The MSP business environment is always changing. Many MSPs started out as value-added resellers. Then they became service organizations and, later, managed service providers. Now it seems cloud services are wrapped around most MSP offerings. As the delivery model has changed, so must the way we view profitability. If you are only looking at the margin on a product sale, you are missing a lot of the information.
Understanding the profitability of a product is critical, as you will have to compare it to others you could offer to your clients. Recently, an MSP client of ours approached us for help in determining whether to resell cloud services or to build the functionality in-house. While this is a hot topic with some strong opinions on both sides, we decided to look carefully at the numbers so as to provide the right answer for the client. It should be noted that most end-user customers will not care how the service is delivered, so the decision lies completely with the service provider.
We broke the analysis down into its component parts as each one has critical importance: Fixed up-front costs, fixed per-client costs, variable costs, revenue and product lifetime.
First, what are the fixed start-up costs? If the client went to an established cloud provider, there would be no fixed start-up costs. If a cloud solution were to be built, we would have to understand the time, materials and service costs. The client's costs for on-boarding customers to either an in-house cloud service or resold one would be about the same.
The next step of the analysis is figuring out variable cost. While it was less expensive to maintain a homegrown cloud solution than to pay the OEM provider, the real question was whether it made sense given the higher fixed start-up costs.
The last part of the dollar flow was revenue. The rate was largely the same since the same cloud service was being provided to the end-user client from both the homegrown system and outsourced provider.
After the economic components were identified, we looked at the useful life of a built system. What we found was that we would be able to recoup our costs before we needed to invest substantially more to keep the system current.
Now comes the fun part. Once we were comfortable that our model reflected all the costs, we looked at which one provided better profitability. After you have researched all the assumptions, the math is fairly straightforward. The hard part is making sure everything is reflected in the model.
As it turned out, the client decided to develop a hybrid solution, working closely with cloud providers. The options and parts keep evolving in this move from MSP to potential cloud service provider, so we will continue to monitor the economics of our client's choices. Just as the right answer today was not what we would have recommended two years ago, it may also not be the right answer in a year.
This analysis did simplify things a bit in terms as we did not talk about operational risk, reputational risk or leveraging the branding of an OEM, but those parts can be considered once you understand the profitability.
Larry Cobrin is a director at MSPCFO, an outsourced CFO and bookkeeping firm focused on technology service providers.
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PUBLISHED ON MAY 15, 2013