Learning to Love the Channel

A Comprehensive Guide to Startup Channel Sales

I’m increasingly meeting founders who are organizing their sales strategy around channel sales, and for good reason. So what is the “the channel” and why should founders care?

Take Microsoft for example. With 7,500+ new partners joining their ecosystem every month, Microsoft earns 95% of its commercial revenue through partners. Microsoft is channel-led for any customer that has fewer than 250 employees; their channel business accounts for 95% of their revenue. Or look at Hubspot, Salesforce, and Hashicorp.

HubSpot notoriously turned marketing agencies into a lucrative channel that now accounts for 36% of their total customers. Systems Integrators (SIs) are so valuable to Salesforce that the company created a $50M venture fund to invest in newly-formed SIs. Some estimates suggest that HashiCorp sources one-third of its revenue from AWS partner referrals. So what are channels and how can startups use them to grow to the size of Microsoft?

For channel selling to be effective, founders must first consider where their product might achieve channel-market-fit and understand the various channels. While the definition of “channel” varies widely, most companies organize their channel programs according to three main areas: resellers, service partners, and technology partners (including OEM partnerships). I’ll break things down along similar lines here.

Resellers

In a software context, these partnerships often start as referrals where a third-party might point customers toward your product or service and earn an affiliate fee up-front or a small percentage of the transaction for doing so. As a partner demonstrates viability as a source of revenue, a co-sell model is a savvy next step whereby the partner and your sales rep sell the product to the customer in a joint motion. Put simply: They’re both on the customer call.

It’s usually at this stage that a company might consider a resell model. Resellers literally resell your software to businesses. They earn a commission from the transaction by purchasing your software at a discounted price and reselling it for a higher price.

Example: You normally sell your software for $100 and offer it to resellers for 20% off your list price. Regardless of the price at which they sell it — $70 or $700, you receive $80 (20% off list).

The other pricing approach is revenue sharing. In this model, you negotiate a percentage share of the final customer price with the reseller.

Example: You normally sell your software for $100 and negotiate an 80% revenue share model meaning you earn 80% of the end-customer price. If your partner resells the software for $70, you receive $56. If they sell it for $700, you receive $560.

Resellers either own the customer relationship directly — creating an indirect relationship for your businesses — or act as an agent whereby they sell the software on a company’s behalf to establish a direct customer relationship for your business. The tradeoffs between direct and indirect largely manifest in who supports customers when they have issues.

The advantage of starting with referrals and co-sells before moving to a reseller model is that these structures are much easier to implement. They also provide optionality such that you can determine if indirect sales channels warrant the investment.

When to use resellers: The easy method is applying a market maturity test. If you’re selling a product in a known category, resellers are great. Conversely, resellers aren’t a great fit if you’re undertaking category creation. Here’s why: While many businesses rely on resellers as trusted advisors, resellers are largely outsourced procurement departments. They manage the tasks associated with finding the best products according to their clients’ budgets and use case requirements. For example, your customer prospect requests an analytics tool to which the reseller recommends a product from this category. If your competitors’ products or those that are closely complementary transact through these channels, then you should give resellers serious consideration. If the market does not currently conceive a category for your product, then stick to direct sales until the market matures.

Systems Integrators (SIs)

SIs help customers design and implement technology strategies. For example, a company might hire an SI to migrate to the cloud or digitize an experience for their customers. Your product might fit into one of these initiatives and cause an SI to recommend purchasing your product as part of the engagement. These partners range in size from boutique operations to global consulting firms like Accenture and Deloitte.

Software companies often rely on SIs as “outsourced” professional services. Rather than create a services organization to help businesses implement their products, they rely on SIs to support these implementations. Your customers pay the SIs directly, and no money would change hands between you and the SI. The downside of this approach is you’re putting the probability of successful implementation in the hands of the partner. On the other hand, there are a few benefits:

  • Your product could be part of a larger initiative, so you avoid the tension of “scope creep” where customers ask their vendors to help them implement other technologies.
  • An in-house professional services team scales according to the rate at which you’re able to hire people. These roles tend to be technical and challenging to hire.
  • Enter the referral flywheel. As you recruit SIs to implement your product, they’ll start introducing your products to their clients.

