Published for the week of December 06, 2004 CRN by John Roberts and Timothy Long

The coming year could be dubbed the season of the niche for solution providers in the small-business market. While the 2005 technology spending outlook for the small-business sector IS somewhat clouded, solution providers that focus on bright spots in technology spending have an opportunity to achieve steady growth over the coming year, according to CRN research.

“It’s still a bit of a mixed market out there,” said Bob Whiton, president of Net Solutions, Tustin, Calif.

Whiton has adapted to the market by moving aggressively into managed network and security services, a strategy that has helped the solution provider maintain steady growth over the past year and prepare him for whatever may come in 2005.

For one thing, moving away from a fee-for-service and contract business model has helped Net Solutions cope with the uncertain economy. Whiton said it has been good for both his company and his customers because it encourages predictability: Net Solutions gets a predictable, recurring revenue stream, while the customer can more accurately predict IT expenses.

“The gee-whiz element disappeared a long time ago,” Whiton said. “Customers want to see ROI.”

For another, security will continue to be a strong specialty area for Net Solutions and other network integration firms. The CRN Business Spending Survey, conducted in October, showed that security will remain the No. 1 priority for small-business owners.

“Customers are willing to pay for anything that protects their data,” Whiton said. The “security issues du jour” for small businesses include antivirus, intrusion detection, firewalls, hot-site replication, fault-tolerant architectures and backup solutions, he said. “It’s at the point where they can’t ignore their security needs anymore, and there’s a real willingness to spend and do it right.”

IT security is a do-or-die issue for small businesses, agreed David Sockol, president and CEO of Emagined, a security solution provider in San Carlos, Calif. “It only takes one compromise, one flaw, to shut down a small business,” he said. “Security truly is a key foundation to building or growing any small business today.”

Small businesses also placed Web services and wireless technology among their top three Internet-related spending priorities. But in general, hardware and software ranked even higher. Storage, networking and desktop PCs are all likely to see solid growth rates over the next two quarters, the survey indicated.

While focusing on ROI and remaining careful about spending, small businesses have been loosening up their IT purse strings in certain areas and are likely to continue doing so with increasing confidence in the year ahead, the research found.

As with many solution providers, Decisive Business Systems, Pennsauken, N.J., has been seeing what COO Pete Busam described as “a pretty good increase” in spending among its smaller customers. “Forty percent of our work is supporting organizations with 50 users and below,” he said.

The survey also identified five technology categories that offer the best opportunities for channel sales growth over the longer term. These include CRM, VoIP, notebook PCs, Unix servers and access to legacy systems.

In each case, the level of spending priority in these categories was higher in October than in July and higher than the level the prior year. This indicates that these categories are not only increasing in importance to small businesses over the near term, but that their level of importance is rising over the long term as well.

Busam said his VoIP business has increased noticeably in the past six to eight months as SMB customers gain more trust in the technology and understand how cost-effective it can be.

SPINNAKER NETWORK SOLUTIONS, a CRM consulting and services solution provider in Irvine, Calif., is enjoying “phenomenal” growth as customers outgrow their initial CRM deployments and move to more mature systems, said Mitch Cannady, president and CEO.

“Customers want more complex and mature functionality,” Cannady said. “Now that they’ve got the basics done, they’re saying, ‘Let’s take this to the next level.’ ” This, in turn, results in higher integration requirements, he said. “Integration is, by far, the fastest-growing part of our business,” he said.

Optimism among solution providers isn’t just confined to niches and specialties. Sixty-five percent of solution providers surveyed by CRN in September expected their overall sales to rise at least 6 percent during the fourth quarter of this year.

Yet the October CRN Business Spending Survey also showed ample reason to avoid being carried away by the optimism. Overall, sales trends in the small-business market will likely mirror trends in technology spending growth in general, which CRN believes will be slower next year compared with this year.

