Managed Services Step By Step: How To Get In The Recurring Revenue Game

A smooth transition requires a willingness to redesign sales strategy, a powerful value proposition and a creative approach to customers. More than ever, customer relationships need to be evaluated based on the long term as opposed to the immediate, up-front opportunity.

The decision to move into managed services is by no means a small one, and solution providers come to that decision in different ways.

MAKING THE SHIFT

Typically, solution providers move toward a monthly recurring revenue model either through customer demand, or through an assessment that the industry is firmly moving in this direction and that missing the transition would be a bad idea.

"We started out with consulting and resale, but our customers started demanding various service functions," said Ranjeet Vidwans, vice president of marketing for Identropy, a New York-based reseller-turned MSP. "This gave us the idea to turn these installations into managed services. So we set up a specialty in unified identity management and related services. In 2010 we had seven or eight customers, but by 2012, managed services were about 12 percent of our revenues. This year's growth rate looks to be 50 [percent] to 100 percent."

Not all companies move into managed services organically. Some use the M&A route as a means of adding managed services to the portfolio without running the risk of legacy employees becoming distracted by the new model at the expense of executing on the business at hand.

"We recognized that while we do a lot of things well we did not have the DNA to be in the managed services business," said Andrew Rein, vice president of sales and marketing at Hargray Communications, an integrated voice, video and data specialist firm in Hilton Head Island, S.C. "So we acquired a company that gave us this capability. Not only do they have the expertise in managed services, they extended our footprint to new geographical areas. They brought remote monitoring and management to the table, and this was connected to our network. They have a very solid vision for how this market is evolving, which made them the perfect company to acquire." When both business models are in use within the same company at the same time, an accurate assessment of customers' best interests and biases becomes the necessary first step to the sale. Is an on-premise solution the best fit, or is this particular customer better suited to an off-premise solution? While this may seem to be a fundamentally technical question, it's important to note that some customers will be predisposed to one model or the other, based on the subjective opinions of the decision-makers.

"If they are unclear, their current configuration is a good starting point," said Identropy's Vidwans. "We can explain the benefits of managed services or the cloud, but we don't try to force the issue. The smaller the company and the lower IT spending head count, the more likely they are to be amenable to a cloud-based offering or a managed services offering because the economics are typically so much better. But we don't try to change people's minds. We tried that, and that doesn't work. It's an emotional discussion, as well as a rational discussion. If they're not ready for the cloud right now, two years from now they will be ready."

Vidwans also noted that most managed services are moving steadily toward the cloud in an organic and step-by-step path. The common denominator is the focus on monthly recurring revenue, as opposed to the traditional up-front investment associated with traditional resale. The use of the cloud becomes more of a means to the end.

DUAL SALES FORCES

In many cases, solution providers making the managed services transition begin by dabbling in the new model, oftentimes experimenting with the assistance of longtime clients with whom the organization has a close relationship. Frequently, specific tiger teams targeting the managed services space are assembled so that most of the company can maintain revenue for the current model, thereby giving the tiger team some room for experimentation.

"We have different sales teams within our organization," said Vidwans. "One person is dedicated to finding consulting, another person is dedicated to resale, and a third person focuses on managed services. Each deal is tagged with the desired business model so we can clearly identify which part of the company needs to address it. However, we also do a ton of collaboration. It's important that the two sides talk to each other, and certain resources, such as marketing, are shared."

While Vidwans admits that this strategy leads to a certain amount of overlap, his company is by no means the only one that segments its sales force in this fashion.

"We believe the opportunity is large enough to have two sales forces for the foreseeable future," agreed Rein. "They can bring each other in on all sorts of partnerships, depending on the circumstances. This keeps the respective mission of each group very clear, and we don't have to worry about extensive cross training."

Developing effective compensation plans for each of the two sales forces is clearly a work in progress. Some companies attempt to keep the compensation plans as comparable as possible, but others are more open to experimentation.

