after SPIF, Rebate and MDF of $0.08

$0.38 – after compensation

 

Here is the most profitable model:

$0.70 – net to vendor, no deal registration

$0.59 – after compensation, direct sales uplift goes to $0.04 and channel sales goes to $0.07

 

You can see a big swing in margin to the vendor from $0.38 to $0.59 – If we take an average the cost of doing business through channel partners can be roughly 50%.

 

This is why it is important to keep partners focused on delivering net new customers while a vendor can benefit by making more margin on the maintenance renewal, which is yet another model…

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1 Comment Post a comment
  1. May 7 2014

    This is a must-read for any company in talks with re-sellers and distributers. We’ve re-considered our partner model based on several insights in Adam’s post.

    Reply

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