According to Porter, below is a list of factors determining the Threat of Entry from new providers:

• Economies of scale
• Product Differentiation
• Capital Requirements
• Switching Costs
• Access to Distribution Channels
• Cost Disadvantages Independent of Scale

Here is what Michael Porter has to say about Capital Requirements as a factor in creating Barriers to Entry in his book Competitive Strategy:

“The need to invest large financial resources in order to compete creates a barrier to entry, particularly if the capital is required for risky or unrecoverable up-front advertising or research and development (R&D). Capital may be necessary not only for production facilities but also for things like customer credit, inventories, or covering start-up losses. Xerox created a major capital barrier to entry in copiers, for example, when it chose to rent copiers rather than sell them outright which greatly increased the need for working capital. Whereas today’s major corporations have the financial resources to enter almost any industry, the huge capital requirements in fields like computers and mineral extraction limit the pool of likely entrants. Even if capital is available on the capital markets, entry represents a risky use of that capital which should be reflected in risk premiums charged the prospective entrant; these constitute advantages for going firms.”

The MSP model is not inherently capital intensive, but certain service lines can have very high capital requirements and therefore can be considered a barrier to entry. Service lines that are lower in the technology stack (infrastructure or “plumbing oriented services”) such as those that are datacenter and telecommunications oriented and hosted multi-tenant cloud based services tend to be more capital intensive.

It is important to note that high capital requirements can be a barrier to entry due to economies of scale (lots of capital is needed to build scale to compete with other firms that already have it), but there are other high capex needs such as R&D and marketing that benefit less from economies of scale but can still be a barrier to entry. This is why Michael Porter broke them out as separate factors impacting Barriers to Entry.

The MSP model is not inherently capital intensive as it is fairly low cost these days to set up shop now due to the pervasive nature of tools and training out there available to the practitioner. Low cost PSA (Professional Services Administration) and RMM (Remote Monitoring & Management) tools which became available within the last 5-10 years are some of the main factors in driving the growth in the model. SaaS versions of these tools have only reduced the barriers to entry more by eliminating the need for upfront capital expenses and by variabilizing the cost of deploying the software in a growing firm. Previously these type of tools were quite expensive and only made sense for large providers to deploy them in the service of large enterprises. As low cost versions of the tools became available, it created a proliferation of providers that could service the market by lowering the barrier to entry and it also brought the model down market into the service of mid market and SMB customers.

As you go up into the technology stack into the applications, the work tends to be more labor intensive vs. that lower in the tech stack. Therefore the classical economic decision of whether to apply more spend to capital vs. labor tends to be impacted based on where the service lands in the technology stack. Likely because of this factor and due to the ease with process automation driving very large economies of scale and very large businesses, Telecom and Datacenter Services attracted large amounts of capital which lead to overcapacity in both industries. Now because of the capital attracted, both tend to be highly competitive service lines without a lot of differentiation between competitors.

There is a high barrier for new providers to enter these spaces, but it is not entirely relevant any more as they both have a very competitive landscape already. Being a capital intensive business with low differentiation and an oversupply of capacity has led both businesses to be quite rough to have a profitable strategy in. What we are seeing in the marketplace now is that the true differentiation is found higher in the stack with other offerings such as cloud based services and high touch managed services models. Providers in these services lines need to be prepared to accept low margins to drive growth.

Another fairly new set of services that can be very capital intensive are cloud based applications such as IaaS (Infrastructure as a Service), PaaS (Platform as a Service), and SaaS (Software as a Service) including such variations as VDI (virtual desktop). Cloud based applications typically require building out shared multi-tenant architectures which by their definition require sufficient capital to build out an infrastructure environment large enough to cover multiple customers. A cost advantage comes from economies of scale on these environments and therefore the larger the environment, the more cost advantage a provider has. This means that the capital required to build out that scale and have a competitive cost basis can be quite large.

