Transitioning To Managed Services? Remember, Time Is Money


Forward-thinking solution providers recognize that the channel is evolving from the old business model with its emphasis on reselling and implementing IT products to a new model built around managed services and recurring revenue.

But there's a major hurdle to making that transition: the possible interruption of a solution provider's cash flow. If cash flow from product sales and implementations drop off before a solution provider has built up a steady flow of services revenue to cover costs, the company could find itself in a cash crunch -- and possibly out of business.

Improving cash flow requires some basic blocking-and-tackling financial management. Forecasting sales and expenses and integrating those forecasts into a cash flow outlook is a good start. Setting up a cash reserve, accelerating receivables while slowing down payments, and controlling spending to preserve cash may sound like obvious advice. But some solution provider managers may be too busy selling, serving customers and hiring employees to devote the necessary amount of time to such tasks.

In interviews with several solution providers that have either successfully made the transition to managed services -- or are in the middle of doing so -- it was clear that cash flow was top of mind. Here's how they are navigating the move to recurring revenue.

MAKING THE LEAP -- AND AVOIDING THE PITFALLS

Lloyd Group, a New York-based solution provider, made the move to managed services between 2001 and 2003. Founder and CEO Adam Eiseman thinks Lloyd Group was among the first solution providers to do so.

"We didn't think we were fulfilling our mission of helping small businesses," Eiseman said in an interview, noting that many customers were largely using Lloyd Group to maintain their IT infrastructure, rather than using IT to grow their business. Serving customers as an MSP, the thinking went, would better allow the company to help customers focus less on IT and concentrate on growth.

But that meant changing Lloyd Group's business entirely, including its cash flow. Where the solution provider may have received big deposit checks for IT sales or implementation projects, subscription revenue trickled in monthly at a fraction of that. "It's like having two different businesses," Eiseman said. "If you move [all customers] right away, it can kill your cash flow.

"We took two years to plan this out and we did it strategically," Eiseman said. Somewhere around 40 percent to 50 percent of Lloyd Group's revenue at the time was from product sales with the rest coming from traditional implementation and support services.

Lloyd Group started by identifying which businesses among its 300 or so customers would be open to making the transition. Nearly all of the 50 to 70 targeted customers agreed to change their IT models and engage Lloyd Group for managed services. Lloyd Group, meanwhile, worked to move clients who didn't want to change to other solution providers. Ultimately, more than half of the customer base went elsewhere, Eiseman said.

Lloyd Group was careful to maintain as much of its existing business while growing its managed services business. That's a challenge because it means maintaining enough staff to meet the needs of the traditional business' customers. Another challenge was scaling up the subscriber base quickly enough to offset fixed costs.

Eiseman and other Lloyd Group owners took less money out of the business during the transition period. And the company developed a line of credit at a local bank it could tap into when cash flow didn't keep up with expenditures.

For Lloyd Group, being prepared for any potential scenario was the key.

TACKLING THE TRANSITION

Blytheco, a Laguna Hills, Calif.-based solution provider, meanwhile, has been making the transition from selling on-premise systems to providing customers with SaaS applications from NetSuite. Today the cloud applications account for about two-thirds of Blytheco's new business, said CEO Stephen Blythe in an interview.

With on-premise software, customers generally paid their bills to the solution provider within 30 to 60 days of a sale, Blythe said. But now customers pay the subscription fees to the vendor, which then pays the solution provider a commission. That stretches out the time before a solution provider gets paid to at least 60 days, if not 90 days or more.

"So there's a significant negative cash flow," Blythe said. "The biggest challenge is the 90-day lag before you really get paid."

Also making the move to managed services is Fidelus Technologies, a New York-based solution provider that works with unified communications and collaboration software from Cisco Systems.

Most of Fidelus' revenue today is generated by VAR sales and professional services, while recurring revenue from managed services is only a small percentage of total sales. That will be changing, however, said Nancee Pronsati, operations vice president.

"We are transitioning from being a VAR to more software and services," she said. And that includes moving from selling software with perpetual licenses to SaaS applications on a subscription basis. "Like many companies, we realize recurring revenue is more reliable," she said. "And it's cumulative with each new customer."

Fidelus recognizes that that could mean changes in the company's cash flow and are having discussions about to plan for it, Pronsati said. But just how big the impact may be is uncertain. A lot hinges on how many customers make the switch and how quickly they do so, she said.

LINES OF CREDIT CAN BE A LIFELINE

Several solution providers said developing a line of credit to tap into when cash flows run tight, as Lloyd Group did, is a smart move.

Fidelus has lined up a line of credit with GE Capital to facilitate its resale business, and that could come in handy should the company need it while expanding its services offerings.

GE Capital offers financing and lines of credit that solution providers can use to improve their liquidity as they transition their businesses, said Michael Marcolina, managing director. The company provided $12 billion in channel financing in 2012 alone, he said.

