I’ve previously discussed selling through VARs as a distribution channel strongly favored (maybe a bit too much!) by many early-stage technology and software companies. In this article, I will look at another “holy grail” channel that is often misunderstood and misused: The Hardware & Software OEM Channel. This channel can pay big dividends. But more often than not, companies aren’t realistic about the potential of this type of partner and what it takes to be successful in working with them. By the way, I realize that some folks don’t like the term “software OEM”, since software companies don’t technically manufacture anything. But I will use it in this article for simplicity.
Let’s look at some important points to consider:
Leverage with a hardware or software OEM
If you approach potential partners too early — without a brand and existing sales — leverage is lost in negotiating with the larger, more established hardware or software OEM prospective partner. In addition, it’s a much harder sale, because your company and product don’t have a track record.
Important–but secondary–revenue source
It’s usually best to treat OEM business as an important, but secondary revenue source relative to your own brand. This will keep things in perspective. It will also prevent you from putting your company’s future in someone else’s control other than your own. I have seen some companies who have succeeded with an OEM-only or heavily OEM-centric philosophy. But I’ve seen many more unsuccessful companies who pursued this strategy littering the side of the road to success.
Bundle rather than integrate
There are ways to take advantage of large hardware and software OEMs, without the downside of losing your own identity. One way is to seek simpler bundling deals, rather than private label deals. By doing this you are essentially co-branding. This helps build the power of your brand through affinity with the bigger partner company. This may leave you with greater marketing, selling, and support requirements than a private label arrangement. But it can lead to a larger, more profitable company in the long run.
Address a vertical out of your reach with a software OEM partner
A good way to utilize a software OEM is to fill a key vertical market where your technology has a place, but where you have little or no current presence in that segment. This makes sense when you decide that you currently can’t address this vertical as well with your own brand. In this case, it doesn’t make sense strategically to expend resources to develop a serious presence. So partner with and license to someone who can.
Leverage your IP in a new market
There are also cases where your main technology base can be easily used to create an entirely different type of product. This new product will serve a completely different market relative to where you are selling under your own brand. In these cases, it may again make sense to team with an OEM in this disparate segment. They are better positioned to market this spin-off product that you’ve developed from your main technology.
When a company goes about it the right way, OEM business can be an excellent additional revenue source for startups. Or any software or hardware company for that matter. As I alluded to earlier, I want to throw out one caution flag. That’s when a company decides they are going to rely on OEMs as its primary–or only–channel of product distribution.
Now this can work, you might say. And you would be right. But in most cases, it isn’t the best way to proceed imo. It can work if you have the right type of product and you’ve thought your strategy through very thoroughly. The problem is that with most companies this is not the usual scenario. What I find more prevalent is an old, simplistic approach. That’s “let’s make it and we’ll get someone else to sell it for us”. As I’ve discussed before, ‘let someone else sell it’ almost never works. This sentiment often occurs with a technology-driven senior team. One without direct experience in or a good feel for marketing or sales. The natural tendency is often to avoid the current weaknesses in the organization and “let somebody else do it”.
The problem is that sales and marketing need to be a core competency in almost EVERY situation. That’s if a technology company wants to become as successful as possible.
So what are the “bad effects” when an early-stage technology company pursues OEM relationships as their sole distribution strategy? Or at least when they do it “too early” in their company’s development?
EFFECTS OF “BAD” OEM STRATEGY
No development of internal sales & marketing
Companies with OEM-only business models tend to have weak (or nonexistent!) sales and marketing departments. Again, it’s my belief that sales and marketing almost always need to be a core competency, which makes this a bad idea. You can run a company this way. But in most cases, the ultimate size and profitability will be a fraction of what your technology IP could have otherwise supported.
All push, no pull
Nearly every sales and marketing strategy works better if there are “pull” elements in addition to “push”. When selling to the OEM is almost solely a “push” activity with no brand awareness to help pull the OEM to you — the process is much harder. This is usually the case for a startup tech company.
All your eggs in one basket
Even if you do well and win OEM deals with premier partners, success is far from guaranteed. In my experience, it isn’t unusual for OEM deals to yield actual revenues in the 10-15% range of forecasts. This is especially true with the early-stage variety. That’s because you’re taking a product from a smaller, less developed company. You’re dropping it into the much more established distribution channel of a larger, stronger company. Should lead to huge sales, right? But usually, it doesn’t happen, for many reasons. If this happens to you and you’ve built your company around these projections–you’re basically screwed. You risk “crib death” or at least a difficult restart with your own brand, due to the disappointing sales from the OEM relationship(s).
