EPUB Ebooks: Free ebook sample of "Microsoft Dynamics Cloud Partner Profitability Guide" by Microsoft Corporation

Microsoft Dynamics Cloud Partner Profitability Guide – First Edition, March 2011

Microsoft Corporation

Copyright 2011 by Microsoft Corporation

Smashwords Edition

Microsoft Dynamics Cloud Partner

Profitability Guide

March 2011

Table of Contents

Introduction

The cloud is a fundamental shift in culture. It is a shift in delivery. It is a shift in approach. It is a shift in mindset led by a strong desire for all of us to have access to the information we want when we need it most, anytime, anywhere. For our customers, the cloud is represented by a demand to consume technology as a utility in order to achieve this desired state, maintain competitive advantage, and maximize return on investments. For the software industry, the impact spans productivity tools like Microsoft® Office and Microsoft® Exchange® Server to business applications like Microsoft® Dynamics® ERP and CRM.

The shift to the cloud changes customer expectations. Customers want faster results. They should be able to turn on a service and go. Software is quick to be chosen as a monthly operating expense and not a burdensome capital acquisition with a complex implementation process. The way we think about and use software has forever changed.

Microsoft and our partner ecosystem must transform how we bring value to our customers. We must adjust our perceptions and the way we operate. For Microsoft partners who want to increase profits, it requires developing a better business model that will have tremendous and sustainable upside long term.

This guide will help Microsoft partners understand the key success factors for their transition to the cloud, in particular, when selling or delivering business application services and solutions. Every partner’s journey will be unique. While we cannot describe every possible issue and its solution; our goal is to provide some of the most relevant tools to develop a solid business plan.

The Microsoft Dynamics Cloud Partner Profitability Guide will help partners to:

• Understand the market perception for services

• Establish an execution roadmap by business function

• Optimize business processes and investments

• Apply profitability models to create a financial plan

This guide is one of several cloud resources Microsoft Dynamics is delivering to our partners. It offers a critical first step in planning a business in the cloud. Additional resources include online courses, sales and marketing content, technical guidance, and customer-ready materials, which are available at www.microsoft.com/dynamicscloudpartner. I am also excited to announce that Microsoft Dynamics Partner Development Centers around the world have been staffed to provide partners with one-to-one coaching to help partners develop a cloud business.

Transitioning to the cloud is an evolution. We expect it will take most partners a few years to create and refine their end-to-end business model and build a strong base of customer subscribers. Microsoft sees the cloud as an opportunity for larger, more stable, and self-sustainable annuity streams for partners. There is no better time to begin the transition.

Please review this guide for insights to drive profitability in the cloud. We look forward to helping partners succeed in this new business arena.

Sincerely,

Kim Smith

Director, Dynamics Cloud & CRM Partner Strategy

Microsoft Business Solutions

Microsoft Corporation

mbscloud@microsoft.com

Executive Summary

Businesses are outsourcing their IT infrastructure to reduce costs, achieve greater flexibility, and enhance competitiveness. This trend is likely to intensify and will expand to include most of the business software market. IDC forecasts the Software as a Service (SaaS) market is expected to grow to US $40.5 B by 2014, at a compound annual growth rate of 25.3%¹.

The rapid emergence of cloud business applications has vividly demonstrated significant demand for enterprise resource planning (ERP) and customer relationship management (CRM) in the cloud. We believe this shift is fundamentally driven by customer demand, not by the technology industry.

Most companies demand cloud computing so they can realize the benefits of the solution at a decreased cost. The cloud can deliver better profits in three ways:

• Reduce time to value. Customers expect Cloud apps to be turned on and off as needed, with virtually no startup effort, or added complexity of integrating with existing IT infrastructure

• Optimize investments. Cloud computing offers companies

1. The benefits of a solution without paying a large amount up front to acquire it

2. Less costly analysis and heavy bureaucracy than a capital acquisition

3. Less consumption of working capital they would prefer to apply to other revenue-generating activities

• Realize cost savings. Cloud customers can substantially reduce actual IT infrastructure costs because costs are leveraged, marginal, shared, and optimized by Microsoft across many customers.

We expect some traditional revenue streams will begin to deteriorate. This is not necessarily bad news for business application partners. This guide shows how to manage a transition to the cloud and actually increase profits and long term sustainability.

Most partners will need to adjust the nature of their revenue streams. Building a sustainable annuity stream using packaged intellectual property (IP) is critical for success. Developing consistent functionality and packaged services for re-use across similar customers or verticals enables repeatability and efficiency. These services can help acquire and successfully implement customers faster and less expensively. It is the development of repeatable IP and services that can create a rapidly growing annuity stream, increase profitability, and drive higher business valuations.

A successful transition to the cloud means most partners must operate and execute more efficiently. This requires the following changes:

• Increased demand generation delivering a higher volume of better educated prospects that can be closed quickly.

• Closing deals with fewer interactions with salespeople, who are compensated for driving volume. Services delivery must develop predictable, well-scoped offerings as fixed bids and provide proof-of-concept trials for customers.

• Services offerings must provide customers with cost-effective, valuable, low risk solutions that help the partner avoid early customer attrition (known as “churn”).

• Careful management of the causes of late cycle churn by developing a customer life cycle management strategy.

This guide does not assume every customer will do all of their business in the cloud. In fact, some customers will opt to continue purchasing on premises solutions or a hybrid model depending on their policies, business requirements, or geographies. However, this document focuses primarily on helping the Microsoft partner community understand how to evolve their business model to meet the expectations of customers subscribing to cloud based services.

This guide is organized by functional area and includes links to many additional resources for a Microsoft partner’s evolution to the cloud. This guidance and its related documents will be updated regularly as the market evolves.

As an overview, below is a view of a 36 month roadmap for transitioning to a cloud based model with key decision points identified. Partners should assess the current state of their business throughout this process to determine if the appropriate investable cash is available, new capabilities have been created, and operational milestones have been met. Throughout this document there is detailed guidance for how to optimize business decisions against this roadmap as required throughout the lifecycle of cloud transformation.

