Product-Service Partnerships

If I'm a senior IT executive at a large enterprise (someone like Shell, United Airlines, or Walmart) I'll need to acquire some large software systems to manage my business. Often I may choose to buy these systems from a product vendor who sells this kind of thing to many such companies (someone like SAP, Oracle, or SalesForce). However buying these kinds of large-enterprise packages isn't as simple as popping over to the app store with a credit card. Such systems require a lot work to install, configure, and customize. I could train up my own staff, but that would probably take too long, so I'd rather have staff from another firm who have more experience. So for this I'd probably engage with a large software service provider (think Accenture, Wipro, or IBM).

In this article, I'm representing the business relationships as a simple three-role model. When I use these names in the article, they refer to these kinds of roles. The example companies are all large companies, since they are well-known, but smaller companies also play these roles.

Customer

The company buying the product and related services to improve their operational outcome

Walmart, Southwest Airlines, Citibank

Product Vendor

Builds and sells a software product

SAP, Oracle, SalesForce

Service Provider

Sells capability through skilled staff to build and configure software systems

Accenture, InfoSys, ThoughtWorks

This interaction is so common that the product vendors and software services firms often agree to partnership deals, where they agree to work together to support a particular installation, or to pursue customers companies across a larger business segment.

Although these arrangements are common, I don't think they are well understood as well as they could be. As someone who works primarily in custom software development, where these are less significant, I include myself in the list of relative ignorance. That ignorance is one reason to explore them a bit. Another reason to better understand them is that these kinds of arrangements are becoming more significant in the custom software world with the shift to cloud computing. We're now seeing similar partnership arrangements with cloud vendors having a significant impact on companies like ThoughtWorks that focus on custom software delivery.

The simplest case of a product-services partnership is where the partnership is formed for a single customer engagement. In this situation the partnership could be formed by the customer telling the product vendor to work with the customer's preferred service provider. Or the service and product companies might form the partnership when they see the opportunity, possibly in competition with a rival product-service match-up.

Things get more involved when a service provider and product company agree a longer term partnership arrangement. Here they agree a deal that will work for several customers, perhaps globally, or perhaps limited to a particular business sector (eg airlines, banks) or geography (eg East Asia).

A significant factor that leads to differences in these arrangements is the relative size of the companies involved. A small service provider is going to have a different relationship with SAP than Wipro does. I'll start by assuming two large companies, and then talk about how things differ when we get to varied sizes.

Large organizations have divisions dedicated to partners

When both companies are large partnership arrangements will usually be non-exclusive. A company like Accenture will do ERP work with SAP and Oracle, and indeed do substantial work with both - each one involving multiple customers world-wide. The scale of these partnerships means that the service provider will often create whole organization structures just for a particular partner (in the mid 2000s, IBM Global Services had around 20,000 staff dedicated to working with SAP).

So a service provider might have a banking division, that focuses on that sector, and an Oracle division that focuses on Oracle's business software platforms (which is a whole different animal to its database software). If a bank is looking at reforming its HR systems, it would talk to a contact in the banking division. Folks in that part of the service company try to be relatively independent of the software vendors. If the customer had decided to implement PeopleSoft (an Oracle subsidiary that does HR software) then the banking contact would introduce people from the service company's Oracle division as part of the work.

In the product vendor organization, large vendors will also have a dedicated organization dedicated to working with partners. These will provide education and product news, help with sales pursuits, and coordinate on delivery work.

In both cases, it's important to remember that a partnership arrangement isn't just about negotiating and signing a deal. It's a on-going relationship that requires constant work to maintain.

Why don't product vendors build their own services division?

From the product vendor's point of view, the service provider primarily acts as a delivery organization, providing the staff to do the installation, configuration, and customization which complex software products need. Product vendors don't tend to like building their own delivery organizations for several reasons. For a start the work tends to be have much lower margins compared to selling product - so the vendor would rather invest in improving its product and supporting sales and marketing. Secondly projects to install large software products tend to carry a lot of risk - so it's good for the product vendor to have an arms-length relationship with any delivery project. That way, when things wrong, it's the service provider that carries the responsibility.

A further financial reason is the knotty issue of revenue recognition. This is the legal and accounting principles that govern when you can recognize some revenue on your balance sheet. If you sell some software, you immediately count it as revenue. But if you sell services, then even if you sign a contract today to do some work in six months time, you can't show that revenue in your accounts until that work is done six long months away. If you sell a deal that bundles software services with the product sale, then it's hard to avoid the revenue from the software sale also not being recognized for six months. This is a considerable incentive to a product vendor to ensure there is a bright line between the software sale and any delivery work - having a separate services provider helps keep that line clear.

The complications of a growing a delivery arm compounds once that delivery organization has to integrate products from multiple companies. Now a product vendor finds that not just is there all the risks involved with their own familiar product, but extra risks from other companies, some of which may be involved in competitive relationships.

