Knowledge Base

The Current Service Model Cannot Work

By The Wasmer Group

A recent informal poll points to a serious problem facing the channel. Virtually all of the more than 200 resellers present at a recent industry conference indicated that services were more profitable than selling hardware and that service volume was up over last year while hardware sales slumped. Many resellers even announced that they are purposely shunning hardware sales and concentrating on the more profitable services. Although not good news for distributors and manufactures, the reseller community at least should be enjoying increased profitability. Yet, in a stunning contradiction, this same group of resellers, by an overwhelming majority, indicated that they were significantly less profitable this year versus last.

This illogical state of the industry begs the question, "Are services really more profitable than hardware?" For the average reseller, our experience and financial analysis would answer the question with a resounding "no." The fact is that many, if not most, resellers are actually losing money providing services. This problem is compounded in that many resellers are reducing profitable hardware sales, while watching their profitability erode, still thinking hardware is the problem.

To point out the fallacy of the services profitability myth, let's look at a recent survey conducted by VarBusiness, which indicated the "average" engineer or service technician in the channel produces 1.78 times their salary in revenue. Keep in mind that this is the average, so that 50% produce less. This is consistent with our research in that many resellers set a goal for engineers to produce two times their salary. This model is the reason most resellers continue to lose money in service. It's time that we abandoned the Computerland/FutureNow/Vanstar/Entex/Inacom/Microage model because it simply does not work.

Here's the problem in detail. If an engineer produces revenue that is 1.78 times his salary, his salary as a percentage of revenue will be 56%. The engineer has a manager who typically earns 5%. (This means if you are producing $1 million in service revenue, your service manager is paid only $50,000 a year.) The service department has assistants, dispatchers, and other administrative personnel. These people typically earn 2% of the revenue produced, or $20,000 for every million of service revenue. Therefore, the service department is receiving 63% of every dollar of service revenue.

Typically, services are thought to generate 35% gross profit, and for sales commission purposes the average reseller will compensate the sales department (sales rep, manager, and assistants) anywhere from 30% to 40% of GP. At the lower end, the sales department is paid 10.5% of service revenue (30% x 35%). Adding sales and service compensation together, we get a total of 73.5% of service revenue (engineer 56%, service manager 5%, service administration 2%, and sales 10.5%). Let's include payroll taxes and benefits at 14% of compensation (industry average), which translates into 10.3% of total service revenue (73.5% x 14%), and we're at 83.8% of total service revenue.

At this point, we still have to pay for the administrative/operational staff of the business as well as all non-compensation relate expenses. Non-compensation expenses include rent, utilities, interest, communications, equipment, training, travel, advertising, marketing, etc. The typical reseller spend between 18% and 30% (average of 24%) of service revenue on non-compensation expenses. Using the low end of the scale again, we get a build up of costs at 101.8% of revenue (83.8% plus 18%). We are now in a loss position and we still have yet to pay for the non-revenue producing department personal, such as executive management, accounting, human resources, etc. Most importantly, we have not set aside a piece of the service revenue pie for profit.

How can we expect to make a profit if our engineers only produce two times their salary? Yet this is the accepted business model for services in the industry. It illustrates why we continue to see hardware sales supporting most service departments, not the opposite. If you want to provide services profitably, and they must be delivered at an acceptable profit if you plan to stay in business, then take a look at accounting or law firms. The break-even point for these professional service firms is production at 2.4 times compensation. Keep in mind that in true professional service firms, managers and partners (owners) bill as well as the professional staff. Another key difference is that true professional service firms, such as accounting and legal firms, do not have sales reps to compensate.

Factoring in these two critical differences means that in our industry, in order to be profitable, an engineer or service technician must produce revenue that is at least 3 times his salary. After studying professional service firms, it's easy to determine the financial ratios and targets, but how do we get there?

 

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