"I would like to think that both sides have a good comp plan, but they're very different," said Vidwans. "The consulting person is kept based on the number of SOW's [Statement of Work] sold, with billable hours calculated in, too. The managed services reps only get paid on the first contract. After that it's up to the product and support organizations to maintain the renewals. Otherwise, by year two, the sales reps would be making so much money on follow-on revenue that they wouldn't have to work anymore. Right now it looks like this approach is on the right track. But we will revisit it on a quarterly basis and make sure it's working out for both sides."

Rein, however, takes a different approach, and hopes to evolve compensation plans into something as close to identical as possible.

"Their comp plans are similar, and we will strive to make them more similar over time," he said. "If one side refers a deal to the other side, we will definitely comp them both."

Rein added that in most cases it is a fairly straightforward process to identify whether a given sales opportunity is optimized for resale or for managed services.

"If the business does not have a 30-person IT staff, then we can advise them on how to meet their IT challenges, reduce their total cost of ownership, and talk about what headaches we're going to take away from them," he said. "It's a pretty compelling value proposition. But before the sale, we get to spend some up-front time to get to know the customer before we actually take over their service. This way, they have a pretty good idea of who we are and where our skills are, and that eliminates a lot of the anxiety."

HOMEGROWN PLATFORM

Beyond the aspect of sales strategy, Vidwans recommends that solution providers consider the possibility of building their own service platform as a means of establishing greater autonomy.

"That was our IP running on top of somebody else's platform," he pointed out. "Some of the vendors were concerned about whether we would build something on top of their platform and then use it to compete against them. So developing our own platform pushed our timetable back about six months, but I think it was well worth it because it gave us the necessary levels of autonomy."

Building a platform can be a difficult and costly undertaking, given that the platform needs to offer full management functionality while at the same time supporting as much vendor interoperability as possible. Using a third-party platform can be a solid strategy for the reduction of up-front investment, but a partner that builds its own platform retains a much more substantial element of control.

Clearly, the move toward managed services and cloud-based services can therefore require substantial investment as the transition gets under way. But as the customer base begins to expand, the move can be quite profitable.

"This was an improvement to our books because the money was more predictable and more consistent," said Mo Aminian, president of Aminian Business Services, Irvine, Calif. "Initially, it was difficult. But as you sign up clients, you get a much better grip on what to expect in terms of ongoing revenues plus renewals and any services that go along with that. In the resale model, all of this was a lot more difficult to predict because everything was geared towards finding new business all time. The annuity doesn't give you the cash up front, and you have to plan for that while you build up your business."

Another benefit that comes with a shift to managed services results from the elimination of the need for truck rolls associated with non-premise support. As support becomes something that is delivered remotely, this opens up opportunities to extend one's footprint beyond the local community. This is often counterintuitive to partners accustomed to the old resale paradigm in which preference is given to customers who are both lucrative and within easy reach. For some partners, this is an oversight they've learned the hard way.

"One thing I would do a better job of is to expand into new locations and other geographies more aggressively than we have," said Aminian. "We looked at that, but maybe we should have been more aggressive."

SERVICE SELECTION

Another key task associated with the transition involves making a decision on exactly which services the company should offer. In many cases, this process is guided by the current value proposition of the company. However, it is also extremely important to look at how the market is evolving and decide which services will gain in relevance as time goes on.

"There was healthy debate as to what types of services we should offer and how we could make our offer compelling, and do things in a way that made the transition natural, efficient and cost-effective for our customers," said Tony Safoian, CEO of Los Angeles-based Sada Systems, which focuses on cloud-related services. "And, of course, that is something that needs to continue to evolve over time. It is crucial to maximize the value of the service and the platform that underlies it."

After an initial transition into managed services, Safoian's company then extended the transition toward cloud-based services, beginning in the 2006 to 2007 time frame.

"After making a bunch of migrations happen in the cloud platforms we went back and asked ourselves how we could add value to those customers that we migrated on a continuing basis," he said. "So we looked toward managed [service delivered through the] cloud and cloud-related help desk, and other types of services. It's about letting the customer know that there are a lot of other things that you can do to make the cloud experience more effective and easier for the users."

