How to Determine the Right Margin to Share with your Partners?

Defining this key attribute of a Partnership Strategy doesn’t need to be Rocket Science

When defining a partnership strategy, the distribution of value among the parties is one of the most important elements to consider.

When it comes to a vendor and their channel partners, this is usually defined by a margin, which is the difference between the cost at which the channel partner purchases goods or services from the vendor and the price at which the channel partner sells those goods or service to the end customers.

This margin represents the gross profit that the channel partner earns from selling the vendor’s products or services, and it’s usually calculated as a percentage of the MSRP (Manufacturer Suggested Retail Price).

This is one of the key elements in any Partner Program, determining which incentives, resources, and support the different types of partners - distributors, resellers, system integrators, and service providers - will receive from the vendor.

A Partner Program is a business strategy implemented by a company to create and manage relationships with other businesses or individuals (partners) who can help the company sell its products or services.

Determining the right margin to share with their channel partners is not as straightforward as it seems, and many vendors new to the partnerships world, tend to underestimate its relevance.

The answer to “Why our partners aren’t selling enough of our products/services?” tends to be directly related to the margins the vendor is setting for their Partner Program, even though it’s not always the first place partnerships team look to understand what are the challenges they are facing to develop a partnership strategy that generates value to their companies.

If you are familiar with the Value-Based Partnerships Strategy, you’ll know that Margin is one of the three elements that determine the success or failure of your partnerships, with the other two being the Effort and the Delight.

The relationship is clear: The margin that channel partners receive from the vendor needs to be enough to cover for their effort and provide them with enough delight so they will be willing to partner with a manufacturer.

How to Setup the Right Margin?

There are several factors a vendor should consider when setting up the margin for their channel partners. Competitors’ margins are a relevant benchmark and starting point, but simply copying them is neither enough nor the right approach.

While it's expected that a vendor will want to retain the majority of the value for themselves and setting up margins as low as possible, focusing solely on this will already set the wrong course for the partnership strategy.

Any vendor that is expecting to develop an indirect model based on channel partnerships needs to take an approach that ensures the highest possible capture of value for their partners. Two factors must be considered: the Serviceable Addressable Market and the Price of the vendor’s products and/or services.

The Serviceable Addressable Market (or SAM) is the portion of the Total Addressable Market (or TAM) that a company’s products or services can serve. It takes into account the company’s business model, geographic reach, and specific product features that align with the needs of a subset of the overall market.

The combination of the Serviceable Addressable Market and the price will determine the actual gross profit the channel partner can make through the relationship. A 20% margin on an opportunity worth 10,000 euros per year is not the same as a 20% margin on an opportunity worth 1,000,000 euros per year. This will determine how relevant the alliance will be for the channel partner and how much effort they will be willing to put into it

Depending on the type of vendor and their experience with partnerships, the process to determine or update the margin in their Partner Program will drastically differ, considering a varied number of steps, data points and tests. In my case, I prefer to follow simpler approaches, as I will show you below.

Starting Simply

I personally use a very straightforward tool when I want to understand what would be a “good" margin for a channel partner.

The first step is to know what would be the Average Customer Value, and the second step is to understand how many customers we can expect a channel partner to acquire in a specific period of time (i.e., a quarter or a year).

The number of expected customers will need to be a small portion of the Serviceable Addressable Market, as we cannot expect that one channel partner will be able to serve it all within the first quarter or year.

The average customer value should be defined based on our historical performance, if available, or our expectations and knowledge of the market. It will determine how much we can expect a typical end customer to pay for our product or service.

With those two factors in place, we can build a table like the one below, that will show us how much value the channel partner could capture depending on the different margins and the different number of customers.

If we expect our average end customer to pay EUR 1,000 per year for our products and services, we can see the gross profit the channel partner will make depending on different margins and potential numbers of customers.

Now, I have a question for you: After reviewing the table above, what do you believe is the right margin to motivate a channel partner to sell a typical B2B software product at the price point we have defined? Not easy to answer, right?

If the vendor sets the margin at 20 %, a typical channel partner will need to sell their products to 100 customers, within the first year, to generate a gross profit of EUR 20,000. In the vast majority of large markets, that doesn’t even cover the salary of a sales representative, and successfully closing that amount of deals is above the possibilities of many of them.

Of course, if the effort is low and the potential for delight is high, that margin could be enough, for instance, if the product or service is easy to sell as a complementary product of something the channel partner is already offering to their end customers, but even so, the vendor won’t be  able to expect a high willingness to partner under those conditions.

Using the above table, we can clearly see the challenges the vendor faces:

• Find ways to provide higher margins, which can be impossible due to their own needs and costs;

• Consider to increase their expectations on the number of expected new customers, something that channel partners might not be able to deliver, or;

• Review their pricing and partnership strategy altogether.

That’s the power of straightforward yet powerful tools: they give you clear answers quickly; this way, we know exactly what we need to work on to set the right margin for our channel partners.

The above exercise will show a vendor how their strategic choices (pricing, markets, channel mix) will determine the margin they can give to their channel partners, and hence already set the course for the potential results of taking an indirect route to the market by implementing a partnership strategy.

Going Further

This approach to understanding the potential margin for a Partner Program will show, even before starting, if a partnership can be successful or not.

If the maximum margin that we can provide to a partner combined with the potential serviceable addressable market won’t generate enough gross profit for the channel partner - or will not cover the effort they are expect to dedicate to work with the vendor’s products or services -  something will need to be adjusted.

This will require different approaches and additional effort from the vendor to increase the serviceable market through business development and marketing activities, reduce the effort for the channel partner by making it easier for them to commercialise the solution or become more efficient so the vendor can offer a higher margin to their partners.

In some cases, it is the pricing strategy what requires review, as there might be space to charge more to the end customer, and generate that way more value for both vendor and channel partner.

The goal needs to be to help the channel partners capture the most value so then the vendor can generate the most as well. The margin is one of the several elements, alongside effort and delight, that needs to be considered for that, as the Value-Based Partnerships Strategy framework shows.

If a vendor is asking themselves why their partnership strategy isn’t working, reviewing their margin strategy, assessing the profit their channel partners can make, and considering the effort they need to invest will help them understand what to do to design and create partnerships that create value and delight for everyone involved.

And all of this can be done with a straightforward tool like the one I shared above.