The Cloud Payoff

Initial analysis shows that the payoff for building a cloud business is primarily based on the value of the annuitized revenue stream. Application subscribers have little reason to switch back to perpetual licensing, if the subscription price is reasonable, the offering is current and competitive, and the service is reliable.

This means that revenue in the cloud is more likely:

• Perpetual: Software subscriptions typically wrap software, maintenance, and training into an annual fee that lasts as long as the customer perceives value.

• Stable: Applications sold on-premises have a revenue stream that must be largely replaced each year. Subscription-based revenue streams are comparatively more stable and larger in aggregate once the break-even point is passed.

• Higher margin: Professional consulting services businesses rarely deliver gross margins over 50%. Cloud services businesses regularly do.

The cost of evolving to this new businesses model will probably exceed revenues from the cloud practice for a period of time. However, margins improve once the “crossover point” is passed.

Figure 1: CROSSOVER POINT

Once momentum has been established, cloud-based revenue streams grow more consistently than on-premises licensing. Because margins in the cloud can improve over time as well, profitability also increases. This is expected to drive up valuations, as shown in Table 1.

Today, privately held services businesses rarely accomplish more than three times earnings before interest, taxes, depreciation, and amortization (EBITDA). Publicly traded companies have valuation ranges (P/E Ratios) from 10 to 25 times earnings. Valuations are usually higher for rapidly growing profitable businesses. Indeed, competitors in this space may trade at nearly 200 times earnings.

A successful, sizeable cloud-based business may have a valuation that is double a comparable traditional services-based business because their revenue is growing faster, they are more profitable, and their IP gives them better operating leverage with size. The potential business valuation for the owners of a business transitioning to a cloud model is shown below.

Table 1: BUSINESS METRIC COMPARISION

Market Perception

It is critical to understand why customers buy and how those reasons vary across business segments. Business segments are defined by how many employees (including consultants, contingent staff and vendors) are potential users of the technology or service. Segment specific considerations will impact how partners operate to maximize profitability. Because being efficient is so critical to profitability in the cloud, partners should prioritize on one segment as an entry point.

Customer Motivations

Balance Sheet Impact

Customers prefer balance sheets “clean” of capital intensive, depreciating assets that do not directly produce revenue. A balance sheet “cluttered” with nonrevenue generating assets depresses valuations.

Income Statement Impact

In the cloud, capital expenditures are effectively “swapped” for operating expenses. Expenses are seen as more controllable and give the business greater flexibility to manage profits.

Capital Availability Impact

In the cloud, capital resources are freed up to invest in revenue generating assets. For small to midsize businesses, capital scarcity regularly limits their ability to exploit market opportunities and grow.

IT Infrastructure Impact

Organizations consuming software as a service on a subscription basis can more completely outsource the IT infrastructure which is both more cost-effective and requires far less in-house infrastructure. In-house infrastructure costs do not scale in a smooth line; they have big step functions when huge new chunks of technology are required. In-house systems are notoriously either more than is needed or not enough as business volumes change and market conditions shift.

Key Points

• Expectations and willingness to pay for traditional services varies by segment

• Customers want to do more with their scarce capital - going to the cloud allows that

• Customer buying processes and decision makers differ in the cloud

Questions to Consider

• What segment will be primarily served?

• Are there potential opportunities for packaged IP?

• How do sales and delivery motions have to change? Can customer expectations be met?

• What segment can current staff best serve?

Time to Value

Right or wrong the market perceives that subscribing to a business application as a service is easier and faster than buying an on-premises solution. For many companies the IT procurement process is long and difficult. Many business decision makers (BDMs) prefer cloud services that bypass long capital acquisition cycles.

BDMs also expect a true utility. It must work for their business and be ready to use the day they subscribe. A customer’s willingness to pay for customization varies by market segment and in most cases should be addressed by offering packaged IP, as described in the following section.

Customer Perceptions by Segment

Enterprise

Many enterprise customers (2,500+ employees) see their business processes as a competitive advantage. They tend to require that the solution be adapted to their unique needs. Partners who focus on this segment will likely continue to realize a substantial portion of revenues coming from implementation or customization services.

However, since Microsoft will host the offer in the cloud, partner billings for installation and configuration will be essentially eliminated.

Enterprise focused partners should adjust selling and delivery motions to a “seed-and-expand” approach. This approach builds credibility quickly by successfully deploying a service to solve a small number of key challenges in one business unit of a large customer. Once a trusted advisor relationship has been established partners can expand the solution across the company. This allows the customer to minimize risk, requires less capital to get started, and removes the need to go through a complex IT analysis.

Mid-market

Mid-market customers (with 251–2,500 employees) will likely require more packaged IP and lower implementation services because they wish to pay for the solution as an operational expense. These customers expect a fixed monthly fee where 70-80% of their business needs are met out of the box. In these deals, only a limited set of customizations may be required. Partners should shift their business accordingly.

Chart 1: IMPACT TO IMPLEMENTATION SERVICES OVER NEXT 18-24 MONTHS

As outlined in this document, offering packaged, repeatable IP is typically more profitable than a traditional services practice. Benchmarking performed by International Data Corporation (IDC) shows that most partners have services margins of 30-45% while partners with packaged IP typically realize nearly double that margin rate for their solutions. Read more on the Microsoft Dynamics assessments.

Small Business and Lower Mid-market

Serving companies with 250 and fewer employees requires a partner’s business model to be very focused on driving volume. This market segment is highly cost sensitive. They demand that the solution be readily consumable (“turn on and go”).

Serving smaller companies means providing simple, easily accessed, and competitively priced, complete packages. Partners must sell and support large volumes of customers in this segment of the market efficiently. This means a very low cost of goods sold and a low-cost support model.

Partner Types

Partners are pivotal to the Microsoft Online Services business. Microsoft expects three primary partner types to play a role in the cloud: Selling, Solution, and Support partners. The operating and financial model for each type varies.

Partners may choose to operate as a hybrid partner type. Below is an overview of these partner types:

Generating Revenue with the Cloud

Evolving to a cloud business can increase profitability.

