Why Harp on Managed Services Model Basics?

Managed services basicsLast week I gave a keynote at the GFI MAX partner conference about the mechanics and evolution of the managed services sales model. Today, my colleague Chris Gonsalves is in London to deliver the same presentation. He asked the somewhat rhetorical question: “If these guys are already MSPs, shouldn’t they get this? Why do we have to explain it to them?”

The answer is simple: Just because solution providers have implemented managed services as part of their business model doesn’t mean they’ve operationalized it. In many cases, solution providers are undervaluing managed services as a revenue driver and mistaking the initial success in recurring revenue as good enough.

Over the last decade, managed services has become pervasive in the channel. More than 70 percent of solution providers offer some form of managed services to their customers. And managed services, according to 2112’s research, produces the highest sustained margins (profit) of the five major channel offerings — hardware, software, professional, cloud and managed services.

Here’s why we — 2112 and the industry at large — continue to revisit managed services basics: It’s not that the model isn’t defined, it’s just not used to its optimal potential.

Technology is important to managed services, for certain. But sales and customer relations are more important. The three elements to achieving true success in managed services is the continual addition of new accounts, continual horizontal sales in existing accounts, and maintaining a low customer attrition rate.

Let’s start with customer acquisition. If a solution provider earns an average $1,000 per month of managed services delivered and has 50 active customers, the annual revenue is $600,000. The importance of continual account acquisition is a matter of compounding revenue. Every 10 new customers increases revenue by 20 percent.

Let’s skip to account retention, another important factor in generating and maintaining revenue. If a solution provider is losing customers faster than it’s adding them, it won’t grow. But the problem is actually worse than it appears. The managed services magic is about predictability. If an MSP has no confidence in the loyalty of its existing customers, it will have no predictability in how much revenue will accrue over the mid- and long-term measures.

Growth isn’t just a matter of adding new accounts; it’s also possible through horizontal sales – or the selling of more products and services that increases recurring revenue per account. Even if a solution provider doesn’t add new accounts, but expands the existing yield per account by 20 percent, it will have the same net-effect of adding 10 new customers.

Which of these factors is most important? All of them. The prevailing experience, though, is most solution providers stop selling when they feel they’ve reached a critical mass in their capacity. Or, worse, they perceive a low rate of customer acquisition or account expansion as good. Neither is true.

Managed services is evolving rapidly. Savvy solution providers are expanding the types of technologies they offer as a service, providing more automation services, building platforms for application delivery and, in some cases, becoming business process outsources (BPOs). They’re evolving because they generate enough cash through strong sales models to reinvest in their business capabilities.

Consider this: Solution providers tell 2112 that an acceptable annual growth rate is 26 percent. In 2012, the actual rate of growth was 17.2 percent. But most solution providers grew between 11 and 15 percent. Is 11 percent or 17 percent growth bad? On the surface, any growth is good. The real question is how much growth previous success enables a solution provider to undertake.

The reality is few solution providers are throwing off enough cash to invest in real growth. Research by 2112 shows that 85 percent of the channel pays for routine operations out of cash flow. Ninety percent of solution providers say they’re paying for growth through the same cash flow. To put this in concrete terms, a $1 million solution provider that grows 10 percent goes to $1.1 million – a net gain of $100,000 before taxes and other obligations. After the bills are paid, the effective net is closer to $50,000. If the overall business is running effect net margins of 40 percent, the net profit for the year is $440,000.

Now this sounds like a lot of money, but it’s not. Rarely does all that cash come in and sit in the bank account at any one time. And solution providers must contend with annual inflation impact – salary increases, health care costs, infrastructure replacement, license renewals, real estate expenses and, of course, taxes. The reality of revenue ebbs and flows is there isn’t necessarily a lot of cash on hand for net-new investments.

They only way to ensure viability is to grow the managed services business faster than the rest of market. This means a managed service provider must make account acquisition, horizontal sales and customer retention a top priority to ensure revenues remain consistent and compounding. This is why we and many others in the channel continue to harp on the basics of the managed services model.