Setting the right margins or discounts for partners is one of the questions we get most often. Pay them too much, and you are leaving money on the table; pay them too little, and they don’t have the incentive or budget to invest in marketing and selling your solution.
In this section we will cover three key elements:
- Margin or discount? Do you give them a margin on the actual sales price, or a discount from the list price?
- Discounts for on-premise licenses. This is what partners are most familiar with, and they will view margins on SaaS solutions from that perspective;
- Discounts for SaaS solutions.
Margins or Discounts?
Most partners are going to prefer getting a margin on the actual sales price, because that means that you are sharing any discounts to the end user with them. This can be an option if there is a small number of large, complex transactions that all end up being negotiated.
The biggest challenges with margin-sharing are:
- You get involved in negotiating almost every transaction, because partners will rarely sell at list price;
- Controlling the end-user discount, to avoid partners selling the solution too cheaply. It will be important to provide the partner with a pre-approved discount, e.g., 10%, that they can offer without your approval, but anything more than that will have to be approved by you. This will effectively reduce the list price by 10%, because more partners will give away the discount to every customer that asks;
- In large, complex transactions there will likely be a large services component, which is where many partners make their real money. This means that the price of your solution can become a barrier to them selling their services, and some partners will be tempted to negotiate your price down as much as possible.
In general, using a list price with a discount is the best option. You will always know what you get from each transaction, and it is up to the partner how they price it to the end user. Do they want to maximize their margin from the solution, or do they want to discount it in order to win a large project?
For on-premise software, the traditional partner discount off list price for enterprise solutions is 40 percent. If you are paying your salespeople upwards of a 10 percent commission – the reseller margin might seem high.
Realize that just like you, resellers need to make a profit. Most on-going, successful software companies build a budget that produces a pre-tax profit of 15-to-20 percent. A reseller’s profit margin may not be that high…but they need to make money to survive.
The 40 percent partner discount breaks down as follows:
- 20 percent to cover sales and marketing costs
- 20 percent to cover overhead (office, customer support, billing/collections, etc.) and profit margin.
This explains why a 30 percent margin often isn’t effective for those who invest in sales and marketing. Unless there is a significant services component that generates additional gross margin, it doesn’t give the reseller enough to cover their costs.
The reality is, most resellers don’t invest in sales and marketing – they want you to do the lead generation for them. In which case you shouldn’t be paying them 40 percent.
You may want to consider having two tiers of pricing:
- 10-to-20 percent for resellers that rely on you to do the marketing
- 40 percent or more for resellers who are self-sufficient.
What happens to discounts for Cloud solutions?
With payments coming in the form of subscriptions, is there enough margin to keep everyone happy? Vendors usually look at the equation from their own perspective and decide they can’t afford 40 percent. They go to their partners with an offer of 20-to-25 percent and sometimes less for renewals.
For the partners it comes down to simple math. If they have been selling on-premise software with a list price of $100K and 20 percent maintenance – they get $48,000 when they close the deal if they are getting a 40% discount.
Now, looking at the same transaction, but on a subscription basis, the typical conversion pricing leads to an annual payment of $53,000, with maintenance included. If the partner is lucky enough to get a 40 percent margin from you, and they can collect the first year up-front, they get $21,000. This is why, given the choice, partners will almost always push the on-premises version. Even if they were to get a 40 percent margin on the initial subscription and all renewals, it would take them almost three years before they collect the same amount they would for selling an equivalent on-premise solution (yours or someone else’s).
Many vendors recognize this is a challenge and are offering an aggressive discount structure to attract partners. NetSuite, for example, has a program called SP100 that gives partners a choice if they bring in a contract for two years or longer:
- 100 percent of the first-year subscription, and 10 percent of all renewals; or
- 50 percent of the first-year subscription and 30 percent on all renewals
For most companies, this is not a viable option – they cannot give away the first year’s revenues. However, it does highlight how important margins are to partners. We are seeing that a 50/30 margin for partners that do the heavy lifting of marketing and sales is emerging as an industry norm.
For many ISVs this will seem unreasonably generous. Unlike on-premise software you also have to cover the cost of maintaining and supporting the application – whether it is on your datacenter or on someone else’s – and this eats into your margin, so there is less to share with partners.
This is an unfortunate reality for Cloud solutions. But it is also true that the Customer Acquisition Costs (CAC) can be quite high as well. A good starting point for determining what is a reasonable discount for your partners is to look at your own P&L. As a percentage of revenues, how much are you spending on marketing, sales and customer support? There are very few successful, growing SaaS vendors that are spending less than 50%. If your partners are willing to absorb those costs, you could actually improve your profit margins by passing 50% of the first year’s subscription along to them.
Finding the right formula for partner discounts and margins is no easy task. The key to establishing a “fair margin” for your resellers is to pay them for what they do – and don’t pay them for what they don’t do.
For a further look at how to best manage a reseller channel, you may be interested in the whitepaper “Why Resellers Don’t Sell,” which you can download here.