This is done by:

• Acquiring new customers who would not purchase an on premises solution due to cost

• Creating new revenue for pre-packaged IP and Services

• Building a predictable revenue stream that increases in profitability over time

This section outlines the core revenue opportunities for partners. The role and mix of revenues will vary by partner depending on their choice of segment, vertical, and their ability to create packaged offerings.

Packaged IP is considered structured, fixed price functionality or services that are highly repeatable. For packaged functionality, prices are likely to be set as monthly payments. For packaged services, prices may be either a monthly payment or a one-time fee.

Establishing a successful, annuitized offer will most likely be the most important profit lever for partners in the cloud. For examples of how this will affect a partner’s P&L, see the next section, Impact on Profit and Loss Statement ».

Traditional Sources of Revenue

Partner of Record Fees

Partner of Record (PoR) fees can be collected for the advisement of a prospect who eventually licenses or subscribes with Microsoft. Partners may also collect fees for referring prospects who purchase Microsoft Dynamics products and services.

• Microsoft Dynamics CRM Certified Software Advisor (CSA) program

• Services Provider License Agreement (SPLA) discounts

• Microsoft Dynamics Referral program

Key Points

• Understand the P&L impacts as your mix of business shifts from on-premises to the cloud

• Assess the value of packaged IP as a profit lever

• Generate Partner of Record fees to cover sales costs

• Relevant and repeatable solutions will form your primary annuity stream

Questions to Consider

• Can the business support the volume requirements for cloud offerings?

• Can current IP be expanded to offer ‘out of the box’ customer experiences at a low cost?

• What additional services could be included to further drive long term customer commitment?

• What investment is required to support the mid-term impact to revenue streams?

• What is the best pricing and packaging by customer segment, geography, and industry?

• Can current IP be expanded to offer ‘out of the box’ customer experiences at a low cost?

For Microsoft these PoR fees are primarily intended to help partners cover selling costs. For Microsoft Dynamics CRM Online, Partner of Record fees also contribute to building up an ongoing annuity stream.

Deployment and Customization Services

The Market Perception section shows that deployment and customization services revenue streams vary by customer segment. Customers may be more willing to pay for deployment services in the short term but a customer’s appetite for services will likely decline over time particularly in the mid-market and below.

Because technology is now consumed as a service the normal deployment costs associated with installation and configuration will no longer exist.

Packaged IP

Selling packaged IP is not a new idea. However monetizing IP on a monthly basis is relatively new. When charged monthly, a consolidated offering can help partners build a long-term, predictable, high volume revenue stream. In many cases this can be one of the profitable aspects of a partner’s business.

Surveys from IDC show partners who provide a packaged offering have a higher average operating margin than a partner whose primary revenue stream stems from billable services.

New Sources

Key Performance Indicators and Benchmarking

Partners who can successfully package and sell IP have an entirely new business opportunity: tracking customer/user level activity and managing performance against a set of key performance indicators (KPIs). In this model, partners can measure customers’ performance across a set of metrics or industry benchmarks to compare an individual company against its peers. This information can then be offered as an incremental service either priced separately or included as a part of the standard monthly payment.

Example: Customers in professional services track

KPIs such as billable rates, average hours billed per individual and billable markup rate. Because of

Dynamics ERP and/or CRM solutions are provided in the cloud, a term of service could be include in customer contracts allowing the partner to anonymously track customers’ statistics. Partners could then normalize the data, and sell it back to customers in a dashboard showing how they compare to competitors or other relevant companies

Business Process Consulting

For some partners this may be considered a traditional source of income. For most it represents a new opportunity. As partners focus on a particular segment and vertical, their improved understanding of the space can help them to provide even more value-add services.

This consulting may be tied to the KPI and benchmarking opportunity described above. Knowing customers’ performance against these figures helps a partner proactively engage and offer billable assistance to address issues around business performance improvement.

Example: A partner who can see the gross services margin metric for their install base on a KPI dashboard can then stack rank the performance of their customers by this metric. The partner can then proactively market to those in the bottom quartile, offering business process consulting services to improve the associated business processes.

Impact on Profit and Loss Statement

Partners who sell or deliver on-premises offerings today should plan to transition to the cloud over a number of years. Most partners will need to manage a blended practice of both on-premises and subscription services during this process. For solution partners in particular, the two practices will probably need to be managed separately because they operate differently across areas such as sales compensation, sales process management, solution delivery, and support. Because it takes time to recover the startup costs of a subscription model, partners will want to use the working capital generated by on-premises deployments to help fund the short-term development of their cloud business.

Managed thoughtfully, pragmatically, and with a focus on process efficiency, a cloud-based business can generate an increase in operating margin as sales volume increases. Research and modeling suggests some financial levers have a greater impact on a partner’s ability to succeed in the cloud. The most critical to consider are:

Total Subscription Price

The Market Perception section showed that with the exception of the enterprise customer segment, customers purchasing cloud-based solutions expect services to be relevant, fast, and cheap. Customers do not want to pay for significant customization; they simply want to consume the service as an operational expense. This aversion is most prevalent among small and medium businesses. Partners need to provide ready-to-use, easily consumed solutions.

Pricing must be both market-competitive and attractive when compared to licensing the same solution in an on-premises setting on a total cost of ownership (TCO) basis.

Example: Compared to competitors, Microsoft

Dynamics CRM Online is relatively inexpensive, leaving room for partners to monetize their incremental IP. To know how to set prices, compete and profit, partners should consider the whole stack of customer costs among competitors in their chosen markets. For example, competitive cloud pricing models should consider the monthly subscription price, the average implementation services required to deploy, and other services such as training and support. The models should also account for the customer’s delayed benefits while waiting for a customized solution, rather than turning on a relevant cloud service.

Average Deal Size

One of the fastest ways to increase profitability in the cloud is to increase the number of users per customer.

This does not necessarily mean acquiring larger customers. Often, pursuing larger customers drives up the cost of goods sold (COGS) and could result in a more expensive sale. Instead, partners who can provide a well-rounded, more complete offering that can be consumed by a larger proportion of employees will find themselves capturing more wallet share while maintaining or cutting their COGS.

Example: Increasing the average number of users per customer by as little as five seats can have a tremendous impact on profitability. This effect is even more noticeable in an annuity-based model over an extended period of time. If the partner has packaged

IP monetized on top of the Microsoft subscription cost, the contribution from these incremental users becomes substantial as more and more customers are acquired.