There is also an early mover advantage as the scale necessary to have a competitive cost basis tends to increase through time. This creates a situation where providers who built cloud offerings earlier who have built up scale have essentially built a high barrier to entry to compete with them as the capital required to build out the scale necessary to have a hosted multi-tenant architecture large enough to have a competitive cost basis can be quite high. Amazon Web Services is a great example in the IaaS space that has essentially built a moat around their offerings due to the low pricing they can offer from their low cost basis due to the scale they have on their platform. The only way now to compete with AWS in the IaaS space is via a differentiated offering as competing with them on price will likely be a losing game.

High capex offerings also create a situation where there is a risk of the “Field of Dreams” style strategy where you hope that you “Build It & They Will Come” and the business can end up with a large hole in the balance sheet if they don’t in fact come. The reason is that there could also be high capex needs to build the sales and marketing capabilities and programs to support the necessary growth on the platform built. The cost of this sales and marketing expense to develop scale on a multi-tenant environment must be considered in the business case for building one.

Even though cloud offerings have high capex requirements to build one out, they can be a differentiator for an MSP. It would be tenuous for an MSP right now to not pursue cloud based services for their product portfolio. It should be noted though that an MSP can add these services to their portfolio via buy, build, or acquisition of a company that already has them.  These offerings will need to be analyzed individually to determine the market pricing and unit costs for buy vs. build vs. acquire to determine if it makes sense to take on the capex risk by developing the offering in house or if there is an alternative way to develop that service with less capital and risk.

Last, an MSP must also decide whether they are building their sustainable competitive advantage via their cost position or via their differentiation. It is certainly a valid strategy to intentionally compete based on a differentiated offering with higher prices vs. the likes of an Amazon Web Services. The key here is that the offering must truly be differentiated and in a way the client realizes more value.

In this series of posts, I discuss Michael Porter’s 5 Forces strategy framework as it applies to the MSP industry. I will be starting with the factors impacting Barriers to Entry and then progress sequentially through the remainder of factors in subsequent blog posts. If you read this and you have any questions or comments, please reach out to us via the contact page on this website or add a comment to the blog. I am sincerely interested in what you have to say on this matter as this is an input into our investment thesis for the firm.

For more articles, blog post, or to provide feedback and comments to this post, please visit Snowmass Capital Partners.

Based in Denver, Colorado, Snowmass Capital Partners is a private equity investment firm focusing on small and middle market IT Service companies. Utilizing the significant operating expertise of its principals, Snowmass Capital Partners serves as a value-added partner to the management teams of its portfolio companies.

According to Porter, below is a list of factors contributing to a Threat of Entry:

·           Economies of scale

·           Product Differentiation

·           Capital Requirements

·           Switching Costs

·           Access to Distribution Channels

·           Cost Disadvantages Independent of Scale

Product differentiation means that established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being first into the industry. Differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties. This effort usually involves start-up losses and often takes an extended period of time. Such investments in building a brand name are particularly risky since they have no salvage value if entry fails.

In general, product differentiation is not a high barrier to entry for new providers to join the industry. It does appear that differentiation becomes more important as firms scale. Below are some thoughts on how Product Differentiation impacts the Barriers to Entry of the industry:

·        The SMB and mid-market are currently fragmented growth markets where many new customers are deciding to leverage managed services for the first time and the majority (90+%) of the MSPs are small (<$5M in revenue). As such, in many cases there is no incumbent requiring a differentiated offering to win the business away from.  This will change through time as the market gets more competitive and consolidation builds larger competitors and winning new logos more often means taking them from competitors.

·        Marketing via expensive vehicles such as advertising and PR are minimal factors. Most marketing is done via inexpensive inbound marketing and some outbound calling techniques. MSPs who have strong capabilities to build an organic growth engine via inbound marketing and sales are rare and seem to be taking disproportionate market share now. Further, most MSPs are local or regional with very few super-regional and national providers which means most marketing is regionally or locally focused.

·        Service differentiation exists between MSPs, but most are small regional players so there are few very large differentiated providers to compete with. As consolidation heats up, it is expected that differentiation will become increasingly important to retain high margins.

·        Differentiation revolves around these factors: Service model (Cloud, Managed Services, VAR, Prof Services, Break-Fix), technologies supported, geographies, verticals markets, and service delivery model.

