Computer Industry Treads Carefully

As the profit margins for many computer-related products continue to fall, more manufacturers face the challenge of increasing their sales while continuing to provide excellent service for existing customers and partners. In their quest to increase their market, some manufacturers risk alienating their existing distributor and reseller channel partners by selling directly to larger customers rather than selling exclusively to distributors and resellers.

In order for a computer or related product to arrive from the manufacturer to the customer who buys it, the product goes through distribution channels. In most cases, computer products pass from the manufacturer to the distributor, who warehouses them and sells them to resellers, who installs them for customers. Less than 20 percent of the computer business goes from manufacturer to customer directly, thus bypassing the distributor and reseller. Dell Computer Corp., Austin, Texas, and Gateway 2000, North Sioux City, S.D., are the two largest manufacturers selling all their computers direct to customers, but they remain the exception, rather than the rule. Some manufacturers also deal directly with larger resellers, which cuts the distributor out of the business.

Compaq Computer Corp., the No. 1 worldwide personal computer manufacturer, recently ran up against the conflicting market strategies of its competitors in a deal with state and local government. The Houston-based company signed a $60 million agreement July 10 with the non-profit agency Public Technology Inc. to sell computers directly to state and local agencies over three years. PTI is the technology procurement arm of three municipal organizations, the National League of Cities, the National League of Counties and the International City/County Management Association.

Compaq has tried to make the deal sound sweet to resellers, rather than one that will take away some business. Local authorized Compaq resellers provide the service and support to the state and local agencies. "Compaq is helping resellers gain access to the [state and local] market," said Peter Poulin, Compaq's director, State and Local Government Markets. "For the relatively small volumes that this market brings to resellers, it costs a lot to do business with state and local governments [because the market is so disparate]. There are so many municipalities, it's hard to reach them individually." Poulin thinks the Compaq/PTI agreements will help some resellers to penetrate the state and local market.

IBM Corp.'s $3.5 billion purchase of Lotus Development in June may also spark a battle in a similar vein. In order for the hostile takeover to be a success, IBM chief Lou Gerstner knows he must expand Lotus Notes' base of users. IBM/Lotus have direct-sales forces to sell Lotus Notes and SmartSuite to customers, and new incentives could pit integrators and value-added resellers against IBM's own systems integration and service units, particularly in large accounts. IBM/Lotus have not approved a channel strategy yet, but the large market for Lotus Notes and SmartSuite will probably lead IBM and Lotus to play both ends of the distribution game in order to expand the market for those software packages. In other words, IBM/Lotus will sell software to both resellers and to large corporate customers.

Novell Inc. has had to alter its distribution strategies for the upgrade of NetWare 4.1 to cut out distributors from a significant amount of business. The Provo, Utah, firm has upset its distributor partners by announcing that it will no longer sell competitive upgrades through distribution. Instead, Novell will deliver them directly to resellers' customers and pay the value-added resellers commissions. Novell announced this policy after finding that some direct marketers and resellers have sold Novell competitive upgrades, which are less expensive than regular upgrades, to customers who are not previous licensees of either Novell or any of its competitors. Novell platinum- and gold-authorized value-added resellers will earn a commission of 35 percent on each competitive upgrade made by their customers, and authorized value-added resellers get 15 percent, according to Novell officials.

As Novell's actions indicate, distributors are more often susceptible to channel conflict than resellers. Manufacturers rarely want to offend resellers by dealing directly with customers, since successful resellers have expertise in certain markets and know the manufacturer's technology.

Novell runs the risk of alienating its distributor partners through its recent actions, but resellers will appreciate that the software manufacturer has shown favor to them. According to sources, upgrades account for 30 to 50 percent of NetWare sales through distributors, but it remains unclear how many are competitive upgrades.

In the government market, few manufacturers engage in channel conflict. For many higher end manufacturers who sell complex products to the government, avoiding channel conflict is not only a matter of diplomacy and good customer relations, but also good business sense. After all, more sophisticated products need strong reseller support for the manufacturer to penetrate a strong customer market.

Bay Networks, a $1.2 billion manufacturer of higher-end networking products with headquarters in Billerica, Mass., and Santa Clara, Calif., tries to avoid distribution strategies that conflict. Joanne Acquadro, the firm's federal channel manager, said some resellers prefer to deal with Bay Networks directly rather than through its distributors. Acquadro said her firm always encourages resellers to source products through distributors, because they provide valuable services. "The federal market needs dedicated sales staff at the distribution level, since government agencies are dispersed across the country, and government users have distinct needs."

Occasionally, distributors sell directly to customers, instead of selling exclusively to resellers, but few distributors will admit this. Many distributors behave as though selling directly to customers whom resellers would normally serve is a breach of a sacred oath. The distributors and resellers who provide services to higher-end, more complex systems, have the most protection from channel conflict issues, since the products that they deal with will probably not appeal to a large audience.