Solution Providers Face the Cost of Doing BusinessBy Alison Diana | Posted 2006-12-22 Email Print
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The federal reserve has stopped raising interest rates, but for solution providers borrowing money is still a risk.
Even though the federal reserve has stopped raising interest rates, at least for the time being, borrowing money is still a costly proposition.
For solution providers, which work on ever-tightening profit margins, higher interest rates can deal a harsh blow to an organization’s bottom line.
Interest rates affect everything from financing inventory to the ability of customers to purchase solutions, so any uptick in rates can be detrimental to a solution provider’s economic health.
Fortunately for them, solution providers can counter high interest rates by taking advantage of creative programs designed to help grow their businesses while bypassing the costs of borrowing from local banks and lending institutions.
“Our costs are going up,” said Kevin McClung, owner of KPM Computer Solutions, a VAR in Winfield, Kan. “Everyone we talk to is taking a hit.”
Even though in recent months interest rates have stabilized, they have more than doubled in the last three years. The prime rate—that which banks charge their most creditworthy borrowers—was 8.25 percent on Nov. 1, 2006, compared with 7 percent one year earlier and 4 percent in 2003, according to MoneyCafe.com.
On Jan. 1 of this year, the prime rate was 7.25 percent versus 5.25 percent 12 months earlier, according to the financial portal.
“People are thinking twice about borrowing money today,” said Bruce Zanca, senior vice president and chief marketing/communications officer at Bankrate, a North Palm Beach, Fla., aggregator of financial rate information for consumers on more than 300 financial products, including credit cards; automobile loans; money market accounts; certificates of deposit; and checking, ATM and online banking fees.
For the IT channel, in particular, the effects of any increase in the cost of borrowing are immediate, say industry executives.
“For the reseller channel or business partner channel, an increase in interest rates is going to have an impact on all their business models because the cost they’re going to have to pay for working capital is going to increase. Many of these businesses, especially in the distribution area or those resellers that sell primarily online or on the phone, have very thin profit margins they're running on,” said John Callies, general manager of IBM Global Financing, in White Plains, N.Y., who manages a portfolio of about $36 billion.
“As interest rates go up, clients buying equipment, software and services are going to be more challenged to figure out a more cost-effective way of paying for it,” said Callies.
Where the Bucks Are
Luckily, solution providers can leverage the generally larger bank accounts and credit lines of the multimillion- or billion-dollar organizations with which they do business, and those include the finance divisions of such giant vendors as IBM and Hewlett-Packard, as well as distributors such as Ingram Micro, Tech Data and Synnex.
“A lot of vendors are really pushing their financing programs. As much as it is for interest rates, it is also about spreading payments and getting people over the hurdle,” said Skip Tappen, vice president and general manager of managed services at NWN (previously Netivity Solutions), in Waltham, Mass.
One popular financial resource available to solution providers is inventory financing or floor planning, whereby a distributor or other finance group does not receive payment on product for 30, 60 or 90 days. This gives the VAR the opportunity to collect payment from its client before shelling out money to a distributor or vendor.
“That gives business partners a significant amount of working capital to run their business,” Callies said, noting that in the first half of the year, IBM’s Global Financing group grew about 15 percent versus the same period in 2005.
Solution providers also can leverage their clients’ credit by tapping into accounts receivable financing. In this case, the customer is directly billed: The cost of the product goes to the distributor or finance company, with the balance, which constitutes the profit margin, going to the channel company.
“The fastest growing business for us is financing to end users, followed by the inventory financing and accounts receivable financing,” said Callies.
Leaping for Leasing
As interest rates rose in the last three years, leasing, a financing option that had not had much traction in the channel, started to become more popular.
Enterprises and the solution providers that serve them as their IT trusted advisers have been embracing leasing as a cost-effective option, said Peter DiMarco, general manager of sales at Ingram Micro, in Santa Ana, Calif.
“When you look at rising interest rates, there’s more strain from a working capital standpoint,” said DiMarco. If there is more pressure in the future as a result of further interest rate hikes, he added, businesses will want to make their costs as predictable as possible.
For this reason, distributors such as Ingram Micro have invested heavily in educating their channel customers about leasing, DiMarco said. “We think there’s an opportunity to aggregate leasing. VARs who select partners today have to understand leasing because it will enable them to be competitive. The majority of high-value, high-impact VARs have leased a transaction in the past [and] a strong portion have a leasing portfolio in their business.”
Next Page: The power of leasing.
Managed services, a recurring revenue business model that is increasingly popular with VARs, lend themselves to leasing, said DiMarco. Channel experts say that leasing IT equipment, in what has become known as “hardware as a service,” rather than buying it outright, goes hand in hand with managed services, and even though the practice remains limited, it is growing.
“As managed services evolve, leasing will evolve as well,” said
DiMarco. NWN, a provider of managed services, is investigating several finance
options, said Tappen. “We are talking with some banks about bundling financing
products and refresh products, so it is all part of the price. Customers need
new servers every two years and desktops every three, so they could build it
into their budget schedule and plan and then [adjust their leasing arrangement]
to refresh that. We could build it all into their monthly fee. That idea came
from the bank: They approached us, and we had been talking about it. It has
a lot of value to it, honestly.”