·        When asked, most MSP say their customer service is their source of differentiation. So many say it, that it can’t be true for all just like all of the children can’t be above average in Lake Wobegon!

·        Pricing Model: The MSP service model itself is a source of advantage vs. break-fix and project based models as it gives the client a business outcome based contract with predictable costs across a team of technology domain specialists. Another source of differentiation is pricing based on user vs. pricing based on device count.

·        Proprietary tools and workflow can be a source of differentiation. As off the shelf software in the industry such as PSA and RMM tools become more robust, proprietary tools will become less of an advantage vs. the workflow and integrations built on them.

·        Cloud offerings are hot and are a source of differentiation as many companies realize the value that is added by moving into the cloud and are looking for MSPs that can get them there. By moving services from physical on premise devices to the cloud, MSPs also risk cannibalizing their remote infrastructure management services if they don’t have this capability to offer (in house or via white label). MSPs which don’t have a cloud capability and are not actively pushing clients there (even at the risk of cannibalizing RIM revenue) are at a distinct competitive advantage.

·        Since technologies supported is a source of differentiation, having a breadth of supported technologies or a great amount of depth of talent on technologies that are hard to source talent for can be a solid differentiator.

·        Vertical marketing strategies can be a substantial source of differentiation as firms that have developed a vertical market capability (especially one that goes up the stack into vertical specific applications) have a better view of what drives value for their clients and thus are in a better position to differentiate themselves by creating and marketing value based offerings.

·        Certifications such as the SSAE-16 (formerly SAS-70) or capabilities around regulations such as HIPPA can be a source of differentiation. This is especially the case when it alleviates the need for a client to build these internal compliance capabilities in house which can be costly and cost prohibitive for smaller companies.

·        The service delivery model can also be a source of differentiation. This could be via a high touch service desk with high first call resolution percentages, or via service delivery managers which bring technical expertise and can act as a vCIO in addition to managing a high level of service.

In this series of posts, I will be discussing Michael Porter’s 5 Forces strategy framework as it applies to the MSP industry. I will be starting with the factors impacting Barriers to Entry and then progress sequentially through the remainder of factors in subsequent blog posts. If you read this and you have any questions or comments, please reach out to us via the contact page on this website or add a comment to the blog. I am sincerely interested in what you have to say on this matter as this is an input into our investment thesis for the firm.

For more articles, blog post, or to provide feedback and comments to this post, please visit Snowmass Capital Partners.

Based in Denver, Colorado, Snowmass Capital Partners is a private equity investment firm focusing on small and middle market IT Service companies. Utilizing the significant operating expertise of its principals, Snowmass Capital Partners serves as a value-added partner to the management teams of its portfolio companies.

According to the study, “the ramp-up time metric is very valuable in determining when the results from new hires will begin to impact the revenue stream”. When they asked their study group the following questions “On average how long does it take for a new sales rep to be fully productive?” here is what they uncovered:

• 17.6% of new sales reps require >1Year
• 2.2% of companies don’t know
• 6.6% of new sales reps require <3months
• 30.9% of new sales reps require 3-6 months
• 25.4% of new sales reps require 7-9 months
• 17.3% of new sales reps require 10-12 months

From this data they surmise that 59% of companies in their overall survey needed more than 6 months to ramp up new hires. In addition, 60.3% of the Sample Industry Companies say the ramp-up time is over 6 months.

Unfortunately, this means that if your new sales rep either just came on board or has been on board for a few months, the chances that they provide an impact to your 2012 sales numbers is, to say the least, not so good.

The other piece of bad news is that there are two other forces at work that you may have already encountered in the marketplace:

1) Sales cycles are taking longer and

2) Its harder to get in the door and to the right people.

WHAT CAN YOU DO

Since you can’t change the behavior of your prospects, all of the above including, the stats from CSO Insights really boil down to one thing: increasing the effectiveness of your sales team. With better tools, methodologies, and approach, you can give your team what it needs to fight the good fight and make an impact on your bottom-line.

So what can you do?  There are 3 things:

1)      Highly targeted sales training: This specific training would be targeted to areas that need improvement. For instance, increasing appointment setting rates.

