The prognostications of a vast untapped enterprise application market with small and medium enterprises (SMEs) have forced the vendor community into re-engineering the ways they have traditionally done business.
Revising sales models to include significant contributions from third parties is proving most challenging, because the economic drivers that have forged partnerships in the past are not valid in the SME market. The changes needed to build a new class of channel partners will require SMEs to modify assumptions traditionally associated with business application sourcing.
Meta trend: During 2004/05, post-"go live" ERP organisations will focus on total cost of ownership, value delivery, usability, continuous business improvement, and targeted extensions (e.g., supplier relationship management, channel management). ERP vendors will offer enhanced post-implementation services to maturing ERP customers. During 2004-07, ERP vendors will redouble their efforts to penetrate the mid-market, competing more aggressively with Microsoft and a shrinking set of small ERP vendors. By 2007, ERP vendors will embrace Web services to support inter-enterprise integration.
Targeting the market for SMEs has become something of a mantra in the current IT industry. Whether it is voice, middleware, or servers, vendors across the spectrum of IT products are considering what they believe is an untapped market for their wares. However, the opportunities that exist to exploit this market are in many ways a result of neglect. Both product design and go-to-market models have evolved throughout the years on a steady diet of very large sales into resource-rich and cost-immune enterprises. As such organisations seek to digest what they own and question the way they ended up with their current state of affairs, the vendor community has been left with little choice but to -move downstream." With SMEs now more necessity than nicety, all four P's (i.e., product, price, place, and promotion) of the market mix are being reconsidered.
Enterprise application vendors are now starting to realise that success in the SME market is predicated on the reduction in demand for professional services.
For the enterprise application market, there is one P -- place (or the means of distribution) -- that is proving to be a particularly sticky wicket. Until the advent of the SME focus, channel partners provided three primary roles: lead generation, professional service capacity, and legal risk mitigation (by allowing the vendor to be subcontracted in relation to service work directly provided). The heavy lifting around the product expertise and the account management necessary in selling the licenses was the primary responsibility of the vendor. The realisation is now clear that this model is simply too costly for a market segment comprising a higher volume of smaller opportunities. A substantial channel recruitment race is currently on because vendors see this as the only way to scale their sales efforts affordably. However, unknown to many in the vendor and partner community, the assumptions used to build the mutually beneficial business relationships of the past are not valid for the SME market. By 2007, successful SME enterprise application vendors will instead have built vibrant partner communities by positioning their products as platforms and enabling third parties to build, resell, and provide services for their own products. By the second half of 2005, leading SMEs will already have adopted new sourcing practices to accommodate for this outcome.
As Meta Group highlighted in previous research, the factors that unite SMEs are cost and resource constraints. Furthermore, our report, Deriving Value From 21st Century ERP Applications , identified that professional services were, on average, 40 percent of total ERP implementation costs -- the single largest component. By comparison, software licence costs were 25 percent. As the application vendor community has sought to tap into the SME market, it has also been pressed to find ways to reduce the costs associated with the service implementation components of such projects. The methods of doing this have been two-fold.
First, from an architectural perspective, vendors have been seeking ways to design products for heavy configurability and low customisation. Second, vendors have considered fixing the price of ERP implementation by working with their systems integration partners to lock down a specific set of deliverables. Oracle, Siebel, and PeopleSoft have all been pursuing this approach. Enterprise application vendors are now starting to realise that success in the SME market is predicated on the reduction in demand for professional services.
At the same time that the demand for services is under pressure, the availability of offshore service providers is on the rise. We predict that 40 percent of IT operations will be moved to offshore facilities by 2007/08 and that 50 percent of corporations will establish facilities and move wholly-owned operations to offshore locations.
By the end of the second quarter, we expect experienced on-site/offshore teams with proven methodologies to take 10 percent to 12 percent of all midmarket ERP implementation projects.
The other 50 percent will engage in offshore outsourcing. We estimate that enterprise application implementation consulting costs can be reduced by at least 27 percent by using offshore services. Offshore service providers are also focusing on the SME market. By the end of the second quarter, we expect experienced on-site/offshore teams with proven methodologies to take 10 percent to 12 percent of all midmarket ERP implementation projects, and the first use of such teams for application management will occur. As the presence of offshore teams grows, the result will be pressure on the margins associated with this work.
It is the dual dynamics of reduced demand and margin for services associated with the SMB market that strike at the very heart of the economics that have traditionally bound enterprise application vendors and their partners. Although the new licence sales and ongoing maintenance fees they generate account for the bulk of the vendors' gross margins, it is the services fees that do the same for their partners. The margins from hardware and software product sales are generally incidental. The application vendor community is facing a dilemma. It needs partners to support its sales efforts to SMEs. However, what they have traditionally offered as an incentive -- large professional service fees at high margins -- is mutually exclusive with market requirements.
There is essentially only one solution available to vendors. They need to allow third-party partners to augment their revenue streams with sales of products that they build themselves and that extend on the vendors' offerings. These are exactly the same types of relationships that many of these same vendors have established with suppliers of databases, application servers, or rules engines (e.g., Siebel and Microsoft/Oracle, Siebel and Tibco/WebMethods/etc., SAP and IDS Scheer). This -independent software vendor" approach will prove challenging to many vendors that have never set explicit boundaries on the extent of their development efforts or examined the procedures necessary in adjudicating the process for moving partner-developed functionality down the stack.
Not only will such changes prove challenging to the vendor community, but also many in the existing partner community will not be able to modify their businesses properly. The successful partners will be those that recognise that the shift from systems integrator to independent software requires a fundamental assessment of their internal processes. Therefore, SMEs will need to augment intelligent IT sourcing processes with three major partner selection criteria:
Service capability: These are traditional qualifications normally tied to system integrators that involve organisational capability through service methodologies and the background, training, and experience of the individuals involved.
Commitment to research and development: Fluidity in staff allocation is a reality in service organisations but is not optimal when product consistency is an issue. Therefore, potential partners should be scrutinised on whether there is both an R&D budget and dedicated staff and processes tied to product development and maintenance.
Adherence to consistent engineering standards: Although leading SME vendors will seek partner ecosystems, it is critical that development standards be established that minimise conflicts when customers source solutions from multiple partners. SMEs will not be able to make such assessments themselves, and therefore should look favourably on vendors that certify partners not just on staff skills, but also on the quality of their product development efforts.
Bottom line: SMBs will not only have to factor in the competency of a vendor's channel partners as key criteria in package selection, but also have to do so on modified criteria. Equally important as professional service skills will be the partner's competency and commitment in developing and maintaining products that extend the vendor's core product platform.
Business impact: By taking a holistic view of vendor and partner as the ultimate product provider, SMEs will increase the likelihood of obtaining value from their investments during the long term.