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MSP business model: How to achieve the perfect revenue mix

MSPs across the board derive their revenue from a variety of business lines, including break/fix and IT project work, according to an Autotask study. Is the pure-play managed services business model an elusive dream?

A recent study of 1,800 managed service providers (MSPs) confirms that companies generate significant revenue outside of the managed services space and suggests that many are grappling to achieve the optimal MSP business mix.

Fifty-three percent of MSPs produce less than half of their revenue from managed services, according to the Autotask 2015 Managed Services Market Study released April 20. While Autotask says managed services have solidified as an MSP's "top revenue producer," the report also points to the continuing importance of other business lines.

Indeed, survey respondents identified break/fix and IT project work -- along with managed services -- as their leading revenue-producing offerings. Networking and projects, according to Autotask, which markets its IT business management platform to MSPs, account for as much as 40% of revenue for about three in four respondents.

'I'm not sure anyone ever really had managed services at 100% revenue.'
Michael Kranerco-founder and director, MSPCFO

"Managed services cannot be viewed in isolation," said Christian Nagele, Autotask's general manager, remote monitoring and management global sales. He said break/fix and IT project work remain key sources of revenue for many companies, adding that managed services are best viewed as a "business model in a wider service mix."

Autotask's report is on track with Tech Target's 2014 Channel Directions survey: 63% of the 337 North American channel partners queried in that study said they derived 50% or less of their revenue from managed services. The Channel Directions survey also noted a slight decrease in the percentage of respondents offering managed services, 63.5% in 2014 compared with 71% in 2013. The survey results suggest the task of developing a managed services practice remains a difficult proposition.

Tweaking the business mix

Industry executives suggested that the typical MSP will employ a portfolio of services that include the managed variety. A pure-play MSP is a rarity, they noted.

"I'm not sure anyone ever really had managed services at 100% revenue," said Michael Kraner, co-founder and director at MSPCFO, a financial analytics and consulting company focusing on MSPs and value-added reseller IT consulting firms.

"I think there are many people who still have clients on the old break/fix, time-and-materials model," he said.

Nagele also noted that some service providers find themselves wedded to the break/fix business. But most of the MSPs that Autotask surveyed seek to more fully embrace managed services: Nearly three-quarters of the respondents said they are looking to increase their managed services revenue goals.

MSPs face challenges reaching their managed services objectives. For example, clients may not be ready to try a new way of acquiring services. It boils down to what customers are willing to do and what services they are comfortable paying for, Kraner said.

Another issue: channel companies that misread their core business model and apply the wrong business practices. Paul Dippell, CEO of Service Leadership Inc., based in Plano, Texas, said there are no standard definitions to distinguish an MSP from a break/fix specialist. So, channel companies may struggle to properly define themselves.

Dippell's company, however, has created the Service Leadership Index, a financial and operational benchmark for solution providers. The index groups solution providers into what the company calls Predominant Business Models, which are based on revenue mix. This approach defines an MSP as a company that generates more than 40% of its revenue from services and for which managed services revenue is at least 10% greater than any other service line.

A problem arises when a company that has the bulk of its revenue in break/fix -- and less in managed services -- runs the entire business as a managed services operation.

"Even though they have managed services, best practices for managed services companies will hurt them," Dippell said. "Just ask anyone transforming from break/fix to managed services."

The pain stems from the sharp differences between the break/fix and MSP businesses.

"In the break/fix business, more work per customer equals more profit," Dippell explained. "In the managed services business, less work per customer equals more profit. They are diametrically opposed business models."

Building a better business model

So what's the ideal revenue mix for an MSP? Service Leadership noted that MSPs in the top quartile of profitability had the following average revenue mix in 2014:

Managed services (support for flat fee): 44%

Product resale (including cloud resale): 32%

Projects (implementation): 9%

Break/fix/time and materials (support by the hour): 8%

Private cloud: 7%

Dippell noted that even true MSPs are rarely "pure" managed services companies. That's because most started life in a different business model before transitioning to managed services and few new companies launched offering only managed services, he said.

The portfolio-of-services model, rather than a strict MSP business, appears to be the norm. To wit: Service Leadership found that among top-performing MSPs the proportion of revenue in product resale and projects is actually increasing.

Managing such a business mix is challenging, Kraner noted. He said the management job was in many ways easier when solutions providers were selling boxes and working on a time-and-materials basis. Kraner said today's MSPs need to actively monitor their key performance indicators to stay on top of their diversified business lines. To that end, MSPCFO offers a financial analytics service that pulls data twice a day from an MSP's professional service automation system, crunches the numbers and generates reports on client profitability trends and other metrics.

"The best-of-breed companies always know their numbers," Kraner said.

Next Steps

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