"Look for a financing partner that has domain expertise in your space and is going to be a committed partner," said Marcolina.

Some IT product and service vendors also have programs that lend their channel partners a hand. Verizon, for example, pays its partner agents a portion of a customer contract up front and then pays the rest over the life of the contract, said Rich Williams, executive director of channel programs with Verizon Enterprise Solutions, in an interview. Some vendors only pay their partners as the subscription revenue trickles in, even though the partner has already incurred costs associated with the deal.

Verizon also targets some market development funds toward helping strategic partners with the cash flow challenge. Not with direct financing, but in other ways such as helping defray the cost of a sales representative who's out selling the services, Williams said.

The cash flow issue could even become a factor in vendor-solution provider relationships. SAP is recruiting prospective partners that put a premium on managing cash flows and have healthy balance sheets, said Kevin Gilroy, SAP's head of global indirect channels. Gilroy, in an earlier interview with CRN, said solution providers with healthy balance sheets and working capital are better able to invest ahead of revenue and make the move to a cloud- and services-focused business model.

"Vendors don't want to be equity investors in every VAR partner," said Marcolina, noting that he's hearing more discussion within the vendor community about how partners manage their channel cash flow.

THE SALES COMPENSATION FACTOR

Managing sales compensation in a recurring revenue model also is a big part of managing cash flow. Salespeople being salespeople, they want as much of their commissions up front as possible. And that's easy when a solution provider gets a one-time check shortly after making a sale.

Not so easy is adjusting sales compensation when subscription revenue is trickling in. While some MSPs continue to pay full commissions when sales representatives ink a deal, more are paying a percentage of the subscription revenue on a monthly or quarterly basis. That helps with cash flow, not to mention providing salespeople with an incentive to stay engaged with a customer rather than focusing on the next big sale.

"Salespeople look at it as building an annuity," said Blytheco's Blythe. He expected sales commissions to be smaller with cloud software than with on-premise implementations because SaaS contracts rarely involve hardware. But to his surprise he's paying bigger commissions because the deal sizes for cloud computing have been bigger. In some cases that's because the cloud software is of higher value, he said, and the cost of the hosting is built into the price.

GAINING VISIBILITY INTO CASH FLOW STATEMENTS

One problem many solution providers face is that their founders may be entrepreneurial engineers or great salespeople, but many don't understand finance and cash flow. They may understand the bottom-line numbers on an earnings report, but cash flow statements are a mystery.

Many solution providers manage their business using applications that primarily record transactions and provide information about payables and receivables, but don't offer much visibility into cash flow, said GE Capital's Marcolina.

Fidelus has a finance director to help manage cash flows, Pronsati said, and the solution provider contracts with an outside CFO to help with strategic financial planning.

Lloyd Group had one advantage in that Eiseman has an accounting background and an acquisition in 2002 brought in a manager with financial experience. "So we run more like a business," Eiseman said.

Alex Solomon, co-president of Net@Work, a fast-growing solution provider based in New York that is expanding into managed services, said that one strategy that works for the company is selling blocks of service time at a discount that customers purchase in advance. The more they buy, the bigger the discounts. "It's probably one of the best strategies we ever implemented," Solomon said. The practice gives the company more flexibility as it moves into services with recurring revenues, he said.

Lloyd Group followed the same sales strategy of preselling blocks of service time. While Eiseman acknowledged that's great for cash flow, he said the practice is essentially borrowing money from your customers -- money that has to be paid back in the form of services. And that can reduce cash flow flexibility because it requires maintaining staffing levels to meet customers' unanticipated needs, he said. It also lacks long-term commitments from customers.

As a solution provider expands into managed services, building up a backlog of professional services contracts can help with cash flow during the transition, said Fidelus' Pronsati.

Managing Blytheco's cash flow has been less of a challenge than Blythe anticipated because the company's on-premise business, based on Sage Software products, remains substantial. "The nice thing is you can gradually get into it, ramp up in a moderate way, so you can absorb the cash flow changes," Blythe said.

And being a solution provider of significant size helps. "We have enough cash flow. We don't live day-to-day," Blythe said.

Blythe notes that while solution providers who dive into cloud and managed services earn less from implementation work, other services such as mapping applications to business processes, customizing and configuring software, converting data and training employees all stay the same. And solution providers bill customers directly for those services and, presumably, get paid faster.

Upgrades are different, he warnED, and solution providers can't count on generating much revenue from them with cloud services. "But that's offset by a larger commission on contract renewals," he said, declining to provide specific numbers. "The real benefit is in year two of the SaaS contract."

In the end, managed services represent a major opportunity for solution providers. But there's danger as well. Solution providers that ignore cash flow while making the transition could find themselves squeezed right out of business.

PUBLISHED OCT. 21, 2013