Don’t Bank on It
Of course, local lenders and national banks are an alternate source of funding,
but since they generally are not well-versed in the technology industry—especially
those solution providers and MSPs (managed services providers) that primarily
sell intangibles rather than physical products—typical banks usually are
leery of the channel’s finance needs, said industry executives. Even so,
there are exceptions, as in NWN’s case, when banks with enough knowledge
of the channel’s inner workings can be proactive.
More often than not, though, solution providers turn to the very vendors that sell them products for a hand with financing.
“The bank’s business is different from our business,” said Keith Kendall, vice president and managing director, Americas, of HP Financial Services, in Murray Hill, N.J. “Their business, no matter how they mask it, is to lend money for a certain amount of time for a certain rate. Our financing is far more tailored to the customer and to the VAR. We can create below-market finance solutions for specific situations.”
HP Financial Services, which says it has more than $2 billion in annual revenue and $8 billion in assets, has programs such as leasing and pay-per-use designed to encourage corporations to invest in new equipment without the overhead associated with out-and-out buying. Insurance giant Aetna, for example, reduced its total cost of ownership, improved its IT flexibility and slashed its outlay of capital by leasing, according to HP Financial Services literature. Home furnishings retailer R.C. Willey, on the other hand, saved 20 percent over a traditional lease, HP Financial Services states.
Aside from tapping the financing resources of vendors, solution providers can fight high interest rates simply by having cash. Providers with cash on hand can take advantage of today’s more generous returns on cash deposits at bricks-and-mortar or online banks, said Bankrate’s Zanca.
“Generally companies are guarding their cash right now,” Zanca said. “Cash investments are making more sense now. For short-term deposits and [certificates of deposit], businesses really should shop for the best rates. The worst thing you can do is let it automatically roll over.”
Since many technology companies have cash, this could bode well for the entire
IT sector, said some observers. “If they have cash in the bank, the interest
on that cash goes up and certainly elevates their balance sheets,” said
Don More, partner in Updata Capita, in Redbank, N.J., which operates, advises
and invests in the IT industry.
Invest in Yourself
Another way to fight high interest rates is to borrow from retirement funds, which is possible to do without incurring penalties, said experts. In addition to traditional IRAs (Individual Retirement Accounts), 401(k) plans or money market accounts that invest in companies, several companies offer “self-directed retirement” funding: Instead of investing in an external business, individuals with retirement accounts can use those funds to form or expand their own company, said David Nilssen, co-founder and CEO of Guidant Financial Group, in Bellevue, Wash.
“A lot of people in business don’t have a lot in savings, but they do have a lot in their 401(k),” Nilssen said. “Typically, small businesses look at several methods of funding—credit cards or [U.S. Small Business Administration] financing or a home equity line of credit.”
With credit cards, SBA loans and home equity loans, the higher prime rate means increased interest rates. But under Guidant Financial’s Audeo program, an individual creates a C corporation and then Guidant sets up a 401(k) and rolls the existing retirement fund monies into the new account. Funds from the Guidant-formed 401(k) then fund the business venture, Nilssen said.
“They’re doing a stock-for-cash swap,” Nilssen said. “It’s not subject to cash or penalties. As far as the 401(k)’s concerned, it’s making an investment in a private business.”
On average, Guidant Financial clients have about $150,000 in their retirement plan and are looking to create businesses worth between $3,000 and $11 million, said Nilssen. Within 30 days—and without the costs associated with a broker or lending fees—the process and funding are typically complete, Nilssen said. “The worst thing that happens is they’ve lost their retirement fund,” he said. “But if the business fails, you’re going to pay somehow.”
That is because, of course, loans are not forgiven, whether they come from the SBA or a local bank. And with a home equity loan, business owners face the potential of losing their residence.
Risks are unavoidable, so experts recommend that solution providers select the least risky financing paths to ease the pain of rising business costs. As for interest rates, experts said they believe a plateau has been reached for the time being.
At its most recent meeting the U.S. Federal Reserve decided to leave interest rates alone. Experts believe the Fed may continue to take that track in the near future, though fears of inflation could trigger more rate hikes.
Whatever happens, experts recommend solution providers keep a good handle on their cash flow, as well as on that of their customers.
Alison Diana is a freelance writer and editor based in Merritt Island, Fla.,
and has covered the channel and technology for almost 18 years. She can be reached
Getting Around High Interest Rates
Solution providers have a multitude of options that can help them keep their
cost of doing business under control. Here are some ideas:
* Comparison shopping Look around for high interest rates on any type of savings account
* Customer contact Involve the customer with finance experts from distributors or vendor finance companies to help the customer come up with end user-based funding or financing
* The lease alternative Consider leasing products or services, rather than selling, to defray interest rates
* Retirement plans Look into alternate funding, such as self-directed 401(k) plans
* Talking it out Distributors and vendor finance companies have an array of flexible finance programs to help solution providers afford and win deals
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