In most cases, service selection is a relatively straightforward process that begins with an assessment of the partner's key talents, as well as other value propositions that it may be able to establish, either organically or through alliances. These capabilities are then compared with the business and technology needs of the customer, and how those needs are likely to evolve in the future. With both of these aspects clearly in mind, the necessary service line begins to take shape.

PRICING STRUCTURE

Establishing fees for managed services is a delicate balance between keeping the numbers within the range of the customer's ability, and pricing it high enough to avoid leaving money on the table. Rates are usually based on a given number per user, per month, with greater savings as additional seats are added to the equation and new services are added to the mix. Other criteria include the type of applications being offered and the degree to which those applications are mission-critical.

"When you look at the pricing models you have to look at the value that you're providing to the consumer, and what price maintains the margin moving forward," said Mark McCaffrey, global software leader at PricewaterhouseCoopers. "The pricing model has to identify your cost structure, and you have to understand the value of the customer relationship, and how that's going to look over a period of time, and how does that match to your costs."

McCaffrey predicts that the "freemium" model will become more prevalent as time goes on. The opportunity to receive a certain level of service free of charge and then expand to a fee-for-service after proof-of-concept is a compelling one for many customers. This strategy also provides a viable opportunity for customers to sample cloud-based services if they have not already done so.

"You can start with a limited number of seats, or limited functionality," said McCaffrey. "But you need to make sure that your efforts to limit functionality don't actually sabotage the sale by making the customer think your offering is too limited. If you get it wrong, they either do not like the functionality, or you give away too much and they don't need to make an actual purchase. And if you don't price it correctly, your ability to correct pricing later is very hard. If you price it too high, you end up lowering prices when you've already built infrastructure based on a higher price point."

In most cases, attempts to raise rates at the time of renewal will be resisted by the customer unless additional features are bundled into the mix. At that point, effective cross-sell and upsell strategies are critical.

WHAT'S AHEAD

As is often the case with predictions, it is difficult to assess whether the IT market of the future will be dominated by managed services and/or cloud services, and to what extent traditional customer premise equipment will remain in use. The consensus seems to be that it will be a long time before information technology goes the way of the power grid and is merely something accessed through a plug in the wall. Despite the advantages of outsourcing and cloud-based solutions, many customers will likely preserve control over their data by keeping many of their services in-house. However, it stands to reason that a growing percentage of data will continue to shift off-premise.

"We're going back to a situation where businesses have terminals and everything is going in the cloud," said Rein. "But it's often uncomfortable for businesses with mission-critical data to rely exclusively on third parties. Many of them will continue to leverage the earlier paradigm, meaning that a certain number of systems will remain on-site. At the same time, we believe that we can do it a lot more efficiently than they can, by taking capital-intensive equipment and partitioning it among many users. We also have highly experienced and highly trained IT professionals to support this effort."

The focus on cost containment, including the necessary investment in trained personnel, will play a big role moving forward. In addition, the march of technology likely will continue to drive investment toward Web-based solutions.

"I don't think traditional resale will ever really go away," said Aminian. "A certain number of companies will continue to rely on that. But I think when you look at software development opportunities, the new companies in this space are mostly focused on Web-based solutions as opposed to on-premise solutions.

"The longer you stay with this program and the longer you add to your portfolio and sign up new customers, the better your profitability becomes," Aminian added. "As time goes on, they become familiar with you, and you have a certain amount of stickiness in place that makes it easier to get the renewals."

In addition, Safoian believes the new model of managed and cloud-based services amps up the need to continually develop an offering and provide greater value to the customer.

"Recurring revenue becomes more and more important because it gives us a lot of financial stability and adds ongoing value to clients," he said. "It makes us fine-tune our services to the highest level in order to maximize client value and secure the renewals."

PUBLISHED APRIL 29, 2013