Combat Falling SAN Margins

VARs involved in the SAN (storage area network) market are starting to see the classic good news/bad news scenario. Let's start with the good news. SANs are finally making their way into midsized companies, which is primarily the result of decreasing hardware prices. In the late 1990s, a typical SAN installation could cost a company $750,000. Today a medium-sized business can purchase a SAN starting at under $10,000. Greater cooperation among vendors has also caused many of the interoperability problems, which plagued SANs from the beginning, to go away. But, don't start celebrating just yet ...

As hardware prices have come down, so have reseller margins. So if you think you will make a fortune selling SAN hardware alone, you'd better think again. That's the word we get from Richard Baldwin, owner, president, and CEO of Nth Generation Computing, Inc. (San Diego). Baldwin is one of the few VARs who have been selling and installing SANs from their genesis. According to Baldwin, SAN margins are eroding rapidly. That's not good news for many VARs who are just now gaining access to the SAN market. Baldwin believes margins are dropping by one to two points per year. If you don't think that sounds like much, consider this. If you sell 50 SANs a year at an average price of $100,000, a change in margin from 5% to 4% leads to a 20% drop in profit. "Service and support are where the VAR's value is and also where the high margins are," he said. "That is where VARs need to focus."

Baldwin launched Nth Generation in 1987 as a reseller of Digital Equipment Corporation products. In June 1998 Compaq bought Digital, thereby acquiring StorageWorks, Digital's modular storage package. When the Fibre Channel version of StorageWorks was launched, it became one of the first SANs to hit the market. "We saw the SAN trend coming and invested early," said Baldwin. By December 1998, Nth was selling SANs and has now sold several hundred.

Knowledge = Profits
When SANs first entered the storage market, interoperability problems plagued many implementations. When early SAN adopters tried to take advantage of the technology, they soon found there were few storage professionals who knew how to solve their interoperability problems. "Even vendors did not seem to have the necessary skills," said Baldwin.

To get a quick jump on the learning curve, Baldwin purchased SAN hardware for his own company, thus giving his engineers a product on which to train. He then put all of his engineers through vendor training and certification. Because his employees understood the technology, Compaq was soon bringing Nth into some very large accounts, including Walt Disney, Fox, and Southern California Edison. "We volunteered to be a beta test site for Compaq, so we had the equipment before it was even released," he said. "When their SAN was released, we were experts on it, more knowledgeable than some of Compaq's own people in the field.

"When you are trying to instill confidence in the customer, the last thing you want is for one of your people to show up and say, 'Geez, I've never seen one of these things before,'" he said. "I decided early on that our people would not be like that."

Keeping his employees among the most knowledgeable in the industry has not been an easy or inexpensive endeavor. Baldwin has 15 engineers on his staff, and each one receives three to four weeks of training per year. Each year he spends $10,000 to $15,000 per engineer on training courses, which does not even include the associated expenses for travel, lodging, and meals.

Sell Training And SAN Services
But Baldwin will quickly acknowledge that the investment is critical and will be even more so in the future. With the expertise he has in house, Baldwin is able to sell SAN training and services. As SANs continue to penetrate small- to medium-sized companies with limited IT staffs, training and services are required.

Lower hardware prices typically result in a lower margin per unit. Selling training and services is one way to maintain higher profitability. "Both businesses are growing for Nth," said Baldwin. "The training business is growing because many of the companies adopting SANs want to control their own destiny and learn how to take care of themselves. But many end users don't have the resources to do SAN management themselves or just don't want to." In those situations, Baldwin will sell a service contract. "We can put in a SAN and support it for the customer, or we can train them to be self-sufficient. We will get our revenue either way, either on the consulting and support portion or on the training portion."

Working in Nth's favor is the fact that it's very difficult for a company's IT department to keep up with every new advancement in the technology. A customer recently told Baldwin that he simply could not keep up with every new release of every product. Customers like that rely on Baldwin and his crew to evaluate new releases and upgrades. For most end users, it is more cost-effective to rely on an integrator than to keep their own IT staff up-to-date.

"Those customers also want a support agreement, where we would be on call if something goes wrong," he said. "We are the front end support, but also the mediator and referee for all of their disparate systems." A common problem faced by a SAN customer occurs when a server stops working. The server vendor tells them the problem is with the storage; the storage vendor tells them the problem is with the server. The finger-pointing game can waste a lot of the end user's time. "Our people can go in, isolate the problem, and usually fix it as well," he added.

Precertified SAN solutions are currently the rage, but Baldwin cautions that being proficient in just one or two of these configurations is simply not enough. "Most manufacturers have a cookbook solution," he said. "If you use this HBA [host bus adapter] with this switch and with this storage unit, the SAN will work. But if you deviate from that configuration in any way, all bets are off - and they do not want to be called if there is a problem. But today there are many HBA and switch options. Although Brocade has the lion's share of the switch market, some customers prefer Inrange, McDATA, QLogic, or Ancor. That is where our expertise comes in. We know who is on each vendor's product support list. We can tell customers if a certain configuration will work, even if it is not a manufacturer's supported configuration."

The revenue Baldwin receives from training and services has been on the increase. That revenue grew by 50% in 2001 and now accounts for 25% of Nth's total revenue ($6.25 million). Baldwin would like to drive that percentage even higher. "SAN sales are up," he said, "but we have also seen an increase in the number of places where you can purchase one. You can now buy SANs on the Internet and via mail order, and the hardware will continue to become a commodity. Raising additional revenue from training and services will be the biggest challenge SAN VARs will face."

Pick A Niche, Any Niche
For VARs entering the SAN market, the news is not all bad. The percentage of companies that have a SAN is still low, and that percentage is expected to grow rapidly as companies continue to make the move to networked storage. Seventy-five percent of all storage is still direct attached, and the move towards networked storage will create installation opportunities for VARs.

Baldwin believes the key for VARs will be focus and specialization. "Pick a storage niche where you have some area of knowledge or expertise and try to be the best in that niche," he said. "That is what we have done. A few years ago we were licensed to sell the entire product line of several manufacturers. I am constantly looking at our list of partners and asking whether all of these partnerships are worth the investment." Nth Generation currently has six or seven key partner relationships, down from 10 to 15 last year. "I'd rather be the best at what we do in a few specific areas of storage than mediocre in many," he said. "That is where customers see our value. It's a stretch just to try to stay on top of being a SAN expert, let alone in storage, networking, and other areas. If margins continue to erode, selecting a storage niche and selling training and services in that area is where a VAR's return on investment will be."