Branding Managed Services: Have You Really Moved up the Value Chain?

By Dave Roberts, Inkra Networks

March 28, 2002 -- (WEB HOST INDUSTRY REVIEW) -- With basic colocation pricing commoditizing rapidly, most service providers are searching for new, high-value revenue streams to offset declining margins on colo products. Over the past couple of years, managed services have emerged as a new, higher-margin service product for many providers. By offering managed services, the theory goes, service providers can "move up the value chain" and offer products with greater differentiation, and therefore higher margins.

Unfortunately, most managed services products have not moved very far up the value chain, and risk becoming commoditized themselves at a very fast pace. For instance, managed security services are a very popular offering for many service providers. As a matter of fact, most service providers are really offering a very specific consulting service - managing a 'Brand X' firewall or a 'Brand Y' VPN appliance. This is a far cry from offering a true firewall or VPN security service. The difference is subtle, but has profound long-term ramifications.

In offering to manage a standard appliance, the service provider is really offering no more than a consulting labor service. The customer knows this, and ascribes the value of the overall solution to the appliance vendor, Brand X, rather than to the service provider. The service provider is accurately seen by the customer as simply providing the labor - the "remote hands" required to set up, configure, and maintain the device. What the service provider needs is a way of bringing the value home.

Many service providers have taken the approach of branding the ingredient technologies on which the service is based. That's because most service providers think that advertising Brand X as the underlying technology allows them to ride the coattails of the appliance vendor. The theory says that more customers will be willing to use a service if they know it's based on a trusted vendor's appliance, because then they feel the solution is "safe." This is similar to the Intel Inside branding strategy in the PC market.

In the long run, however, a coattails strategy won't work. To see why, let's consider the results of branding ingredient technologies as opposed to the comprehensive service.

One problem with a coattails strategy is that its downside is disproportionate to its upside. While advertising Brand X as the underlying technology may win a few accounts, every customer will ultimately hold the service provider accountable for the service performance. If things go wrong, the service provider will likely lose the account; in this case, blaming Brand X won't keep the customer. Because this is a "managed service," customers will feel that the provider should have been able to prevent the problem, whatever the cause.

More importantly, operating on a coattails strategy marginalizes the service provider in the long run. Because the end customer is exposed to the underlying technology, the service provider can only compete on labor costs to manage a standard appliance. If other service providers also offer managed Brand X appliances, there is little flexibility for pricing a solution competitively. Unless you can strike a deal with the appliance vendor to acquire appliances at a discounted price, the only way to stay competitive is to drive down labor costs. This leads to a commodity margin structure, as we see today with standard colo products.

Alistair Croll, chief strategy officer at Coradiant, a managed service provider, says that managing appliances doesn't provide any differentiation. "By saying, 'We'll manage your Alteon,' you get the IT director saying, 'But I can do that myself,'" he says.

So if the coattails road leads downwards, what is the alternative? More and more service providers are turning to a total service branding strategy. This strategy brings the comprehensive solution under the service provider's brand without specifying the underlying component technologies used to deliver the solution. The service provider agrees to an SLA with the customer, and otherwise retains complete flexibility in choosing solutions to manage the SLA. While the downside risk is still the same - a service incident occurs and the customer leaves - the upside is now much better. Over time, the service provider can adapt the cost structure of the solution to the market by choosing different security solutions, as appropriate. As long as these solutions deliver to the customer SLA, the provider can control costs and compete on more than just labor rate.

SAVVIS Communications, a global network service provider, is one company committed to comprehensive service branding. "SAVVIS has positioned itself as a new kind of provider, with an abstract product in a space where most carriers sell boxes, racks, circuits, and consulting," says SAVVIS chairman and CEO Robert McCormick. "Our product is service and SLAs." Service branding is critical, says McCormick, because it positions the managed service as the real value added. Branding the entire service also "allows the service provider to have flexibility in the use of core components."

In fact, SAVVIS is moving away from traditional appliances altogether and towards a virtual solution. "Bundling an abstract, virtual, network solution allows scaling on the operational side, which greatly increases margin," McCormick says. Coradiant's Croll agrees. "Platform isn't a differentiator any more, and squeezing operational expenses out of things is critical."

A further advantage of the provider-branded comprehensive strategy is that it allows for greater differentiation and variation. Since the offering is a high-level package of security services, the provider is free to mix and match underlying technology to produce a more varied service product offering. This helps prevent the security offering from commoditizing.

Are there downsides to the provider-branded strategy? Yes. First, because you're actually responsible for designing and maintaining a security architecture, you'll have to hire and train staff that really understand the technologies rather than just knowing how to configure a Brand X appliance. Depending on the skill set already employed, this may be a bigger task for some providers than for others.

Second, larger customers who understand the technology themselves may not feel comfortable going with a provider who does not itemize the underlying technology. "Some customers will have fervent and long-held opinions on hardware and software and, as a result, some business will not be won. These customers would not, however, be profitable, so selling to others is the right move," says McCormick.

While service providers that offer a custom-branded managed service product take on more responsibilities than those that don't, the rewards will be well worth it. Rather than competing on labor rates, providers will be able to control costs more effectively and create a higher level of differentiation than peers that simply offer a managed appliance service.