2)      Work with a outsourced company to provide sales appointments/lead generation: There are lots of companies out there to choose from. We suggest utilizing companies that offer guarantees of their work and who understand your industry, such as, technology.

3)      Try a Hybrid Approach: The goal is to make your sales reps more effective and the steps above are ideal components for your solution, however, a hybrid approach is optimal. A hybrid approach, where you have an training/appointment setting organization providing a knowledge transfer while at the same time providing you appointments will accelerate your success. As the old adage suggest, the best way to learn is by doing.

Let us know what you think?

Porter’s five forces analysis is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. It draws upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An “unattractive” industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching “pure competition”, in which available profits for all firms are driven to normal profit.

This blog series will start out with a discussion around the first force which is Threat of Entry. Below is a list of factors contributing to a Threat of Entry:

·        Economies of scale

·        Product Differentiation

·        Capital Requirements

·        Switching Costs

·        Access to Distribution Channels

·        Cost Disadvantages Independent of Scale

In this post, I will start out with a discussion of the first factor Economies of Scale and then progress sequentially through the remainder of factors in subsequent blog posts. If you read this and you have any questions or comments, please reach out to us via the contact page on this website or add a comment to the blog. I am sincerely interested in what you have to say on this matter as this is an input into our investment thesis for the firm.

Economies of scale refer to declines in unit costs of a product (or operation or function that goes into producing a product) as the absolute volume per period increases. Economies of scale deter entry by forcing the entrant to come in at large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage, both undesirable options. Scale economies can be present in nearly every function of a business, including manufacturing, purchasing, research and development, marketing, service network, sales force utilization, and distribution.

Are Economies of Scale a factor in the MSP industry? We believe they are and below are some thoughts that we feel validate this.

·        MSPs achieve economies of scale as evidenced by the large variance in revenue per employee between small and large firms. Due to the relatively high gross margins found in MSPs, the smaller MSPs can still function albeit with lower operating margins and without the ability to invest in new capabilities and growth. These smaller businesses tend to be lifestyle type businesses because of this.

·        The main sources of the economies of scale are:

o   Spreading the SG&A expense across more revenue and bringing down SG&A as a % of revenue. Many of the smaller MSPs we see tend to have a much higher SG&A as a % of revenue, which is what leads us to believe this.

o   Specialization of delivery capabilities (people, process, tools) for different technologies. We have seen that companies that are “jack of all trades” type firms which support many technologies but without scale in any of them, tend to have lower gross margins from those that are more focused on the number of technologies that they support or have enough scale to develop depth in a larger number of technologies.

o   Spreading the fixed costs of Service Delivery Tools (ticketing, monitoring,…)across more units managed.

o   The ability to invest in professional procurement capabilities which drive down unit costs.

o   The ability to get technical product for resale and internal use at lower costs from volume discounts.

o   The ability to leverage the service desk and service management infrastructure to support a more diverse set of technologies and thus spread it over more revenue.

o   The ability to invest in IaaS (Infrastructure as a Service) type offerings where order entry is done via a website by the client without the need of an account manager or provisioning personnel involved and their subsequent costs.

o   Increased brand awareness from scale leading to more impact from marketing campaigns.

It is important to note that large scale could be viewed as making firms less responsive which is the value prop of most small MSPs. We feel that it is important to still feel small by staying responsive as scale increases.

For more articles, blog post, or to provide feedback and comments to this post, please visit Snowmass Capital Partners.

Based in Denver, Colorado, Snowmass Capital Partners is a private equity investment firm focusing on small and middle market IT Service companies. Utilizing the significant operating expertise of its principals, Snowmass Capital Partners serves as a value-added partner to the management teams of its portfolio companies.

In the article, which describes how Oracle had missed analyst expectations, he stated the following:

“However, Oracle isn’t seeing IT budgets being cut. Rather, they’re watching proposed projects come under greater scrutiny and going through longer sales cycles. “All of a sudden the CEO had to approve it or something like that, where before it was all set,” Oracle CFO Safra Catz said.”