Certainly product vendor companies commonly make an attempt to build up a services arm, since that way they get a deeper relationship with the customer. And most customers would rather work directly with the product vendor, since that way they have a more direct line to the product vendor should things go wrong. But the common pattern seems to be that such efforts don't usually last long, as the product vendor runs into the problems I described earlier, and pulls the plug on the effort. (IBM would be a notable exception to this pattern.)

Service providers, of course, are used to the business model of billing for professionals' time, and are also used to the complications of managing projects and client relationships. The appeal of a partnership for them is more defensive. When competing for an product installation engagement, customers naturally look for expertise and connection with the software product. A partnership arrangement provides that assurance, and lacking it raises questions.

Product vendors look for dedicated staff with certifications

The number of staff in the service provider that are dedicated to the product is an important part of the relationship. Most product vendors have some kind of certified training program in the product. The quality of these programs is often poor, thus acquiring a bunch of certifications often doesn't correspond with competence for the task at hand. Even a well-run training course will tend to focus on the quirks of an individual product, rather than broader technical principles which are usually more important. Building software requires lots of decisions and this kind of training is not likely to discuss superior approaches that don't involve the vendor's product. Certification targets often appear in partnership arrangements, indicating how many staff from the service provider have various levels of certification. Certified training is revenue for the product vendor, an indication of the commitment of the service provider to the relationship, and, even with all the common flaws, ensures that these staffers have at least a basic knowledge of the product features.

Some partnerships involve commissions

Some partnership deals involve commissions - which can go either way. A service provider that sells work, either the initial project or follow-on work to install additional modules or projects, may earn a sales commission on the software sale. Similarly a product vendor that introduces a services company may earn a commission on the service company's billed hours. Some service providers make a commitment to not being paid commissions in order to preserve their client-focused advisory services. This is easier to sustain if they have significant work with several competing software vendors.

But financial incentives exist even without explicit commissions. Software vendors typically rank service providers by allocating revenues that they feel the provider has influenced. This ranking will play into their referrals and providing the service provider access to (and perhaps influence on) product plans and technical support. Similarly leaders of a service provider's division that works with a product vendor will be assessed on how much billable work they sell and the margins they sell that work for.

As well as delivery work, partnerships often involve joint sales and marketing campaigns, attempting to take advantage of both companies' product positions to generate more sales for both. It seems, however, that these efforts usually don't lead to much. Nobody believes the go-to-market plan until the first deal is made. Even then there is often little trust between the organizations. If a deal like this works, it's usually due to an unusual circumstance, often based on a particularly good working relationship between the people involved. Both sides have to recognize that they are dealing with only one part of the partner organization. Other parts of the service provider will not want to jeopardize their client relationships just to sell some product-based delivery work, other parts of the product company don't want to damage their relationship with other service providers. As with so much in business, how smoothly the partnership works is primarily a function of the personal relationships of the leaders involved in the partner organizations.

Is a service provider faced with conflict of interest?

Service providers are hired both to carry out implementation work and to give advice. This advice includes what modules of a complex system to implement, and which products should be chosen to support a business function. Whenever a provider gives this advice, they should consider the customer's best interests. But partnerships with product vendors introduce a conflict of interest. This conflict is most obvious when sales commissions are involved. It's hard for a consultant to advise against a product that brings in revenue if that forgone revenue comes up during annual performance reviews.

Even without an explicit sales commission, partnerships can have an influence. Vendors do rank their service partners based on how much revenue they are have influenced. Advising customers against a partner's product will lead to a reduced level of partnership, which may harm sales prospects elsewhere.

My sources who worked with large service providers felt that this was mostly a non-issue. They pointed out that most advisory work of this nature was done by different divisions the service provider to those that managed the partnership. If a service provider has partnerships with multiple competing product vendors, then the inclination to spin advice is much reduced.

Large service providers look for exclusive deals with small product vendors

So far, I've concentrated on the case where we have large service providers partnering with large product vendors. Once we start looking at differently sized corporations, then some changes appear. The biggest shift is on exclusivity. The smaller partner matters less to the larger partner, and so often signs an agreement that they will work exclusively with that partner, at least for some subset of the overall market (a business sector, or geographical area).

The purpose of the deal changes as well, at least for the service provider. There's no market force that makes a small product vendor mandatory for the service provider. So the reason to partner with one is if they feel the product gives them an important edge in their services business. By having exclusive access to that edge, they can compete better against other service providers in that market segment. The service provider will often look to build a suite of smaller products and market their experience in integrating them with many customers.

The larger service provider can also wield more influence over product strategy, prioritizing features the service provider thinks are important for its clientele. They can also get a higher priority for technical support.

