System integrators are the backbone for the digitization of SMEs. Now they themselves are struggling with the change: the cloud is leaving less and less room for their core business. While demand is falling in local IT provision, the expertise is still lacking for the switch to managed cloud models. Five challenges for the system integrator industry, which at the same time offer opportunities for all those who are now resolutely jumping on the cloud bandwagon.
The cloud makes companies more survivable
As if under a burning glass, we are seeing in the Corona crisis that digital business models and cloud technology are becoming a survival factor for companies. Those who can send their employees to the home office overnight or still sell their products over the Internet have a clear advantage. While the lights went out in offices and stores, work continues in many places in the cloud.
In the lock-down, the entire economy is learning to appreciate the value of location-independent, mobile, and interoperable IT. Most certainly, after this experience, companies will drive the digitization of their business with a different awareness. The US hyperscalers, as operators of the world’s largest cloud platforms, are therefore already among the winners of the crisis. In contrast, the accelerated pace towards the cloud is forcing system integrators, as the most important IT partners of SMEs, to bring forward their own transformation at increased risk.
1. Traditional system vendor expertise is not in demand in the cloud.
The virus only accelerates what was already in place: reservations about the public cloud have been dwindling for years. According to the consulting firm Crisp Research, more than 80 percent of companies in all industries see the cloud as a mainstay of their IT. In 2017, SMEs already invested 41 percent of their IT budget in the use of cloud infrastructures. In less than a decade, more than one-third of demand in the IT services market has thus shifted from the traditional retail, licensing & project business to the cloud economy.
Even critical business data is now stored by one in three companies in the data centers of Amazon, Microsoft, and Google. In 2016, it was not even one in five. By 2023, IDC market researchers expect companies worldwide to reduce their budget for on-premises IT infrastructure to just under 42 percent, down from 52 percent in 2018. For the system integrator industry, those were tough numbers to digest even before Corona.
With the growth of the public cloud, their very own turf is shrinking: on-premises IT provision. Small and medium-sized service providers in particular still make the bulk of their revenue at the lower infrastructure levels, i.e. with the sale of server hardware, storage systems, and network equipment as well as the integration of the systems on-site at the customer. In the public cloud, on the other hand, the “sheet metal” value-added stage is completely eliminated. The system house is left with an agent’s commission of between five and eight percent, although in the cloud this is based on the customer’s actual consumption and therefore fluctuates. In the cloud age, the reseller business is shrinking into a sideline.
2. Infrastructure loses value
Competition from hyperscalers is also being felt by those system integrators who have already reached the next evolutionary stage of their business model: They offer their customers largely standardized IT services from their own or rented data centers, so-called managed services. In contrast to the trading, project, and integration business, the IT systems are no longer owned by the customer. Instead, they use infrastructure and operating services from their provider’s private cloud on a monthly basis.
Nevertheless, the public cloud is also setting standards here: With gigantic economies of scale and unrivaled efficient data centers, hyperscalers are driving down the price of infrastructure services. Flexible contract models and highly developed user interfaces lower the access barriers to IT resources. Experiences with such products have a lasting impact on the expectations of business customers. Long contract terms, premium prices, or manual processes are thus under pressure to justify themselves. Advantages are offered here to system vendors with an asset-light approach, i.e., without data centers of their own, because in the cloud there is no longer a lack of infrastructure capacity, but of know-how for the right deployment. This is especially true of the latest trend: the multi-cloud.
3. Experts for hybrid and multi-cloud are hard to come by
According to Crisp Research, three-quarters of companies will soon be using more than one cloud in order to benefit from the broadest possible spectrum of innovations. In addition to the hybrid cloud, a combination of private and public clouds, more and more business customers are pursuing a multi-cloud strategy. Here, they obtain services from different cloud ecosystems. However, medium-sized businesses, in particular, lack the expertise to orchestrate different cloud resources with confidence.
The hyperscalers do not see themselves as being responsible here. They cannot exploit their economies of scale in the small-scale consulting business. The analysts from Crisp Research and ISG expect a new type of service provider to fill this gap: In the future, managed cloud providers will support companies as the most important contact partner in the planning, evaluation, and management of (multi)-cloud infrastructures.
System vendors must address this rapidly growing demand! They are not only geographically close to the customer but also the preferred contact for all IT issues. However, building up the necessary expertise is not easy, even for IT service providers. The market for cloud architects is empty.
4. Hyperscalers conquer the last bastion: on-premises
Until recently, the system integrator industry hoped that at least one budget would not be diverted to the public cloud: There was and is no room for business legacy in the IT factories of hyperscalers. The maintenance of grown, highly individualized IT systems does not fit into the scalable and standardized business model of Amazon, Microsoft, and Google. Instead, enterprises migrated their legacy IT to the private cloud. Until now.
The U.S. hyperscalers have adjusted their strategy: If not all local server capacity will be absorbed into their cloud data centers, then they will make “on-premises” the outpost of their technology stack. Solutions such as Amazon’s Outpost or Microsoft’s Azure Stack offer companies a complete cloud solution for their own data center.
The advance could prove to be a tipping point in the competition for local IT infrastructures: If companies use the same technology in the private as in the public cloud, they obtain a fully interoperable and at the same time scalable IT landscape. At last, they will also benefit from the extreme pace of innovation of hyperscalers on their own systems. In any case, end-to-end cloud architecture is the right strategy. After all, the coming generations of business software will only be developed for the cloud. And now such programs are also running on-premises.
For the system houses, this means that in the long term, value creation will primarily be found on the technology stack of the hyperscalers. All traditional IT and TC business models are being put to the test. The pressure to transform is completely reshaping the market and Corona is doing it at top speed!
5. Legal and financial risks of the transformation
However, to reach the next evolutionary stage, the managed cloud provider, system vendors need not only new expertise and specialist personnel but also a willingness to take risks and an entrepreneurial spirit when it comes to financing this transformation.
How aggressively should a system vendor approach the transformation? How radically should it divest itself of legacy business? While infrastructure margins are disappearing and daily rates in the project business are coming under pressure, the high up-front costs of building up the service business have to be borne. These costs cannot be passed on directly to the first customers. So where is the liquidity to come from for the change?
The changeover to business processes instead of project business, to continuously intact customer relationships and continuous service instead of one-off trading revenues, to 24x7 operation of services and high demand for top experts costs money above all. Not to mention the legal risks that partnerships with the major hyperscalers entail.
The industry’s top dogs, which grow organically by 10 to 15 percent every year, are dealing with this wave on their own. The small and medium-sized providers will specialize and focus even more on industry expertise and radical customer proximity.
Nevertheless: System integrators are indispensable for digitization
The transformation of system vendors is gathering strong momentum and is no less demanding than that of their customers. With the imminent acceleration after the current crisis, the business risks are growing additionally.
System vendors are indispensable as trusted advisors and IT partners for the digitization of SMEs. It will be crucial that they resolutely leave the classic nature of their business behind and, with the right network, open up new growth opportunities in the emerging digital single market.