There’s nothing new about budget’s being cut or longer sales cycles, however, that’s the superficial analysis, Larry goes on to say:

“Analysts are jumping on the trend, believing the tech industry is heading into another low year. Channelnomics offers an alternative explanation: The tech industry is going through a transformation in which the value is no longer in the technology (software, hardware or services), but rather in the business value and delivered outcomes from technology investments.”

LONGER SALES CYCLES ARE JUST THE SYMPTOM

This is where Larry has it 100% right. I’ve been seeing this trend and writing and discussing about this topic for the last several years and the recession has only magnified this problem and accelerated its adoption throughout the corporate world.

As Larry states later in the article the “longer sales cycles” are simply the symptom:

“Across the board, CEOs and business managers are getting involved in tech evaluations and decision-making. They don’t care about the speed of a processor, the storage capacity of a SAN system, the number of virtual machines a server can host, or even the latest features in a CRM application. They are unconcerned with the middleware functions that enable cloud development and management, and they could care less about how services – cloud and managed – work.

What line-of-business managers care about are business outcomes. They have little tolerance for risk, as making a mistake will hinder business operations and sales. They want systems that cut costs, enable sales, open new markets and expedite revenue performance. The essential questions they want answered have nothing to do with the technology, but rather the byproducts of that technology.

What’s worse for tech companies that don’t get this transformative shift is that business managers are willing to wait. They are in no hurry to book IT projects until they are satisfied they are getting not just what the IT department wants…”

WHAT DO WE DO WHEN OUR CLIENTS CHANGE THE WAY THEY BUY?
The reality of it is that how we have approached clients, how we have sold, how we have forcasted and how we have trained our sales people won’t work in a word where the “line-of-business managers care more about business outcomes” and less about the technology itself, but instead the “byproducts of that technology”.

So what does that mean for IT solution providers? First and foremost, we need to do two things:

1) Change how we approach our sales management and planning to match how client’s are buying and making decisions
2) We need to train and arm our sales reps with the tools they need in order to approach clients and sell.

I’ve been told by many of sales and marketing managers that very few of their reps have the confidence to approach line-of-business managers, much less CXO executives. And fewer actually have the ability to have these business conversations (Is this is the product of too many vendor presentations and trainings?).

It’s not impossible to change but like an addiction, the first stage is admitting that you have to change. What we need is a congruent approach from how we start the relationship (marketing tools, campaigns, etc.) to how we personally engage the client (sales). This approach, of course, requires that sales reps, marketing folks, executives, engage the client’s based on business outcomes instead of just, technology outcomes.

I started this post talking about silver linings and lessons, I believe the lesson that we can gain from Oracle’s bad 4th quarter is that if their “buyer” is changing how they “buy” then it can, if not already, filter down to our clients. So, with Oracle and Larry’s help, we see what is in front of us, before we get there, so that we have the ability to take corrective action.

I highly recommend you visit Channelnomics. You can read the full article here: Oracle’s Bad Quarter a Harbinger of 2012 Trends.

Let me know what you think?

“I watched your webinar today on MSPtv and really gained some useful insight and how to determine which customers to seek out.  I spent most of my life as an engineer and computer scientist and always worked on the technical side of marketing campaigns but never really understood how to apply them until I began to work as a consultant a few years back.” -  Aaron W.

“I found your “Door Opening Campaign” Webinar very insightful…I have been trying to secure meetings with IT Directors, CIO’s  and Marketing/Advertising Directors of Fortune 1,000 companies.  My personalized, creative emails and phone calls have recently provided a much greater response rate but your “Lumpy’ Mail ideas are spot on!  Especially when prior research has been done regarding my prospects personal interests, hobbies etc…Thank you for sharing your tried and true marketing techniques to “Get my foot in the Door”. – Suzanne P.

“Thanks for the Presentation, I’d love your book. I was quite impressed with the lumpy mail idea! I’ll come up with a few unique to my company ideas and run them past you, again thank you so much for the presentation.”  Brandon H.