Customer Acquisition Costs/COGS

Selling cloud-based ERP and CRM solutions is very different from selling on-premises. Mainly, sales cycles must be significantly shorter, and salespeople must be able to close deals largely remote, with fewer meetings and at a lower cost than an on-premises deal. A key enabler of sales COGS reductions is effective marketing. Marketers must execute digital media and ‘push’ content, demand generation, and lead generation more cost-effectively. Each marketing program should be analyzed on cost per lead generated, cost per deal closed, and length of sales cycle.

In the cloud, COGS should be managed very closely and needs to be in the range of $6,000 to $8,000 USD depending on the market segment. This will prove challenging for many since the average in the Microsoft partner ecosystem is much higher today (the U.S. average can be over $25,000 for ERP or CRM).

Hosting Costs

For partners who have developed or are considering developing a hosting practice, success in this model requires scale. That is to say, unit costs decline significantly as the number of users served increases because hosting is a capital and infrastructure intensive business activity. It also requires specialized expertise.

Many elements are involved in the delivery of a hosted offering. The following table illustrates how these costs may behave based on the number of end users served.

As the deals become larger or a higher number of customers are acquired, partners will see greater economies of scale in the data center investment category which consists of hardware, software, and facility services required to run a data center environment.

Chart 2: HOSTING CO ST PER USER

Self-hosting is likely to be cost-prohibitive except for partners who have already achieved a relatively large customer base for hosted applications. For most partners, working with a company who has hosting as a primary revenue model will likely be a more cost effective way to deliver this type of offering.

Higher Volume of Customer

Acquisition

A successful cloud-based business must fundamentally achieve higher sales volumes and a growing subscriber base. Partners who understand this and execute well should see annuity streams build more quickly and recover costs faster.

Higher volumes require a shift in how partners fill sales pipelines and manage sales processes. Partners will also have to change the types of salespeople they hire and how they compensate them. Partners must establish a mindset where generating 35+ customer adds per year per salesperson is the norm (rather than 10). Increasing the pipeline volume and decreasing the time from lead to close are critical to success.

In certain segments at the upper end of the market, the cloud sales development plan should include strong Solution Architect(s). Good solution architects can quickly reject unqualified deals and educate viable customer opportunities about specific cloud offerings.

Solution Architects will be building IP while they are also helping to sell.

Successful solution architects create a virtuous cycle of lead qualification, sales assistance, learning from the installed base, and wrapping that knowledge into IP that helps the next sale. This role is a key success factor for a partner’s ability to win customers quickly and create volume.

Deployment Costs

For many partners today, consulting services represent over 80% of revenue. Much of this revenue comes from deploying the software solutions. As customers shift away from on-premises deployments full of billable hours toward more of a consumable utility, the ratio of revenue sources is likely to change.

Understanding the segment and market’s appetite for services will help partners move to the proper level of consulting services in a cloud model. Because customers are becoming more sensitive to deployment costs, partners will need to determine which offerings can be packaged and sold as an annuity rather than as customizations. Other billable services normally associated with deployments will need to be revisited and offered in other mediums.

Example: By offering pre-recorded training, partners can increase its quality; reduce their expenses per user, scale across geographies, and charge for access to training on a monthly basis rather than as a single billable event.

Churn Rate

While initial sales are critical to starting a cloud business, customer retention is crucial to its long term success. That means keeping the churn rate of customers as low as possible. Churn is defined as an erosion of customer base. Limiting churn is primarily driven by each customer’s perceived value to cost ratio for the solution compared to competitive offerings that consistently improve.

A defecting customer may state that they are no longer able to afford the service. But usually the customer just did not see enough value compared to a competitor’s current offerings to justify the continued expense of the solution. Customers usually do not drop an ERP or CRM system after having acquired one. They tend to move on to the next generation of a competitive system.

Like cell phone plans, subscription audio services, cable bills, and other monthly expenses, the service may seem to be a great deal until a competitive (satellite dishes to a cable provider) or disruptive (MP3 for CD sales) technology or provider arrives in market.

That means offerings must remain leading edge from functional, technical, and economic perspectives. This is a key reason we all must move to the cloud. If we don’t pave the road there, a competitor will pave their road right over us. This means we are in a permanent race to maximize the value to cost ratio that drives customer renewal behavior.

Given the immediacy and ease with which a customer can unsubscribe from a service, we need to increase the speed with which we deliver value and reduce the costs at which we supply solutions. This is the glory of the free market set loose on behalf of customers - more for less always.

Customer Lifecycle Management

Partners should carefully think about the long term implications of managing and maintaining customer relationships. The old saying still holds true, it is less expensive to retain a current customer than to acquire a new one. This is not to say partners should not focus resources on new business but rather find the right balance of focus on driving a high volume of new customers and existing business.

While the focus on customer acquisition is vitally important to increase revenue, the shift to cloud services – with its subscription based licensing model and lower exit barrier - forces us to put more emphasis on long-term customer retention to maintain and grow profitably.

Cloud offerings reduce up front license revenue. So it is important to increase monthly revenue per customer by cross selling additional subscription services throughout the customer’s lifecycle. To be effective, partners must have regular deep discussions with existing customers to discover how a solution can expand its value. These follow-on sales in the cloud help replace the high upfront on-premises revenues but with lower infrastructure and support costs.

Figure 2: LIFETIME VALUE OF CUSTOMER

Not only do follow-on sales create revenue for partners, but they increase customer loyalty. The more a partner’s solutions and processes are foundational to the customer’s business, the more committed the customer is to the solution.

In the illustration above, note that the traditional monetization of on-premises software (blue line) shows most of the revenue at the beginning of the customer lifecycle and then again when they upgrade. Most other revenue is driven by maintenance and support. The in-the-cloud monetization (dark blue line) demonstrates the opportunity for a partner that builds effective subscription based services throughout the entire lifecycle.

Cloud models and on-premises models are not mutually exclusive. The services and IP offered can also supplement on-premises or hybrid deployments. The more partners prepare themselves with these additional services, the easier the transition to selling and retain customer loyalty to cloud solutions.