When to engage SIs: If the word “deployment” describes how your customers might get started with your product, you should consider bringing in a partner. One exception is if access to your internal tooling or systems is necessary for customers to get started. If you’re building a SaaS business — where negative retention defines the success of your business — you want to double-down on strategies that ensure your customers successfully adopt your product.

Technology Partners

Tech partnerships usually correspond to product synergies (I went to business school, and even I hate that word), meaning together both products are better. These synergies most often manifest via product integrations or complementary use cases. Money seldom changes hands with these types of partnerships nor do they require contractual agreements — “I like you. You like me. If we work together, our customers will be happier and perhaps lead to us capturing more value.”

At first glance, these partnerships are appealing, especially when you’re dealing with a well-established software company on whose coattails you hope to find success. More often than not, these partnerships are a distraction, unless the following structural elements apply:

  • Your product expands your partner’s addressable market or alleviates one of their top 3–5 customer objections they experience when selling.
  • Your partner’s sales leadership has bought in and committed to investing sales resources (training, compensation, co-marketing, etc).
  • Your partner’s sales reps can easily describe your product and communicate how it complements theirs.
  • Your product fits into an existing sales motion. This isn’t as obvious as it seems. For example, if your partner sells application software and you provide software infrastructure on which that application would operate, it’s unlikely that the sales reps would initiate a conversation about the infrastructure layer.
  • There is a natural product use. For example, Segment, a previous company I worked at, connects data from where it’s generated to hundreds of 3rd party tools where it is utilized. The partnerships formed with these 3rd party tools are intrinsic to the value proposition and Segment’s strategy given the nature of the product.
  • Your partnership isn’t one of many. Mindshare among sales reps is hard to command, so if you must compete for mindshare to succeed, that energy might be better focused elsewhere.

When to partner with other technology companies: Other than ensuring the criteria above are in place, think hard about the ROI. If the cost of a partnership is a press release and some shared marketing (webinars, email campaigns, joint landing pages), then the input costs are low for some of the perceived “better together” benefits. On the other hand, if the partnership requires engineering work or dedicated headcount, then carefully weigh the costs against the potential upside. “Upside” has many versions: increased product usage, better customer engagement, improved retention, incremental revenue, etc.

All bets are off if you can incubate a technology partner ecosystem. The product with the best ecosystem will almost certainly beat the best product in a market. The founder of RJMetrics admits this plainly when analyzing the $2.6B outcome of his former competitor, Looker. Salesforce’s dominance continues due in large part to the breadth of their partner ecosystem.

Marketplaces (Technology Partners Part 2)

The big independent software vendors (ISV) all have marketplaces: Salesforce, AWS, Google, Microsoft, etc. If your product sits adjacent to one of theirs, you can expect to receive a call from a partnership manager suggesting you list your product in their marketplace. Many of these ISVs have dedicated teams larger than your company that are fully dedicated to helping their sales reps discover and promote your product. They will even extend marketing dollars (industry term = Market Development Funds or MDF) for you to deploy.

Think of these marketplaces as app stores for businesses. You list your product in a vendor’s marketplace, their customers discover and purchase via the marketplace (usually riding an existing service agreement), they keep a percentage of the transaction. Great, right? I’ll answer by way of analogy. You’ve built a stellar consumer app that you just listed in the iOS App Store so billions of users can discover it. You’re probably not banking on the App Store as a source of demand unless the editors decide to feature you on the main page. With the ISV marketplaces, your “editors” are their sales reps and they will pick you for one reason — your product drives a ton of business for them.

A great example of this is Hashicorp, which delivers workflows tooling to run cloud infrastructure, making it easier to use the services sold by AWS, Google, Microsoft, and others. More Hashicorp = more cloud infrastructure. Hashicorp generates a ton of referrals from the cloud vendors.

When to integrate to an ISV marketplace: You drive considerably more consumption of their products and you’re able to invest human capital. These partnerships require considerable inputs to fully realize upside, including training their sales teams, developing relationships with product and BD leaders, and building the connections to their provisioning and billing systems.

