Will The Cloud Strangle IT Vendor Margins?

By David Floyer

As Cloud Computing matures over the next decade, service providers will take an increasing share of the IT market. Non-strategic functions and large chunks of IT will be etherized. Wikibon predicts that over this time, total spending on external IT services will exceed the declining traditional IT budget in most shops.

Users have needed the support of the IT vendors and have paid premiums for software and services that ensure project success. IT infrastructure vendors are living off the reality that users always buy more than they really need and under-utilize it. Margins have been good, and the IT vendor community has continued to be robust.

Selling to Service Providers
Service providers however have a 'coin operated' relationship with their customers, who just pay for what is used. IT is core to a service provider's business, expertise is high and they consume IT equipment in large quantities. Service providers are astute negotiators and will not pay a premium for software or services. For vendors who supply to service providers, volumes are high but margins are thin – sometimes very thin.

The key strategic decisions for software and hardware vendors are:

• How to sell to service providers;
• Whether to become one.

Selling to service providers means creating relationships with large services companies and creating products that will be effective. Becoming a service provider means changing the product, competing with your traditional sales channel near-term and, increasingly over the next decade, your customers. Either way, the current model of large upfront software costs with big maintenance fees will not be sustainable when dealing with services providers. In general, the philosophy of variabilizing costs will ripple through to software and maintenance models, mandating new ways of pricing and generally changing business practices.

Action Item: The traditional model of selling to IT organizations will be a declining market. It would be imprudent to throw away this cash cow, but it will be essential to develop deep relationships with services companies and create a set of service company solutions. IT vendors should consider developing ‘sandbox' service offerings with two objectives:

• Learn about the requirements of this new marketplace;
• Hedge your bets in case you can't sell to service providers.

For all vendors the strategic imperative will be to drive down product cost and increase volume.