Here’s what the video covers:

• Following a step-by-step process for creating your campaign
• Generating the highest and most profitable leads by implementing the concept of the “Best Customer”
• Creating a unique campaign that gets noticed
• Personalizing your campaign for higher impact
• Leveraging your campaign across multiple platforms (email, direct mail, telemarketing, etc.)
• Learning a proven process for “Follow Up” and why it can double your results
• Learning how much you should spend on marketing campaigns in order to get results?
• Discovering what is the lifetime value (LTV) for a customers and why it is crucial?

Hope you enjoy! Please send us your feedback.

Here’ what others had to say about the content:

“I found the presentation today to be an excellent review of a relevant strategy for today’s business sales. I appreciate the webinar and really enjoyed it. Please keep me on the mailing list for future presentations.” – Chad L.

“Thank you very much for your presentation.  It was a very interesting perspective on creating a good sales pitch.  I like the psychological approach.  I actually have a masters degree in counseling and it makes sense to me.” – Donna S.

“I was on the webinar yesterday – very interested in your materials. Thank you – I found a lot of very good tips about pitching our BDR solution – and many of the mistakes that we are currently making. “ – Phillip B.

The video covers the following:

• Understanding the differences between your client’s stated and unstated priorities
• Structuring your pitch for your chosen vertical market
• Creating a unique client “value story” for your business continuity solution
• Positioning your pitch for “top management”
• Differentiating your pitch from all your competitors

We hope you enjoy! Please send us your feedback.

DIRECT RESPONSE STRATEGY

In our first article in this series, we discussed the “Ideal Buyer” strategy (please see part 1). Basically, in the Ideal Buyer strategy phase of doubling your sales, we identify a profile of your ideal client or buyer. Then, once you have the profile, you build a list of 100 of these ideal buyers. At this point, you conduct research on the business, on the industry, and on the specific contacts or decision makers within the ideal company.

The goal is to find information that you can use to create a meaningful personalized message that speaks to the prospect about their business and industry. You want to find market data that makes the prospect say “wow, I didn’t know that”.

At StreetSmartVAR, we use direct mail, less as a passive tactical device and more for its ability to get a response. Hence, the name that we use: direct response. A direct response package, when done correctly has the following attributes:

1)      It stands out by using what we call lumpy mail or 3D mail;

2)      It’s has a message that is meaningful both personally (for the individual) and for the business;

3)      It’d designed to elicit a response, usually, to set an appointment.

LUMPY MAIL

The first component of the direct response strategy is something that some people call this 3d mail or what I like to call, lumpy mail. It’s called lumpy because if the person who collects the mail were to try to put another piece of mail on top of it, that mail would slide off.  A lumpy mail piece goes on top or stands by itself. This keeps in mind, that getting your piece opened is one of the first challenges of direct mail, so we are already ahead with our lumpy mail piece.

Lumpy packages also pique curiosity. We know they are going to open it, but once they get it open, we’ve got one shot to get their attention so we want to wow them with what is inside; creativity is key. I have to confess that this is my favorite part of the campaign. Coming up with the idea for what will be inside that package is fun for me. We’ve used it for our own business.

MESSAGE

The second component is messaging. The strategy is to create a personalized, 1-to-1 if you will, message that is meaningful to the recipient. By meaningful, we mean, that it should include “market data” about their business and their industry that makes them go “wow”. In others words, it should be about them and be valuable to them in driving their business.

We’ll talk more about market data in the next part of this series but understand you want to include something that will show them that you understand their business. The next thing is making it personalized. Here’s where you use social media to better understand the individual or recipient of the mailer.

Let’s say for instance that they a collect classic cars, then you are going to want to use jargon, buzz words, etc., that are used by classic car collectors. What this does is make the direct response piece meaningful to them versus the millions other pieces of junk mail that they get daily. The next component is response. What do you want them to do? How do you want them to respond? And can you get them to respond at all?

RESPONSE

The key here is making sure that you remember the one and only objective you have for this direct response package is to get them to take action. In the way that we use these packages, our objective is to get an appointment.

Therefore, you don’t want to try and sell them on your product or service. As of matter of fact, I would stay away from even talking too much or at all about your services. Instead, focus on them. Use market data to show proof that you know and understand their business. And always try to communicate what value they would receive. It’s always about them.