Summary Profit and Loss Statements

The financial impact of transitioning selling or service delivery businesses to the cloud is summarized in the following tables. Each provides a five-year view with the first being snapshot of the year prior to beginning the transition. This year (year 0) is intended to show the state of the partner as a starting point. Included are relevant assumptions on the impact to cash flow.

With a cloud based model, most, if not all partners, will likely experience an initial stage of negative cash flow associated with the cost of acquiring customers, and installing the solution. Working capital will typically also be required to fund investments in online demand generation infrastructure and to onboard dedicated cloud sales people. These costs, along with the removal of the upfront payment historically associated with on-premises deployments, are the elements that drive cash flow impact.

The “Start Up” example shows a new cloud partner entering the ecosystem as a new entity with no on-premises legacy business. For partners starting up, this provides an opportunity to move more quickly than other organizations having to transition from an on-premise business model.

Existing Microsoft Dynamics on-premises partners transitioning to cloud can choose to operate in a hybrid model or complete a full transition to the cloud.

The “Hybrid Business Model” example outlines a partner going from being completely on-premises partner in Year 1 to a near even split between on-premises and cloud by year 4.

The “Complete Cloud Transformation” example models a partner moving entirely to the cloud by year 4. Allowing for blended business execution for years 1-3.

Once past the break-even point, overall margins continuously improve as the customer and subscriber base expands. This is accelerated by incorporating functionality that can be packaged and monetized in a monthly fee above the standard Dynamics license price.

Assumptions

Each example includes a set of fixed and variable assumptions affecting profitability. These are outlined immediately following the summary examples below. A full explanation of these can be found in the appendix. All monetary values are in U.S. dollars.

Profit & Loss Summary for Microsoft Dynamics

Summary 1: Start up

While lacking the ability to use the existing on-premises business as a funding mechanism, the advantage of a startup business is the capacity to manage one business model built around creating scale. With the introduction of Microsoft Dynamics CRM Online into the North American market two and a half years ago, there were a number of partners who did just that. As a result, their agility has enabled them to rapidly build up a high customer add rate similar to, and in some cases surpassing what is outlined in this example.

• Working Capital Required: $632,672 (CRM), $439,403 (ERP)

• Cash Flow Break-even: 28 months (CRM) 22 months (ERP)

Microsoft Dynamics CRM

Microsoft Dynamics ERP

Summary 2: Hybrid Business Model

Partners transitioning at a slower pace may choose to operate in a blended environment. For this model, there is a risk in not developing the operational efficiencies required to build the volumes needed to be successful.

Additionally, the strain from running both models will likely reduce the probability of growing the on-premises business resulting in a plateau effect for that portion of the business. Although growth is seen in terms of the number of overall customer adds through the cloud practice, the rate will likely not be significant. The net result is small improvements to operating margin and relatively flat EBITDA.

• Working Capital Required: $186,600 (CRM), $186,880 (ERP)

• Cash Flow Break-even: 21 months (CRM) 17 months (ERP)

Microsoft Dynamics CRM

Microsoft Dynamics ERP

Summary 3: Complete Cloud Transformation

By committing a full transition, partners stand a higher probability of optimizing processes across the business. The net effect of this focus should result in a more dramatic increase in customer adds which is the first key component of profitability. The second is the monetization of incremental IP that can be charged as a monthly fee on top of the base price for the Microsoft Dynamics subscription or license cost. These two variables acting in conjunction can rapidly build up a sustainable, predictable, more profitable revenue stream that grows over time.

• Working Capital Required: $229,889 (CRM), $213,635 (ERP)

• Cash Flow Break-even: 19 months (CRM) 14 months (ERP)

Microsoft Dynamics CRM

Microsoft Dynamics ERP

Fixed Assumptions

Below are assumptions applied to the aforementioned profitability models.

Variable	Assumption Value
Churn Rate	10%
On-Premises CSA Rate for CRM	20%
On-Premises Partner Discount Rate for ERP	45%
Hosting Costs (ERP Only)	45%
CSA Rate for CRM	40%/6%
ERP SPLA License (Advanced Management)	$43
Software Assurance Rate for CRM	5%
BREP Rate for ERP	18%
CRM Online Subscription Price	$44
On-Premises Marketing Costs Per Customer Acquisition	$5,000
Subscription Price Charged for Incremental IP (CRM – per user, per month)	$55
Subscription Price Charged for ERP (inclusive of hosting, base Dynamics license, packaged IP, and any services rolled into the monthly fee – per user, per month)	$300
On-Premises Cost of Goods Sold	$15,000
Cloud Marketing Costs Per Customer Acquisition	$3,500
Cloud Marketing Costs – Retention and Upsell (annual)	$700
Cloud Cost of Goods Sold – Year 1 (acquiring the customer)	$5,000
Cloud Cost of Goods Sold – Year 2+ Retention and Upsell (annual)	$1,000
Gross Services Margin	45%
Cloud Services Value Per Deal (the market value of what the services provided are worth) $25,000	$25,000
Cloud Services Collected Per Deal (what can actually be charged due to adversity to billable	$12,500
Marketing Infrastructure Costs (over 4 years)	$375,000
Additional Cloud Services Revenue (i.e. Business Process Consulting, over 4 years)	$650,000

Execution Planning: Business Management

Overview

Successfully building a profitable cloud practice will require a concerted effort across all functional areas of the business. Partners will need to adjust most business processes and change how roles are performed and staffed.

Before developing an execution plan, the partner must first choose a market to address. Considerations will include at least:

• Core competencies and historical sales

• Which business segment(s) and functional or

• Vertical(s) those competencies address

• Whether the business segment of focus supports

• growth

• Review of the competitive landscape

Having identified the segment, vertical and functional areas partners can begin to think through current workflows and how to optimize each to match the chosen market.

Conducting this gap analysis will help develop investment requirements and a schedule. There will always be some changes required to support the transition such as building stronger marketing infrastructure, changing sales readiness levels and content, or developing packaged offerings.

Before the transition begins, KPIs should be set across the organization and subsequently measured to help ensure progress remains on plan.