The hardware or software OEM partner swallows your company whole
A very common scenario is a much larger OEM that starts treating its smaller, entrepreneurial partner like another department in its bureaucracy. The OEM stunts your overall company development, usually unintentionally. They do this by “tying up” the scarce resources of your smaller company in meetings, special projects, and ever-changing product development requirements. And yes–even more meetings after that!
Given the potential pitfalls, how can I recommend using OEM partners?
THE “RIGHT WAY” TO INCORPORATE AN OEM STRATEGY
Develop your own brand/channels first
Pursue OEM business only AFTER you’ve established products under your own brand. It not only will provide you with a product that will be more well-known and attractive to potential OEM partners. But then you’ve got your own branded business to sustain you, no matter what happens with your partner.
Final harvest
Another smart way to use OEMs is to “harvest” a volume product that may soon be heading for decline. This is a product that you don’t intend to continue significant investments in. If you can get such a deal, it can be a great way to maximize end-of-life revenue, with minimal incremental investment.
Offer another price point
A strategy that can be used successfully in some cases (but is a bit dangerous) is to use an OEM to offer another price point in the market. This is a price point that you choose not to address with your own brand. More often you would do this with your own alternative brand or sub-brand. But there are instances where this marketing investment might not make sense. Special care should be taken if the hardware or software OEM is to fill a lower price point rather than a higher one. In this case, extreme care needs to be taken so that your own brand’s share or margins aren’t eroded significantly.
Integration with software OEM complementary products
There are some instances in the marketplace where 1+1 does indeed equal 3. In these cases, it may make sense to team with a software OEM partner to gain the advantages of product integration with their key product in your market. This enables you to offer the market a single, integrated solution. Just be very wary of the “integration project from hell” that goes on forever. One that hen under-performs the forecast, as discussed above.
Summary
The bottom line is that learning to partner with a hardware or software OEM can be a very important part of tech business success. I strongly recommend that almost everyone pursue this type of business, if it appears to make sense after a full analysis. However, I recommend you do it only as part of a balanced, overall revenue strategy. Tread carefully and wisely. If you do, this may be the distribution channel that makes a break-even, or modestly-profitable business into a big winner. It’s easy to say you want OEM revenue. But like most things in business, doing it right is hard. The devil’s always in the details.
That’s how I think OEM strategy best fits into a typical high-tech business. Post a comment and let me know how YOU approach hardware and software OEM relationships. I look forward to your opinions.
Follow Phil Morettini and Morettini on Management via Twitter, Facebook, LinkedIn, RSS, or Subscribe to the Morettini on Management Newsletter hosted by LinkedIn. Contact Phil directly at info@pjmconsult.com
Great insights into software OEM’s Phil! Two other things to consider when pursuing OEMs is the long sales cycle (a year wouldn’t be unusual) and the “low hit rate” (in my experience maybe one in ten delivers significant revenue as expected/hoped). When you do succeed developing a good strong OEM relationship, it can be a thing of beauty delivering low cost of sales and support revenue (strong profits) for several years. As you said, this makes OEMs a good source of incremental business – but building a business with OEMs as the core customer base is very very hard.
Jim, thanks for the excellent additions to the discussion, as always.
Hi Phil –
Good insights. I know you mention it, but I think it is worth emphasizing that the decision whether to pursue an OEM path depends on the characteristics of the market. Some markets (e.g., cell phone, disk storage) are oligopolies where the path to the end customer is controlled by only a few companies. In that case, an OEM go to market approach may be the best way to maximize revenues and company valuation. Pursuing an alternative approach may alienate the large players and they subsequently will not engage.
Marc
Thanks for the additional comments, Marc, all very true and useful.
Hi Phil, great and insightful article again. However whist I fully identify with what you say (along with Jim & Marc and the awareness they bring) in a sales only silo, as a CEO with other considerations, particularly an exit strategy, it might be the major (only?) activity a company needs for the investors to achieve a high ROI (value & time). That is, if it’s the right product, with the right OEM, and low cost of sales. If the market is diverse, the agenda longer term and independence the goal, then your article increases in value.
John, totally get what you’re saying. Certainly this is the type of activity that can make an exit happen or bigger and better. The only caution I’d add is that I’ve seen a lot of CEOs chase a major OEM with an exit in mind, when the timing or partner wasn’t right and it fails miserably. Sometimes eagerness for an exit (or bigger exit) clouds business decisions to the extent that a company tries to do things that aren’t really the best thing for the business at the time. But with that caveat, I agree with you.