On the product vendor's side, the reasons for a partnership are similar to larger companies, but with a higher weighting to the sales and marketing side. Setting up a sales and marketing organization is expensive, especially if you are selling to large enterprises. A service provider already has the right contacts, so if you can impress them with a unique capability, then they will do this work for you. You lose direct access to these customers, and supporting the service provider can be a lot of work, but for most companies it's the better deal to do. Customers are often wary of small product vendors, as they are concerned that they may not last. Partnering with a large services firm reduces that risk (or at least the perception of it).

Large product vendors similarly want exclusivity with small service providers

Unequal sizes work the other way too. While smaller service providers don't have the existing reach that the big companies do, the product vendor can gain by getting a much greater degree of alignment from the service company. This alignment often includes exclusivity ensuring the service company is a advocate for the product. It may include language that makes it a firing offense for employees of the service provider from criticizing the product. This close relationship is likely to lead to a more energetic sales effort from the service company and the ability for the product vendor to take a larger slice of their consulting fees for referring customers to them.

The impact of the cloud

The rise of the big cloud vendors, (Amazon, Google, and Microsoft) extends the scope of partnerships with service providers. This is particularly relevant to those developing custom software. Partnership arrangements have been around in this sector for a while - notably partnership with Microsoft in the use of their development stack, and with the big database vendors. But there was also considerable scope for using open-source tools, which avoided any need for vendor partnerships around languages and frameworks.

With the big clouds, this is no longer the case. Custom software is increasingly designed to run on a cloud vendor's stack, requiring detailed knowledge of the services available and how to use them effectively. There is much to be gained by moving infrastructure management to companies that are specialized in doing it well, but their influence reaches everyone involved with software. It's almost impossible for a service provider to avoid the need to engage in a partnership with at least one of these vendors.

The cloud business model adds an extra twist for the financial aspects of partner assessment. With software vendors, revenue comes primarily for licenses, once the license fee is paid, that settles the revenue aspect. But clouds offer a pay-for-usage model. Since, even without commissions, service providers are rated by how much revenue they generate, it sets up some tricky incentives. If I'm designing a system that processes alerts from lots of sensors, do I program the sensors to only send alerts to the cloud to reduce processing costs when my partnership with the cloud vendor encourages me to send all the signals there?

What this means for the customer

If you're a customer of either service providers or product vendors, you'll need to understand how these partnership deals work. Indeed it's expected of you. I asked one source about the question of whether a service provider's partnership with a vendor was a conflict of interest when they gave advice to their customers. They answered by saying that since customer CTOs knew how this game was played, they didn't need to worry about any such conflict.

Transparency is a vital first step. Customers should insist that partners make the terms of their partnership clear, so the customer can judge how the partnership is in the customer's interest. If there are any sales commissions involved, these should be disclosed to the customer so they know how to interpret statements from the partners - this is essential if the service provider is working as an adviser that has influence over adoption and scope of the product vendor's wares.

My sources who've worked in large service providers didn't consider partnerships led to a conflict of interest since they partnered with several competing vendors. If I were a customer, I would be skeptical. In particular I would need to know the nature of their partnership deals with various product vendors, and be wary of any advice concerning non-partner product vendors that are competing with partners.

When partners are working on a project together, it's important that it's clear what each partner is responsible for and how they are going to resolve any disputes. This allocation of responsibilities should be clear to the customer, so the customer knows who to go to resolve any problems. If there aren't clear lanes of responsibility, that should be a red flag - if these things aren't sorted out early things will only get worse should the effort run into difficulties later.

The pressure from product companies to require service provider staff attend certified training can lead to staff who may be familiar with the surface features of the product, but not the underlying technical principles. This can lead to a surface competence, that in turn leads to a less effective delivery. Customers should be wary of judging competence via certifications, and instead probe for staff that understand technical issues in more depth - enough for them to be able to build alternatives to products in appropriate circumstances.

A wise service provider or product vendor realizes that to ensure long-term success for their work, they need to focus on improving the customer's performance in their work - not merely shipping product or selling people's time. As the current zeitgeist has it - they need to focus onOutcome Over Output. It is, however, difficult to set up organizations to do this. A service provider typically bills by the employee-hour (output) - which isn't very well aligned with a customer outcome. The reason this happens is because it's much harder to come up with any kind of financial measure that's tied to outcome, let alone to allocate the vendor's contribution to that. If this is a problem for direct customer relationships, it's even harder for product-service partnerships. The inevitable result is that the core assessment of the success of the partnership deal is based on product-service output, and customer outcome gets pushed even further into the background. Any energy that either of the partners might invest in understanding customer outcome is reduced as the partners worry about managing the partnership.

Service-product partnerships have been part of the IT world for decades, but the rise of cloud computing makes them more prominent. Any software service company has to figure out how to work with the major cloud vendors, and that will usually result in a partnership arrangement. Customers need to be aware of this, and demand transparency from both service providers and their cloud vendors. As the businesses become increasingly digital, they need a clear understanding of how their critical suppliers work.

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