Lastly, please recall from the Introduction that this is an evolution. For existing partners a successful on premises practice will remain throughout the transition and perhaps perpetually. How partners manage this transition will be based on the portions of the market partners currently or will support in the future.

Key Points

• Building a cloud practice is an evolution

• Operational efficiency requires repeatability

Questions to Consider

• What portions of the market are there clusters of existing and potential customers?

• What portions of the market is the company best able to serve?

• What IP exists that can be monetized and at what price will the market bear?

• How can IP be expanded, standardized, and deployed in specific customer settings and applied to target segments, industries, or geographies?

• How do current statistics align with the benchmarks of the KPI’s outlined in this document – are they actively tracked?

• What role can Microsoft Office 365 play in the offering?

Partners with a healthy cash flow from operations can probably build their cloud practice without additional capital. Other partners may find that sources of additional funding are temporarily required while they invest in key areas.

Primary Considerations

Identify target markets

Operational efficiency creates scale. This requires focus on a carefully selected portion of the market so that partners can create repeatability. Segment, vertical, and geopolitical (political, policy and regulatory) considerations critically affect the adoption of cloud based services. Partners must consider all three elements when defining their target markets.

For example, data sovereignty (where data is stored and how it is transported across the network) may be a prime consideration for some target markets. By learning and knowing the detailed requirements of a particular market, partners can develop a more precise offering that helps ensure they are the master of a chosen space. Target market focus will also improve marketing and sales engines by creating specialized knowledge on those teams. Finally, the virtuous cycle of referenceable customers and targeted advertising in the chosen target market can help drive higher volumes at ever lower costs.

Figure 3: TARGET MARKET

To start partners should think deeply about core competencies.

What markets have been served to date?

In what segment, vertical, and geopolitical groupings have the partners concentrated? There may be IP and services in these markets that can be rapidly packaged and capitalized on as an annuity.

In what portions of the market do current resources have experience?

What are the skills and knowledge of the partner sales and delivery teams? Often, sales and delivery team members know a vertical or industry because they have sold to, implemented at, or even worked within that market.

Where is the opportunity?

What slices of the market are poised to grow? Among the installed base may be customer types that are thriving and others that are doing poorly. With the skill sets in place, a partner may be able to easily transfer those skills to a somewhat different market that is experiencing growth.

Example: A mid-market focused partner who packages their CRM vertical IP at $55 per user per month and keeps churn under 10 percent can generate over $1 million a year by year three. This revenue can be achievable by roughly one and a half sales representatives.

Table 2: FIVE YEAR BUSINESS IMPACT

The Microsoft core value proposition is providing a connected experience across business applications and productivity solutions (Microsoft® Office, Microsoft® SharePoint® team services, and Microsoft® Exchange®). The recommendation is that partners include the Microsoft® Office 365 suite in their practice.

Among many successful partners, the compelling value proposition of the Microsoft integrated platform is a key reason they are selected over competitors. By making the platform part of their story, partners:

• Provide a deeper solution

• Increase their Partner of Record fees

• Sell more packaged cloud services

• Sell more custom consulting services

Effectively manage KPIs

When developing a cloud practice, the leadership team must carefully manage a core set of KPIs. While the metrics may largely mirror an on-premises business, the benchmarks will be different for a cloud practice. They should be monitored daily, weekly, and monthly. KPI goals and performance should be reviewed with the Microsoft account team to help maximize the impact on and influence over prospective customers. The core KPIs include:

Revenue per Employee

Because a cloud-based business is more volume-based and less labor-intensive, the number of traditional staff required to generate similar revenue should be lower.

The absolute revenue per employee will vary by region, and is expected to be 25 to 50 percent greater than for an on-premises business. Partners who invest in a tele-web sales model may further increase revenue per employee because these leveraged resources can be less expensive and create a larger volume of customers.

Services to Subscription (Software) Ratio

Cloud based offerings typically come with lower traditional services revenue so the ratio of services to software or subscription revenue will fall. In the upper market segments the decline in the services to software ratio will be relatively small. In the lower end of the market the decline may be significant.

Example: In the small business sector the services to software ratio will start below 1:1, and fall from there. The ratio may fall to as low as 0.25:1.00 while in the mid-market, it will range from 0.25 - 0.50:1.00.

For enterprise customers this metric will decline slightly because of the removal of installation and configuration services. However, the timing of service revenue may change because prospects want tighter proof of concept and a phased implementation approach.

Subscription Gross Margin

To be economically viable, combined subscription gross margins (Microsoft IP and partner IP) should exceed 65 percent. This is true except in the first year, when customer acquisition and services costs can lower margins by as much as 20 percent.

Services Gross Margin

Top performers should target earning gross margins near 50 percent. This metric may vary by geography. For example, countries in Eastern Europe and Asia that have heavy competition and price negotiations with customers will probably lower their targets to 40 to 45 percent.

Customer Acquisition Costs

To profitably scale in the cloud, partners must reduce customer acquisition costs (sales + marketing) to fewer than 15 percent of revenue. This is a substantial decrease in COGS for most partners. In developed markets, total sales and marketing costs will need to range from $9,000 to $12,000 per customer add. Costs must be even lower for emerging markets.

Research and Development

IP must be kept current, requiring ongoing research and development (R&D). Solution providers should count on spending 5 to 6 percent of revenue on R&D to keep products competitive. Industry or vertical specific IP may have longer life cycles than horizontal or work flow based IP.

The Microsoft Dynamics online services enhancement cycle is six to eight months. Regularly refreshed Microsoft services could require that partners modify their IP and R&D efforts to avoid obsolescence. This speed of change also implies that partners will need to identify and implement new complementary capabilities rapidly (possibly in less than two to four months).

EBITDA

Partners who want to build a cloud business need enough size and profits to fund the transition. This depends on market type (emerging or developed). For developed markets, “healthy” would be over $5 million in revenues and 8 percent earnings (EBITDA.) Partners who successfully transition as described here may see EBITDA climb into the mid-teens or more. But when starting a cloud practice partners will probably see a short term reduction in EBITDA while their annuity stream grows. Successful partners should see EBITDA rebound within 18 to 24 months, and grow steadily from there.