OEM (Original Equipment Manufacturer)

OEM partnerships are less common among startups and generally manifest as business models rather than supplements to an already existing market insertion strategy. Don’t mind the archaic nature of the acronym — these partnerships simply imply you’re charging another company so that they can embed your product inside of theirs. This structure is also sometimes referred to as white-labeling.

For example, let’s say you’re building a file-sharing company with the most powerful underlying technology for storing and sharing files. You sell a branded version of this software under the brand BoxShare. A software company approaches you to embed your file-sharing technology in their application so they can avoid building this technology themselves. They would likely pay you a lump sum or variable fee (% of each transaction or fee per unit sold) to embed your technology within their software.

In the above example, you can see where the tension emerges. The upside is you earn revenue on the back of other companies’ businesses. The downside is you might have to expose core technology and dedicate resources to supporting a partnership like this.

In a public example, Salesforce spun out the underlying platform (Force.com) that powers its popular CRM application as an independent product on which other developers could build enterprise applications. Not only have millions of developers built applications on this platform, but billion dollar companies like Veeva Systems built their software on the platform. It’s worth noting that Salesforce waited 8 years to launch Force.com because Salesforce focused on its core product before expanding an entirely new product line.

When to pursue OEM partnerships: If you’re early in your startup journey, these types of partnerships are likely a distraction as they can dilute focus from succeeding with your core business. The best approach is to be thorough in evaluating these opportunities and to see them as potential product lines rather than partnerships. If an OEM partnership requires new product development, you should request R&D dollars (industry term = Non-recurring Engineering dollars or NRE) from your partner and avoid exclusivity agreements or granting co-ownership of intellectual property.

Channel Market Fit

Partnerships work best if they are good for your partner and, therefore, a function of the partner’s total serviceable market (or pTSM).

pTSM = (Your expected near-term revenue x Partner’s Margin) + Ancillary Partner Revenue

Ancillary partner revenue includes the incremental revenue the partner expects to achieve as a result of the partnership. This ancillary revenue usually results from implementing, operating, or selling additional services as a result of your product. For example, your customer might pay a partner to operate your product or service on their behalf (this is common with security products).

If the expected ancillary partner revenue is zero, the percentage they expect to earn from the total serviceable market (TSM) should be high. TSM is more appropriate than the total addressable market (TAM) because partners typically evaluate partnerships on a shorter time horizon. While you as a founder may be ready to endure the 10-year journey to greatness, your partner is likely focused on the next couple of years. You can define “near-term” according to the time horizon of the partnership as you will actually define an expiration date in the contract.

The pTSM threshold will vary between partners. It is not uncommon for large partners to pass on a partnership without a “reasonable line of sight” to $10M in revenue over the next 12 months, so seek out this information early on in the discussions. Typically, recurring partner revenue is more favorable than one-time. While subscription revenue is recurring in reseller scenarios, your partner also might sell recurring services to operate your product or some other form of ongoing service revenue.

If your product or service belongs to an emerging category meaning the TSM is hard to articulate and the service opportunities are not well understood, develop a strong story for the strategic nature of forming a partnership despite the ambiguous financial incentives. Partner communities will work with companies to stay relevant and position themselves as early experts in a developing market.

Wrapping up

Channel and technology partnerships can be a force multiplier for your business. When considering any prospective channel, start with the most important question: What does my customer need before buying my product? The answer to this question could look something like the following for each of the channels mentioned above:

  • Resellersmy customer needs an accessible channel they trust where they’re used to purchasing products like mine.
  • SIsmy customer needs help implementing, managing, or integrating my product as part of a broader initiative.
  • Technology partnersmy product is incomplete relative to the job a customer might assign my product to do.
  • Marketplacesa customer might not discover or consider purchasing a product like mine unless it exists in this channel.
  • OEMmy customer could derive additional value if they experience my product in a completely different form.

Then ask: Is my business ready and what is the return on investment? As a founder, you’re a capital allocator and you should be diligent about investments made into channel partnerships. If done tactfully, the upside can be immense.

Special thanks to Sunir Shah, Domenic Perri, and Vlad Blumen for their meaningful contributions to this post. 🙏

Investor at Vertex Ventures.