IBM Gives the iSeries Channel Incentives to Grow and Behave

by Timothy Prickett Morgan

There are two things that motivate any player in the server channel: volumes and profits. The two do not always go hand-in-hand. Often, high-volume servers with lots of competitors that are based on similar or exactly the same core technologies are things that companies can sell a lot of, but they go broke trying to sell. Conversely, some low-volume products (like the iSeries) can, in theory, have high margins because of the lack of direct competition and the uniqueness of the box.

I say in theory because that is not the way it has been happening in the iSeries channel, according to partners I have talked to over the past couple of years. And IBM is well aware of this and has taken various steps to try to boost the profitability of the iSeries channel, which accounts for roughly 85 percent of the deals and about half of the revenue in the iSeries market. Some of these steps--and one in particular called opportunity qualification--are not necessarily making IBM's iSeries resellers happy in the short term.

Before I get into all the details of the iSeries channel initiatives, let's take a step back. Selling any product through a dealer network presents some difficult challenges, particularly in a world that has been flattened and shortened by the Internet. The iSeries channel is somewhat more complicated in that IBM pushes so many boxes through its three master resellers--Arrow Electronics, Agilysys, and Avnet--who in turn have their own channels of resellers. IBM does not directly control all of the deals, and more importantly, the rules under which resellers can engage with each other. This has become a problem--for IBM and the channel at least, but not necessarily for customers--in recent years. A decade and a half ago, the difficulties and expense of maintaining offices in many different geographies--either within a country or spanning countries--made it a lot easier to assign a particular reseller to a particular geography. That reseller had those accounts, and it was too expensive to raid those accounts from an area that was geographically remote. OS/400 shops expected face time with their resellers, and lots of hand-holding, too. But in the Internet world, where customers are used to buying some components online, where entry iSeries boxes are so-called customer setup units, and where prices are a lot lower and margins are a lot thinner on baby OS/400 servers, it has become relatively easy--and more importantly, necessary--for resellers to chase each other's deals.

Obviously, these combined forces have had an adverse effect on profits in the iSeries channel, even if it has meant that OS/400 shops could sometimes grind two or more resellers against each other to get a deal on an iSeries box. The need to boost channel profits is something we have heard every so often from IBM when talking about the iSeries, but in 2005, Big Blue is pumping $230 million in various incentives into the iSeries channel, an increase of 36 percent over 2004's levels. IBM and its master resellers have also mapped out a means of keeping iSeries resellers from coming in at the 11th hour and stealing deals away from each other to meet revenue quotas by simply cutting the price on the iSeries box sufficiently to win the deal.

"Last summer, it became apparent that the channel wasn't making enough money," explained Joyce Bordash, the new director of iSeries channel marketing, who talked to me about the iSeries channel incentives recently. Bordash was an executive assistant of former PartnerWorld General Manager and former iSeries General Manager Buell Duncan, and after working part time at IBM for a number of years, she has been re-activated into full-time duty to get the iSeries channel in order and making money.

To try to figure out how to fix the iSeries channel, IBM hired the consultants at McKinsey & Company--where former IBM chairman and CEO Louis Gerstner cut his teeth--to do an 11-week study focused solely on the iSeries channel. In this study, McKinsey looked at transactional margins on the front-end of iSeries deals and then the back-end margins that resellers were seeing on their overall iSeries-related businesses, which, because of value-add rules, include software, services, and other products that get bundled into an iSeries solution.

In the Americas region, a new channel incentive program actually went into effect on March 1. The centerpiece of this new program is called "opportunity certification," and what that essentially boils down to is that a reseller has to document their interaction with an OS/400 account such that they prove they have the primary relationship with that account.

In the past, depending on the reseller and the size of the iSeries deal, there might be 25 to 30 points of margin in an iSeries sale. However, because of competition between resellers, discounting started at 20 percent off list price and quickly moved to 25 percent. This meant that there was really not much margin left. With opportunity certification, only the reseller who can demonstrate that they are the primary reseller servicing the account will get the base margin on the box. If you don't certify--which presumably means lots and lots of paperwork--you don't get the opportunity to sell the box.

According to Bordash, IBM has not only added this opportunity certification process, but it has changed the margin incentive structure to more accurately reflect IBM's own goals of expanding the sales of the iSeries platform in the entry and midrange server markets at large. In the Americas, you start out at the base margin of 25 to 30 percent, just as before, she explained. Then, if the reseller is chasing a new customer, they can add 10 more points. If it is a small or medium business (SMB) account, they can add another 5 points through the SMB Advantage program (which has margins ranging from 5 to 9 percent, depending on the geography). If resellers are pushing a vertical solution on top of that, they get another 5 points of margin. That is an extra 20 points of margin in the Americas region, potentially. Although Bordash didn't say this, the opportunity certification requirement is the stick that accompanies the carrots of a lot more margin involved in the iSeries sale.

"This is a clear message that partners need to invest in customers, that they cannot just come in at the 11th hour and win a deal on price," she said. "We want partners who differentiate on the value they bring, not on price."

In addition to the changes in the front-end transactions relating to iSeries sales, IBM has made some other changes in the iSeries channel, which includes some 2,400 companies worldwide who are certified to peddle iSeries iron. IBM has boosted its All Partner Rewards program, and now customers who sell $100,000 or more in iSeries get can get anywhere from 1.2 to 3.75 percent of the value of the sale back from IBM as an off-invoice rebate. Prior to March 1, the floor on All Partner Rewards was $750,000, and the incentives were 30 to 40 percent smaller.

"This is no longer feed the strong and starve the weak," she said. "We're really committed to double digit growth, and that is going to take a little investment." She added that IBM hoped that these and a few other channel incentive changes would add up to at least an increase of 8 points of operating margin for iSeries resellers on their own books, adding that this growth was double what PartnerWorld would be delivering in 2005 for other eServer platforms, including the beloved zSeries, pSeries, and xSeries lines.

While it is hard to argue that this setup will not be a big improvement for IBM, its master resellers, and the thousands of downstream resellers, it is hard to say if it will be a good deal for customers. I'm no lawyer, but the ones I know say that angry customers who catch wind of IBM and reseller practices might be inclined to think of this as a very sophisticated form of price fixing. Some of the iSeries partners I have talked to have said the same thing. The real question is what the users think. My guess is that IBM has vetted these channel incentives with its lawyers and it feels pretty comfortable that what it is doing will stand up in a court of law if disgruntled users or, perhaps, disgruntled resellers who want to compete on price gang up together to sue IBM and/or its channel partners. Considering that OS/400 shops have businesses to run and no time to sue Big Blue, no place to turn to for alternative iSeries iron and OS/400 software, and channel partners stand to make more money on the iSeries deals they do certify, I don't expect legal problems with the channel incentives.

But, you just never know with people.