Tracking Success

Below is a long-term dashboard of KPIs for a cloud-based solution provider. However, it is unlikely that all of these targets will be met initially.

Execution Roadmap: Financial Planning

Overview

Executing a successful cloud strategy requires investments. For most partners, these investments will be substantial and require current operating profits. Without the upfront bulk payments for on-premises deployments, partner cash flow will be temporarily impacted. This obstacle can be overcome through sound operational management.

Depending on partner maturity, profitability, and size, funding sources may vary. The sophistication of current processes and the skill of staff will influence the size of the investment.

The following section outlines a range of investment and cost considerations. The Partner Development Centers (PDC) can help partners build a personalized plan and investment schedule.

Primary Considerations

T
able 4: PRIMARY CONSIDERATIONS FOR FINANCIAL PLANNING

Key Points

• The investment in a cloud practice is significant and should be funded over multiple years

• Budgets will change across all functional areas

• Investment amounts will vary depending on existing infrastructure and sophistication, and the target market(s) chosen

Questions to Consider

• Is there enough cash available? Or, can enough cash be generated from operations? Will borrowing or selling equity be enough to fund the transition?

• What business scenarios can be constructed based on market conditions, competition, pricing, packaging, and projected sales forecasts? What is the ROI of each? Which will be chosen? Why?

Execution Roadmap: Marketing

Overview

To build a successful cloud business demand generation must achieve critical mass. Sales representatives need far more leads than their on-premises peers. A good cloud sales representative should close 30 to 35 deals in a year and maintain a minimum 30 percent close rate. That means they need 100 to 116 fully qualified opportunities annually (defined as 20 percent based on Microsoft Solution Selling Process (MSSP) methodology).

For most partners in developed markets this means marketing-driven customer acquisition costs must be reduced from U.S. $5,000 to around $3,000. In addition, investment in marketing spend must increase proportionally to generate a larger volume of leads. (Refer to Chart 3 “The Marketing Mix”)

This is possible through focused and precise market segment and vertical demand generation activities enabled by a sharp market definition chosen by management for the cloud. The net results are increased response rates and a higher proportion of qualified prospects driving down the cost per customer acquisition.

Primary Considerations

Funding demand generation

To generate the volumes above partners need to invest from 3 to 5 percent of gross revenues in marketing activities, excluding labor costs. An IDC survey of the Microsoft Dynamics partner ecosystem2 shows that the average partner spends much less than that today.

Understand buyer behavior & adjust marketing mix

Prospects for cloud-based business solutions are far more likely to find a solution provider online. Search engine marketing (pay-per-click advertising) and search engine optimization (achieving high rankings in “organic” searches) will dominate the marketing mix.

These efforts will be supplemented by email-based nurture marketing and webinars as shown in Chart 3.

Exposure in the Microsoft Dynamics Marketplace

Microsoft has invested in the trial engine and the Microsoft Dynamics Marketplace. These two resources inform and educate potential buyers to help field sellers and assist partners to expedite sales.

These resources also help partners significantly extend their reach. Thousands of prospects come through the Microsoft Dynamics CRM Online trial experience today.

Key Points

• The rapid development of a substantial annuity stream requires a well-funded, and efficient marketing machine

• Cloud buyer behavior and the need to drive down customer acquisition costs forces a shift in the marketing mix more toward the web

• Broad exposure through integration into the Dynamics Marketplace extends reach Sales reps need educated prospects in order to close deals with less interaction

Questions to Consider

• What does the current customer pipeline look like for the business? Are there customers who might be ‘cloud ready’?

• What resources & investments are in place for marketing infrastructure (digital, demand generation, campaigns)?

• Are there resources, campaigns, and processes in place to develop and manage a higher volume of leads?

High volumes also visit the Microsoft Dynamics Marketplace daily. Partners can use these tools to show potential buyers the value of their offerings. The Microsoft Dynamics Marketplace applies to both CRM and ERP and partners should use this space to develop demand for their packaged offerings and customization services.

More information on the Microsoft Dynamics Marketplace can be found in the Getting Started section of this guide.

Create educated prospects to reduce the sales cycle

To achieve more customer adds, partners must reduce both the number of interactions with a prospect and the length of the sales cycle. Marketing needs to educate and inform prospects more in the early stages. Partners should develop web-based assets which help prospects see the solution through self-guided demos and advance to the trial and proof stages quickly.

Chart 3: THE MARKETING MIX

Nurture Marketing

To realize the goals of reduced customer acquisition cost and increased lead volume is no small undertaking.

Successful partners have shown this can achieved by increasing the amount of marketing spend and shifting the marketing mix from low volume-high cost activities, to high volume-low cost online activities, such as pay-per click campaigns and search engine optimization.

These marketing activities should not be executed in isolation. A marketing portfolio that manages the sequencing and connecting of these online activities with stages in the customer engagement lifecycle is critical in producing greater lead volume and higher conversation rates. This approach is commonly referred to as nurture marketing.

Effective nurture marketing requires the inclusion of:

• Digital vehicles like search, email marketing, webinars to generate prospects

• Time-based or trigger-based communications to push activities and offers to prospects

• ‘Trial factories’ where buyers can see, understand, and develop a vision for how to use the offering’s capabilities in a click, try, buy environment.

• Application of standard marketing principles with existing customers in alignment with the appropriate selling methodology by segment.

Execution Roadmap: Sales

Overview

To profitably scale in the cloud, a partner’s customer acquisition costs (sales + marketing) must be limited to 15 percent of revenue. The traditional sales model for on-premises solutions is expensive and long. Sales often take over 90 hours to close, include multiple offsite sales calls and consume pre-sales support. These costs are prohibitive in the cloud given the lower initial revenue streams.

Primary Considerations

Driving volume

Consuming IT as a utility reduces the willingness for an organization to pay for billable services. It also changes how partners manage profitability. Soon, a partner’s business health and value will be determined by the size of its annuitized revenues. Successful early entrants are more likely to weather economic storms and be more attractive to potential suitors. To accomplish this, the focus must be on driving subscription volume to build up this stream of revenue quickly. Doing so requires a large volume of customers.