Then lastly you ask for their response and make it easy for them to respond. You want the package to do one thing: get a response. Did I say that enough?

Let me know what you think?

In the next article in the series, we’ll discuss what you do in the next phase of getting an appointment: your initial contact over the phone.

It is easy to envision scenarios in which competitor response limits any volume gains from the price cuts, thereby reducing profitability. If Microsoft’s primary business objective was to increase profitability and market share, it might have been better served by maintaining a premium pricing strategy, even at the expense of some lost volume.

To be useful, pricing objectives must be set relative to some reference point. Given the strategic importance of customer value to the overall pricing strategy, we define pricing objectives in terms of the percentage of value captured with price. This decision should be driven by judgments about what will yield long-term, sustainable profitability. As noted earlier, a low price will, other things equal, induce customers to migrate to a new product or service more quickly. On the other hand, if the product’s differentiation is likely to be sustained, a low price established to drive sales means foregoing considerable margin over the long run because it is difficult, if not impossible, to raise prices later. There are three options for setting prices: skimming the market, penetrating the market, and neutral market pricing.

OPTION 1: SKIM THE MARKET

Skim pricing (or skimming) is designed to capture high margins at the expense of large sales volume. By definition, skim prices are high in relation to what most buyers in a segment can be convinced to pay. Consequently, this strategy optimizes immediate profitability only when the profit from selling to relatively price-insensitive customers exceeds that from selling to a larger market at a lower price. In some instances, products might reap more profit in the long run by setting initial prices high and reducing them over time even if those high initial prices reduce immediate profitability.

OPTION 2: PENETRATE THE MARKET

Penetration pricing involves setting a price low enough to attract and hold a large base of customers. Penetration prices are not necessarily cheap, but they are low relative to perceived value in the target segment. Hyundai, for example, used a sustained penetration pricing strategy to enter the U.S. market in which the company high value in the form of reliability, 10-year warranties, and well-appointed interiors at prices far below those of Japanese makers such as Toyota or Honda. Similarly, Target and Trader Joe’s stores have positioned themselves as offering the same or better value as their competitors at lower prices.

OPTION 3: NEUTRAL MARKET PRICING

Neutral pricing involves a strategic decision not to use price to gain market share, while not allowing price alone to restrict it. Neutral pricing minimizes the role of price as a marketing tool in favor of other tactics that management believes are more powerful or cost effective for a product’s market. This does not mean that neutral pricing is easier. On the contrary, it is less difficult to choose a price that is sufficiently high to skim or sufficiently low to penetrate than to choose one that strikes a near perfect balance.

For more articles, blog post, or to provide feedback and comments to this post, please visit Snowmass Capital Partners.

Based in Denver, Colorado, Snowmass Capital Partners is a private equity investment firm focusing on small and middle market IT Service companies. Utilizing the significant operating expertise of its principals, Snowmass Capital Partners serves as a value-added partner to the management teams of its portfolio companies.

1) Now that the utilization percentage is fairly high of enterprise virtualization, the growth of virtualization will slow; and

2) There will be an increasing shift to public and hybrid cloud architectures from on premise based installations.

Some projections/stats from their report:

• In 2008, 18% of all server workloads were virtualized
• Recently, the midmarket has begun to virtualize, and penetration in the midmarket already matches that of the Global 500
• During 2011, more VMs will be deployed than in 2001 through 2009 combined
• Between 2010 and 2014, the number of VMs in public IaaS will grow at a compounded annual growth rate (CAGR) of 70% to 80%
• By 2012, half of all server workloads will be virtualized, and the growth will begin to slow
• By 2015, approximately 4% of all x86-based workloads will be running in public IaaS
• By 2016, 80% of workloads running on x86-architecture servers will be running on VMs
• Gartner estimates that in 2010, there were 410k VMs in use in as service provider’s cloud IaaS offerings & this will ramp up to 3.9M VMs in 2014.
• The revenue in the IaaS market is projected to grow from $2.1B in 2010 to $10.5 in 2014.

The Bottom Line: This is a hot market and these are some very aggressive forecasts that are being borne out by anecdotal evidence from what we are seeing in the marketplace.

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