Breaking Down Managed Services Profitability: 5 Things To Know

Kyle Christensen, speaker, coach and founder of K7 Leadership deconstructed managed services profitability by laying out the definition, the methodology and problems, and how to measure the budget and variable costs at XChange NexGen 2023.

Many MSPs find themselves running up against a wall when trying to scale. In some cases, these organizations aren’t looking at the right key performance indicators or are managing their service teams efficiently. That’s according to Kyle Christensen, speaker, coach and founder of K7 Leadership, a San Diego-based business consulting firm.

Strategy and budgeting are the most important things you can do for your business this quarter, Christensen told an audience of MSPs at CRN parent The Channel Company’s XChange NexGen 2023 conference this week. That means understanding the metrics that really matter, keeping the service management team on the same page and at times, redefining profitability based on the strengths of the company, he said.

In his session, Christensen helped MSPs figure out what they want to do next year, “everything they did wrong” this year, and how they can add fuel to their fires. Here are excerpts from Christensen’s session on deconstructing managed services profitability with tips for MSPs of all sizes.

Managed Services Definition

The MSP community needs to make sure they are all talking about the same thing. The managed services model consists of a provider and customer agreement that’s backed by an agreement or contract. It’s defined today as a practice of outsourcing a range of IT functions to improve operations and cut cost and is an alternative to the break/fix IT outsourcing model that has solution providers only billing customers for work done, Christensen said.

Additionally, Christensen said that managed services is availability, consulting, help desk, services, vendor management and operational efficiently, among other things. What it’s not? Hardware leases, cloud storage, cybersecurity insurance, security software, SaaS resell, and procurement, to name a few.

“When you talk to people about what managed services [are] you’ll get about 30 different answers,” Christensen told the audience. “When we talk about our packaging, our strategies, our target markets, it’s very easy for us to assume we’re talking about the same costs, the same products and that we do services the same way. But our cost structures are different, and this is very important because a lot of us came along to become MSPs by being consultants and it was just: ‘Hey, whatever we can do to bring in this recurring revenue we’re going to do.’”

The Methodology

The original methodology of managed services, according to Christensen, was: “[Stuff] breaks, client requests help, collect the change” — a reactive model. The newer methodology, on the other hand, is: “Agreement set, active management and automation, and make money.”

Margin is the relationship between what’s left over between your gross profitability and your revenue. Markup is the relationship between your gross profitability and your costs, Christensen told partners.

“What we’re measuring from is backwards,” he said. “We need to set an agreement that has a set budgeted number of hours per month, actively manage it and make more money. So, when we talk about improving our profitability, it’s very simple. We either charge more, or we do less.”

The Problem

Christensen laid out the biggest problems plaguing MSPs right now. One is that service management is meant to manage services, but instead, service management is seen as managing technology or technical challenges. Business owners often think about service managers as an extension of a technologist, but keeping the service team in step with protecting your profitability is critical, Christensen said.

“Go hang out where they hang out and they’re talking about tools, they’re talking about fixes, they’re talking about doohickeys. They’re not talking about: ‘Hey, how do I take three minutes off my engineers this month? How do I improve my Tier I helpdesk to work more tickets than my Tier III help desk?’” he said.

Business leaders need to guide them and mentor them to protect the gross margin that you are going to reinvest next year, Christensen said.

Creating and Measuring the Budget

Some of the best business leaders are “obsessed” about cost management and how to service their customers while meeting their profitability expectations, Christensen said.

The typical equation of revenue minus expenses equal profit doesn’t work. Rather, MSPs should think of it as revenue minus profit equals expenses. This makes MSPs ask different questions and gives them a limit to what they can spend to service a customer.

“A little exercise. If I was to take a [budget] of $2,000 per month customer and want 65 percent margin, I am required as an owner to put $1,300 a month of profitability on that client in my pocket to put it into the pool that goes to my sales and marketing budget. Think of the conversations you can have [around] ‘How do I service a customer for $700 a month?” Christensen said.

Profitability is an expectation, not a result, he added.

Measuring Variable Costs

There will always be fixed costs for the business, but when thinking about how to measure variable cost, Christensen said that MSPs need to ask themselves what KPIs are important. Common answers include things like first time resolution, ticket backlog, kill rate, and the percentage of issues that were escalated.

“Things like kill rate, backlog and first-time resolution for us as technologists, not as entrepreneurs, feels really good. It means our services are strong. But our margins are not,” he said.

Instead, the KPIs that should be top of mind for MSPs include percent closed by automation, effective hourly rate, Tier I kill rate, and agreement gross profitability. Measuring variable cost has the power to help businesses get to that 65 percent profit margin, Christensen said.

“Our KPIs [must] reflect business outcomes,” he said.