As a managed services provider (MSP), you likely entered this line of business because you wanted to help organizations optimize their IT infrastructures, get the most out of their technology, and become a helpful and strategic business partner. What started as a dream has now turned into a full-time business—one that you must ensure remains successful.
Now, it’s probable that you didn’t earn your MBA to become an MSP, but now that you’re in charge of your business you need to become well-versed in the business-side of things—like finances, accounting, and mergers and acquisitions. For example, you may have a goal this year to grow your bottom line, but what does that actually mean? What goes into that metric? If you want your MSP business to grow and succeed, you need to start thinking like a chief finance officer (CFO). Use this post as your guide to better understand the factors that can impact your profitability and learn how to maximize your managed services margins.
Before we dive in, I must highlight the importance of tracking financial key performance indicators (KPIs). Doing so can help you become more strategic and see what is and is not working when it comes to revenue and profitability. One of the most important KPIs to measure is EBITDA. Standing for earnings before interest, taxes, depreciation, and amortization, EBITDA has become the standard for which to evaluate a company’s financial health and value. Additionally, EBITDA can be used to measure a company’s margins. Therefore, if we’re understanding what can impact EBITDA, we need to understand what can impact your margins. Let’s take a look at the three main factors:
Sales is a figure many MSPs already understand because it represents what flows into revenue. Essentially, this is the amount you invoice for each of your customers, but there can also be a cost associated with sales.
Cost of Goods and Services (COGS) measures the direct expenses associated with the products and services you sell. This metric can be broken down into a few items, including materials, labor, overhead, incentive programs and more. Typically, MSPs like to focus on the sales number—the actual amount they’re billing for their services. What many MSPs don’t think about, however, are the associated costs to make that happen. If you’re finding yourself needing to hire extra technicians simply to support a new client, that’s going to greatly increase your COGS, causing your margins to suffer. Therefore, the lower this number, the more efficient a company will be at utilizing their resources—making it easier to become more profitable.
Your operating expenses cover the cost of maintaining your daily business operations, and are often a hidden cost MSPs don't think about. These are the expenses related to the selling, promoting and delivering of a product as well as managing the company.
One of the key metrics to look at when it comes to operating expenses is selling, general and administrative (SG&A) costs. This metric typically deals with all the other factors that come with creating and maintaining a product, such as office rent, insurance, benefits, and marketing and advertising. SG&A and operating expenses have a direct impact on your net profit, so it’s important to keep these costs low.
Lastly, how you price your products and services can have an impact on your margins. The bigger the difference between your COGS and your price, the higher your margins will be. However, there are a myriad of factors and pricing models to consider, causing most MSPs to struggle with establishing an appropriate price point. Additionally, pricing can be influenced by the cost to deliver services, geography and location, and the perceived value—regardless of which pricing model you choose.
While there’s no singular approach to pricing and packaging that will guarantee success, it’s important to understand the differences between each of today’s approaches to MSP pricing. If you’re looking for an overview of managed services pricing and packaging models, check out our in-depth article!
Overall, each of the above factors can have a direct impact on your net margins, or how much of each dollar you earn is translated into profits. Your margins are an important metric to pay attention to, because it acts as a gauge of your efficiency as a business.
How Can You Increase Your Managed Services Margins?
Now that you understand how margins can be affected, let’s flip the script to talk about how you can go about improving them. Basically, how can you manipulate the line items we just discussed to increase your margins and grow your bottom line?
The first approach you could take is to increase your sales revenue. You could do this by either increasing the price of your services, selling more services, or adding an additional stream of revenue, such as an IT support desk, backup and disaster recovery (BDR) or cybersecurity.
Decrease COGS and SG&A
One of the ways you can decrease both COGS and SG&A expenses is to decrease what you spend on in-house IT labor. If you struggle with high technician turnover and have to constantly replace employees to maintain productivity or staff your techs through the night, you’re spending more on overhead and the costs that come with it. Unfortunately, this will not help your margins and can deter business growth. So, the less you pay for labor and employee coverage, the lower your COGS and SG&A costs. But how exactly can you achieve that?
While it’s true that a little tweak here and there can positively impact your margins, the real success could come from leveraging an outsourced solution. Through a partnership with Continuum’s open and proactive platform platform, for example, MSPs can realize greater margins and achieve scalable growth.
The Continuum Platform is directly supported by our world-class Network Operations Center (NOC), Security Operations Center (SOC) and Help Desk, which enables MSPs to substantially extend their workforce and breadth of expertise—without increasing overhead spend. Working with this outsourced model allows MSPs to offload projects to the NOC, support the episodic demands of IT and empower technicians to focus on more revenue-driving tasks.
And according to an analysis done by Service Leadership, Inc., MSPs who parter with Continuum achieve higher margins, withstand downward market pressures and operate more efficiently compared to their non-Continuum peers. The analysis shows how MSPs who use Continuum are spending less of their gross margin on General and Administrative (G&A) expenses than MSPs who do not—perhaps because leveraging our on-demand workforce may enable them to invest more heavily in other areas of the business. In fact, MSPs working with Continuum were found, on average, to spend 6 percent less of GM on G&A expenses between 2012 and 2016. Without the need to hire or add costly technicians to their payroll, Continuum MSPs are able to achieve greater margins and drive profitability.
The analysis also illustrated how Continuum partners achieved on average 8 percentage points higher gross margins on managed services than non-Continuum partners. Additionally, Continuum partners recorded Adjusted EBITDA figures that were on average 7 percentage points higher than their peers using other platforms. Therefore, when MSPs take advantage of outsourcing certain functions to a third-party provider like Continuum, they’re able to control costs, strategically allocate resources, focus on important business initiatives and optimize profitability.
You just learned about how your peers are achieving greater margins and profitability with Continuum. See for yourself how our transformative platform can do the same for your MSP business!