Persistent high energy prices could trim economic growth by capping consumer spending as people are forced to spend more on gasoline, natural gas and heating oil.

In addition to consumers, companies of all sizes—particularly small businesses—are directly feeling the pinch of higher energy prices, leaving less money available for technology spending. Moreover, as the small-business technology refresh cycle continues to mature, it will provide less of a boost to overall channel sales.

That said, CRN sees no major sales slowdown. The small-business market should remain lucrative for solution providers. But they will need to hone their sales strategies as the overall growth of small-business spending slows by identifying and focusing on those technology niches more likely to offer higher-than-average growth rates.

Emagined’s Sockol said ROI is becoming “an increasingly important discussion point” with customers. “Spending is starting to increase,” he said, “but only when we can show that ROI.”

Month to month, there was a slight decline in the percentage of small businesses that said they expect to increase their technology spending over the next 12 months, down to 47 percent in October from 50 percent in July. Still, nearly three times as many small businesses planned to increase their IT budgets compared to those planning to decrease budgets.

The size of the planned budget increases also dipped slightly, but was still significant. More than a third of businesses planning to increase spending over the coming year indicated the increase would be 20 percent or larger. Another 35 percent projected that they would increase spending in the range of 11 percent to 20 percent.

Perhaps more importantly, those small businesses planning to increase IT budgets were highly committed to actually carrying out these plans. According to the October survey, nearly a third of businesses planning to boost technology budgets were “extremely committed” and another 50 percent were “strongly committed” to their spending plans. Moreover, the highly committed group rose from 65 percent in July to 79 percent in October.

Busam said he’s seen strong evidence to support these findings. Sales close faster now, he said, having shortened from 50 to 60 days at the beginning of the year to 35 to 40 days now. “When people are saying they’re ready to buy now, they’re pretty serious,” he said.

Cannady said customers are more decisive because they’re smarter. “Customers are a lot more educated now,” he said. “They’ve typically done a lot more homework before we get involved with them, which is good, because projects move faster now.”

Overall, the October data reveals that hardware and software categories remain a higher spending priority than the Internet-related categories, as has been the case over the past three years. On a scale of one to five, where five means spending is a “high priority” and one means spending is a “low priority,” hardware and software were rated an average of 3.01 in the October survey, compared with 2.88 for Internet-related categories.

These spending priority levels, however, were flat or lower than in the July survey. This is a turnaround from trends in 2002 and 2003, when the relative importance of spending increased between July and October. The overall spending priorities for hardware and software as well as Internet spending were also lower on a year-over-year basis, as the chart shows. These trends indicate some softening in the relative importance of technology as a spending priority for small businesses.

The findings of CRN’s Business Spending Survey are consistent with solution providers’ near-term sales expectations, which are highest in security-related categories such as antispam, antivirus and intrusion detection. Wireless LANs and Web services also rank high when it comes to expectations for sales growth.

But solution providers may be overlooking the longer-term sales opportunities. Each month, CRN compiles a listing of top 10 products that solution providers plan to sell, resell or recommend to their business clients. The most recent list, compiled in October as part of CRN’s Monthly Solution Provider Survey, contains only two of the five longer-term growth categories—notebooks and servers.

CRN also compiles a list of the 10 products and technologies growing fastest in importance to solution providers in terms of sales and recommendations, and only one of the longer-term growth categories—VoIP—appeared on that list in October.

No discussion of the small-business market would be complete without mentioning the role of custom systems. Custom systems hold a strong position in the small-business market for PC hardware. CRN sees no change in this trend next year; if anything, custom systems are likely to tighten their market grip in 2005.

Solution providers catering to the small-business market are increasingly turning to custom systems. Reasons for the shift include frustration with vendor channel programs and ability to provide better customization.

Whether through customization, aligning IT and business goals or delivering ROI, solution providers say staying close to customers is what it’s all about in the small-business market. “As you work more closely together with your customers you become more of a trusted partner,” Whiton said.