Dedicated cloud services sales reps

Most on-premises sales representatives use a traditional consultative selling approach that may involve several meetings for each of the following steps: pre-sales reviews, customized demos, scoping work, and a proof of concept. These series of meetings require considerable and protracted time commitments. In the cloud, selling must be faster. Sales representatives who are dedicated to and compensated for selling only cloud solutions will probably excel. People who can show value in the first discussion with the customer or who can deliver a relevant instance of the service during the first customer interaction will significantly shorten the sales cycle.

Key Points

• Selling a cloud based service is a volume game and partners should expect to dramatically increase customer acquisition rates

• A sales representative selling a cloud based service, should be 100% focused on selling that delivery model

• Compensation models for cloud based representatives will need to be different than on-premises representatives

• Sales cycles will need to be condensed, simplified, and more transparent

• Sales representatives will need to seed smaller projects, make the customer successful, and subsequently expand relationships to promote additional usage and services

Questions to Consider

• Can the business support a shift to allocate dedicated sales resources to the cloud practice?

• Can the sales processes and compensation be adjusted to achieve target operating margin?

• Does the current business model allow for flexibility to support shorter sales cycles, packaged services, and a higher volume of transactions?

Compensation models that drive volume

Sales compensation plans for cloud-based sellers should reward building a strong annuity stream. Since most cloud customers will not stand high initial costs, a sales representative’s variable compensation should pay for the number of customers and the annual annuity value closed instead of the billable hours sold.

To close volume quickly, most selling should be on the phone (particularly in the mid-market and below).

The offerings should be more straightforward and standardized, requiring less senior representatives.

This probably means a lower base salary than required for on-premises salespeople, with an opportunity to earn strong variable compensation. Sales quotas should generally be set at 30 to 35 deals per year; compared to an on-premises rep who might close 12 to 15 deals.

Sales costs must also be kept low; ideally less than 10 percent of the first year’s revenue. Sales compensation structures that provide residual (renewal) compensation (beyond the first 12 months) to the initial selling representative will discourage their concentration on new business and may be too costly. These “hunters” should be paid based on the annuity they originally create.

Subsequent selling can be executed by lower cost sales personnel (“farmers”). The “farmer’s” compensation structure contains relatively larger fixed base and may include compensation over multiple years for the successful maintenance of the customer relationship and long-term revenue stream.

Shorten sales cycles and reduce interactions to keep down COGS

Matching sales representative’s skills to those required by the cloud is imperative. Success will require shortening sales cycles and increasing the number of potential buyers with whom a salesperson can engage. Historically on-premises sales engagements, have a COGS of U.S. $20,000 - $25,000. In the cloud, partners should aspire to cut these costs by two-thirds, reduce the number of interactions needed to close a deal, and severely limit face-to-face meetings.

Seed an account and expand it over time

There are fewer and fewer large monolithic CRM and ERP deployments taking place. Customers are now often looking to address very specific needs. Sometimes, customers want to protect their on-premises investments until they are ready to make a full commitment to the cloud. If partners can help them successfully solve an initial business issue in the cloud, they are more likely to expand the footprint of the solution over time.

Establishing a beachhead by solving a small set of business challenges through a phased approach helps to establish a role as a trusted advisor while limiting the customer’s risk.

Improve sales execution

Marketing and sales must unmercifully disqualify low probability prospects. Wasting time on unqualified prospects is a significant blocker to creating the volume required. Additionally, partners should consider the following within the Microsoft Solution Selling Process (MSSP).

Qualify and Develop: Potentially disqualifying attributes of prospects should be flagged, escalated, and tested as early as possible for disqualification.

Proof and Solution: The trial engine and the Microsoft Dynamics Marketplace show prospects a relevant experience. These assets can help reduce or eliminate the time required to create and demonstrate custom environments.

Close: Packaged IP and fixed price services reduce the time required for custom proposals. The result is faster and less costly requiring less engagement from finance, legal, and executive management.

Execution Roadmap: Delivery

Overview

In order to meet the changing expectations of customers in the cloud, implementing a cloud-based solution must be faster than an on-premises solution. Today, solution providers regularly require 150 hours or more to implement an on-premises ERP solution and 100+ hours for a CRM solution². A typical implementation can include initial customization, extensions, modifications, localization, and integration.

Chart 4: CONSULTING SERVICES MIX

Companies (especially smaller ones) buying in the cloud will be less likely to pay for large sums of billable hours. They are reticent to pay U.S. $2,000 to $3,000 in monthly subscription fees plus $50,000 or more in implementation and training costs. Partners who provide standardized offerings that can be consumed as a utility with few customizations have a distinct competitive advantage. The element of “a relevant solution billed monthly” is fast becoming the expectation of prospective cloud customers.

Key Points

• The appetite for deployment services varies by segment

• The software to services ratio is lower in the cloud since customers expect their subscription fees to cover software, support, and services

• Typically, delivering packaged IP is more profitable than billable services - especially via an annuity

• Deployment services is changing to a seed and expand approach

• The cloud is creating new revenue streams for both Microsoft and our partners

Questions to Consider

• Can operational efficiencies and technology solutions be created to accelerate implementations and drive down costs?

• Can resource utilization targets be achieved when the velocity and volume of projects increases?

• Can a comprehensive library of templates and tools for packaged implementations be created

Primary Considerations

Understand the impact on services to software ratio

Cloud-based offerings will typically involve fewer billable hours. As described in section above, the overall ratio of services to software or subscription revenue will fall.

Shift toward repeatability to drive greater profitability

Another consideration is what approach, billable services or packaged IP, has a greater rate of return for partners. As outlined in earlier sections, the average partner today sees a margin for packaged IP double that of billable services

Many partners have ERP and CRM IP that could be reused in a readily consumable form. The challenge for many partners is documenting, packaging, pricing, and supporting the offering.

Managing this IP over time in a quickly changing environment also presents challenges. Addressing this challenge by constructing a development and maintenance process should be one of the most critical objectives for a successful transition plan.

Continue reading this ebook at Smashwords.
Download this book for your ebook reader.
(Pages 1-41 show above.)